In the Western countries, Initial Coin Offerings (ICOs) have emerged as a popular new form of fundraising.
The first ICO of note took place in 2014 with the launch of Ethereum. Its coin, Ether, is now the second most valuable coin in the digital currency world. Ethereum is a platform that allows developers to easily and quickly build blockchain products such as smart contracts. More recently in September 2017, Protocol Labs completed an ICO raising of over $257 million for a blockchain data storage network Filecoin. So, many of you may wonder, what is ICO and how is it being regulated?
What is an Initial Coin Offering (ICO) and how does it work?
In ICOs, cryptocurrencies (commonly referred as ‘coins’ or ‘tokens’) are created and sold for a traditional currency (ie: USD or Pound), or more commonly, for another widely used cryptocurrency (ie: Bitcoin or Ethereum). ICO refers to a method of selling participation in an economy, giving investors access to the rights of a future product/service, or share of returns from the project or new cryptocurrency ventures. In contrast to an initial public offering (IPO) which investors buy shares in exchange for the ownership of the company, in ICO, investors buy ‘coins’ of the company, which can appreciate in value if the business becomes successful in a later date.
When launching an ICO, companies publish what is known as a white paper, which outlines the token’s characteristics, any potential problems and solutions, the team and the token deployment plan.
Investors are given a chance to read the white papers and ask questions before investing.
- Investing in ICOs is analogous to investing in a new, innovative technology. Every single ICO is established to revolutionise an industry in one way or the other. A careful analysis of ICOs could help investors get on board to the right startup, and get huge returns when the emerging technology matures and becomes widely accepted.
- For businesses seeking to raise money via ICOs, cryptocurrencies provide a means of raising large amounts of money quickly, and without the need to undergo share dilution. It can also raise these funds with speed and ease; companies do not need to put themselves through the usual lengthy and costly processes applicable to an IPO process.
- ICOs follow the limited supply-demand principle, allowing their coins to gain value in the future. Its initial investors could leverage the economic prominence of the principle, increasing their chances of profiting exponentially.
- Unclear legality and lack of regulation: ICOs are largely unregulated and the legalities surrounding them are not clearly defined. For example, in Malaysia, ICO is unregulated and this means lack of investor protections. Although it was earlier reported that Bank Negara Malaysia (BNM) planned to unveil guidelines on cryptocurrencies by the end of this year, no guidelines have been issued by BNM so far. Looking at different jurisdictions, China’s central bank and South Korea have banned all ICOs. In Singapore, ICOs are allowed to be carried out in accordance with the Monetary Authority of Singapore (MAS)’s guidance on how the tokens should be applied under its securities laws. In the US and the UK, where the substance of a coin represents, for example, a right to share in profits and to vote on business matters, the coin is likely to be seen as functioning like a security, and the ICO will be regulated in the same manner as an offer of the traditional form of such securities.
- Volatility of the market and price: Returns in investment are no guaranteed as the price of the token rises and falls with market forces, responding both to the value of the underlying service and to market speculation. Recently, on 13 November 2017. the European Securities Markets and Authority published a statement highlighting the ICO risks for investors and firms.
- Security: “Wallets” are virtual bank accounts where the tokens/coins are stored. If user forgets his password of his wallet or the account is being hacked, then the funds are lost forever. For example, although the DAO raised $150 million through ICOs, a hacker was able to drain Ether to the value of $50 million out of DAO system.
In short, investors should take note that ICO scheme operators currently do not have a presence in Malaysia. Hence, it would be difficult to verify the authenticity of the scheme and the recovery of foreign-invested monies may be subject to foreign laws or regulations.