By: Florian Uffer

In an Initial Public Offering (“IPO”), a private company or corporation offers its stock to the public for the first time.[1] The main goal behind going public usually consists of raising capital for different purposes, such as expansion.[2]

The drastic rise of cryptocurrency over the past five years, showcasing an increase in market capitalization of 190.27%,[3] has brought a similar animal into existence: the Initial Coin Offering (“ICO”).

Because ICOs are set in the world of cryptocurrency, a brief introduction to it is needed. Cryptocurrency is an electronic cash system which does not rely on banks or third parties to verify transactions.[4] Rather, transactions are recorded on a blockchain, a digital ledger.[5] This blockchain is used to confirm upcoming transactions, thus enabling direct peer-to-peer payments.[6] As of today, there are three main types of cryptocurrency.[7] First, Bitcoin is a digital currency which can be exchanged among people.[8] The second type, Altcoins, usually are alternatives of Bitcoins with minor changes.[9] Third, tokens reside in their own blockchains and represent an asset or utility.[10]

Just like IPOs, ICOs act as fundraisers of sorts.[11] Interested investors buy in to the offering, and receive a new token specific to the ICO as consideration.[12] The company holding the ICO then uses the raised funds to pursue the respective investment it had in mind.[13] ICOs come with unique advantages and risk of which the investor should be aware.

One of the more obvious advantages of an ICO lies in the volatility of cryptocurrency: in this high-risk/high-reward setting, an investor may be able to realize stellar profits. Additionally, ICOs do not require much paperwork,[14] which reduces the administrative costs. All that is needed is a “white paper,” which describes the project and thus is the primary tool used by investors to decide whether they wish to invest or not.[15]
In considering the dark side, it becomes apparent that ICOs are based on pure speculation.[16] The volatile nature of cryptocurrency combined with the extremely low amount of financial information[17] that is available to investors give rise to an unpredictable financial environment.

The major issue arising out of the lack of paperwork inherent in ICO are scams: a 2018 study reported that about 80% of ICOs were fraudulent.[18] The Securities and Exchange Commission (“SEC”) manifests these concerns on its website: “While [cryptocurrencies] and the technology behind them may present a new and efficient means for carrying out financial transactions, they also bring increased risk of fraud and manipulation because the markets for these assets are less regulated than traditional capital markets.”[19]

Regulating the ICO market offers numerous advantages. First, increased investor protection would ensue. Requiring more disclosure from ICO offerors and thus ensuring a more consistent financial environment would drastically reduce the rate of scams and thus promote the market for ICOs.[20] Heightened disclosure requirements would also minimize the use of ICOs to raise money for illegitimate purposes, such as money laundering or terrorism funding.[21] Finally, regulation would increase the certainty of investment in the space, and consequently attract more investors.[22]

The market for ICOs however, remains yet to be thoroughly regulated. Due to the revolutionary concept behind cryptocurrency and its technologically advanced nature, relevant U.S. regulatory agencies have found it difficult to rightfully assert jurisdiction over it. In a hearing before the House Committee on Appropriations however, SEC Chairman Jay Clayton addressed the SEC’s view on ICOs. The SEC views tokens as generally falling within the realm of securities.[23] Because tokens are the financial assets involved in ICOs, it seems that the SEC is in pole position to regulate this market in the future.

 

[1] See Initial Public Offering – IPO, Investopedia, https://www.investopedia.com/terms/i/ipo.asp (last visited Oct. 25, 2018).

[2] See id.

[3] See Visualizing The Meteoric Rise Of Cryptocurrency in the Past 5 Years, HowMuch.net, https://howmuch.net/articles/top-10-cryptos-past-5-years (last visited Oct. 24, 2018).

[4] Adam Levy, What is Cryptocurrency?, The Motley Fool (Mar. 11, 2018, 7:15 AM), https://www.fool.com/investing/2018/03/11/what-is-cryptocurrency.aspx.

[5] See id.

[6] See id.

[7] See Ray King, Understanding the Different Types of Cryptocurrency, Bitdegree (Sept. 17, 2018), https://www.bitdegree.org/tutorials/types-of-cryptocurrency/#The_Three_Main_Types_of_Cryptocurrency.

[8] See id.

[9] See id.

[10] See id.; Definition of Crypto Token, Investopedia, https://www.investopedia.com/terms/c/crypto-token.asp (last visited Oct. 25, 2018).

[11] See Initial Coin Offering (ICO), Investopedia, https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp (last visited Oct. 25, 2018).

[12] See id.

[13] See id.

[14] See Ameer Rosic, ICOs Pros & Cons. Cutting Through the Noise, Huffpost (July 4, 2017, 8:02 AM), https://www.huffingtonpost.com/entry/ico-pros-cons-cutting-through-the-noise_us_595b7f22e4b0c85b96c6646e.

[15] See id.

[16] See id.

[17] Investors usually are only able to consider the ICOs’ “white papers” in making an investment decision, as it is the only paperwork arising out of the ICO. See id.

[18] See 80% of ICOs are Scams : Report, Investopedia, https://www.investopedia.com/news/80-icos-are-scams-report/ (last visited Oct. 25, 2018).

[19] SEC, Initial Coin Offerings (ICOs) (2018), https://www.sec.gov/ICO.

[20] See Thijs Maas, Why ICOs Need to Be Regulated, Hackernoon (Oct. 17, 2017), https://hackernoon.com/why-cryptocurrencies-and-tokens-should-be-regulated-349b920b62c8.

[21] See id.

[22] See id.

[23] See FY 2019 U.S. Securities and Exchange Commission: Hearing Before the Comm. on Appropriations (2018) (statement of Jay Clayton, Chairman, Securities and Exchange Commission).  

Image Source: https://www.sec.gov/ICO