What is an ICO?
An initial coin offering (ICO) is similar to an initial public offering (IPO). In an IPO, a company’s shares of stock are sold to the public for the first time and the company becomes publicly traded. Similarly, in an ICO, virtual tokens called cryptocurrency are sold to the public to raise funds for a company. Both an IPO and an ICO are methods of fundraising for a company; but in an IPO, the buyer receives stock, and in an ICO, the buyer receives crypto tokens. Often, companies issuing ICOs are in the early stages of development.
But why would someone want to buy a crypto token?
A privately held company creates crypto tokens to sell to the public. These tokens carry some sort of value assigned by the issuing company. They may give the holder a right to future services from or products produced by the company, or may represent a share in the company. Some tokens are worth nothing at all until the issuing company develops further.
Businesses issuing an ICO might accept other cryptocurrencies, such as Bitcoin, in exchange for the company’s tokens. The company’s tokens differ from Bitcoin, however, because they are proprietary to that specific company.
Tokens are an attractive investment because they may be quickly traded on a public blockchain platform. Token holders may sell out of their investments much quicker than a traditional investment in early stage companies. However, tokens sold as part of an ICO are risky.
What are the risks associated with investing in ICOs?
ICOs are inherently extremely risky to investors. Many ICOs are unregulated and operate overseas. Investors need to be wary of “pump and dump” or Ponzi schemes. The SEC recently issued an emergency order to stop a fraudulent ICO scheme that raised over $15 million for PlexCorps. The company promised investors would realize a 13-fold benefit in less than 29 days.
But in reality, it may take months or years before an investor realizes benefits, and, in some cases, the investor may never see any return on their investment. According to the North American Securities Administrators Association (NASAA), potential investors should watch out for common red flags, including:
Guaranteed high investment returns: This is a classic sign of investment fraud. There is no such thing as “guaranteed” returns; value of tokens are dependent on the success of the company.
Unsolicited offers: ICOs are promoted aggressively on social media platforms. If an investor did not ask for information, the ICO could be a scam.
Offers that sound too good to be true: If it sounds too good to be true, then it probably is too good to be true. The claims about the ICO may be exaggerated or untrue.
Pressure to buy now: Investors should be wary about schemes that push them to act fast, as they don’t get the chance to do their own research and conduct a risk analysis.
Investors should be careful, do plenty of research, and read any documentation before investing in an ICO.
What are securities regulators saying about ICOs?
ICOs are a whole new territory, and everyone is watching to see how regulatorswill react. Regulators have been unsure how to regulate cryptocurrency, but are beginning to be more vocal about publicizing warnings about ICOs.
The SEC recently created a cyber unit to address this quickly emerging issue and other cyber-based threats and misconduct. In July of this year, the SEC issued a report about ICOs. More than once, the SEC Chairman has suggested that some ICOs will be considered securities and therefore will be regulated as securities.
In September, NASAA issued its annual enforcement report. In it, NASAA claims its members are watching cryptocurrency trading closely and will provide both education and enforcement to counter the threat to investors posed by this emerging market.
Regulators around the world are addressing ICOs as well. South Korea and China have banned ICOs altogether. Canada and Singapore are taking a similar approach to the U.S. by warning that ICOs may be regulated as securities.
Brian Edstrom is a Shareholder and Attorney at Avisen Legal, P.A. He brings to Avisen seven years of experience working for federal and state regulators.
Emilee Walters is a second year law student at the St. Thomas School of Law. Emilee is an Avisen Fellow exploring a legal career in business law.