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Initial Coin Offerings: Devil’s Spawn or Inevitable Future?

 6 min read / 

Initial Coin Offerings (ICOs) have become the ‘weapon of choice’ for many startups looking to fund themselves and generate hype and interest from the crypto community. While they might be a much easier way to generate cash compared with more traditional methods, there is no elaborate regulation (as is the case with its more developed relative, the IPO), nor is there the scrutiny involved in attracting venture capital, this current regulatory limbo comes with its own pros and cons (pun intended on the latter). The word ICO is now often regarded as a synonym for fraud and deception. So there’s a natural conclusion: regulation is needed to return confidence and allow good faith firms the opportunity to follow through on their promises of disruptive technologies and ideas.

ICOs, at their core, offer investors the chance to trade established cryptocurrencies, such as bitcoin or ether, for a new one. The popularity of the services which any new token enables will be the main driver of its value. Based mostly on the Ethereum blockchain and the ERC20 smart contract, ICOs often promise revolutionary and disruptive technological advancement. An excited crypto community often hypes up the latest offerings and their associated promises of progress. All ventures come with inherent risk, but the Wild West nature of the crypto landscape means that there is more opportunity for malicious actors to take advantage of the over-enthusiastic and the under-informed.

How ICOs Got a Bad Name

The most obvious danger of an ICO is the exit scam. The team offering a new coin, armed with a reasonable-looking white paper, established social media presence, and a legitimising marketing budget, gets a lot of promotion and investment. Instead of using the money to build their project, hard work by anyone’s standards, the team just disappears with all the money, never to be heard from again.

There have been several notable examples of the exit scam. Benebit, which advertised itself as a Blockchain technology bringing together a user’s customer loyalty programs in one place, was one of the most prominent. When the facade of the team began to fall apart, after they were found to have used stolen photos and fake passports details, they fled with over $3m. LoopX was even bigger: the team exited stage left after pocketing $4.5m in funding. Confido pulled the same trick, walking away with $375,000. Giza managed to stick around and raise more than $2.4m before disappearing. And this is not an exhaustive list.

PonziCoin was set up as a deliberate fraud. Its website was pretty obvious about it. $500,000 was still sent to the company. To the surprise of all, the founder bolted with the cash.

Exit scams are not the only risk investors face. Venture capital fund DAO’s ICO was targetted by hackers. They exploited vulnerabilities in the ICO smart contract to make away with 3.6m ether. These vulnerabilities were known beforehand, even being highlighted in the New York Times, where investors were advised to stop sending money to DAO.

Regulations are loose in the ICO market. Investors have to be able to trust the teams or individuals they back. Trivial oversight means that there is no legal recourse when scams do occur. No agreements or obligations, apart from a smart contract on the blockchain, are in place. The blockchain is designed to be a trustless technology, yet trust is still an intrinsic part of any transaction.

Gresham’s law states that “bad money drives out good”. Fake and fraudulent ICOs are driving the perception of the funding method. Likely legitimate ventures are at risk of being unable to generate the means to develop their ideas and technologies. Having to use weasel words to describe projects which look genuine shows the effect these scams are having in the market: they have undermined trust in all ICOs.

What Regulations Are in Place

Of course, action has been taken to restore investor trust and belief in ICOs. Right now, however, only the most obvious ones seem to be targeted, like the PlexCoin offering, which was halted in late 2017 by the US Securities and Exchange Commission (SEC). The assets of Dominic Lacroix and Sabrina Paradis-Royer, the heads of PlexCorps, were frozen by the SEC after it determined the promised returns of the investment were unachievable and that such claims were tantamount to fraud.

Regulations have been introduced in some territories to help grow confidence in the market as a whole. Gibraltar became the first place to introduce regulations aimed at ICOs, and the territory remains welcoming to blockchain companies. These rules, where underwriters have to ensure that ICOs disclose proper information and the companies behind them comply with financial rules, are relatively light. Any rules put in place, though, makes for a better environment than the unregulated chaos of before. Light regulation may put off chancers looking to make a quick and easy buck. For the determined scammers though, more extreme steps may be needed to dissuade them. This has led some countries, like South Korea and China, to ban ICOs outright.

There are attempts from other countries to tread a middle path, stricter than the permissive attitude of places like the Isle of Man or Mauritius, though not going as far as the Far Eastern nations. The SEC is interested in providing tighter regulation on ICOs operating in the US. Firms offering ICOs are being reminded that existing rules do still apply to them. Hong Kong’s Securities and Futures Regulator has taken a similar measure and has written to exchanges warning them not to trade in tokens which could be seen as securities. Japan’s Financial Services Agency only allows exchanges to operate with approved coins, though the approval process is relatively painless. While a good first step, more will need to be done than delivering a sternly-worded letter.

Possible Futures

Dutch proposals to regulate ICOs were recently released by Netherlands finance minister Wopke Hoekstra. They included a ban on advertising to ordinary consumers, an approach already embraced by the likes of Twitter and Facebook. In addition to this, the proposals included increasing credit card protections for consumers who buy cryptocurrencies with them, making exchanges and startups launching ICOs register with the financial authorities, and ensuring anti-money laundering rules are followed. Increased regulation is seen as a necessary reaction to the emergence of cryptocurrencies. There’s obvious interest in the space, so neither of the extremes (no regulation or flat-out bans) will work long term. Mark Carney, Governor of the Bank of England, has called for cryptocurrencies to be better regulated, rather than outlawed completely.

For the good of the crypto-community overall, rules must be in place to restore trust. If the blockchain is going to revolutionise the world as its advocates promise, then action needs to be taken to protect both industry players and investors.

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