The ICO
In earlier post we compared the current hype with the gold rush. Today we are touching another aspect of blockchain: the Initial Coin Offering.
The basics
Initial Coin Offering is, analog to its traditional sister concept, the Initial Public Offering, a crowdsale of a financial instrument. However, this is where the similarities end. While an IPO is a regulated offering of (usually common) stock to the organized market, the ICO is more of a Kickstarter-type of money raising, usually with a candy in the form of hopeful future dividends and/or capital appreciation of the tokens issued.
The slow response of the regulators has created a legislative void for the first truly democratic start-up financing. The ICO market is ruled by the ruthless Darwinism on both sides, start-ups and investors themselves. New projects are introduced daily, with high hopes of changing the world, but with little hope to actually succeed. On the other side, however, stands absolutely no investor protection. There are zero guarantees that the people running the ICO will not cash in and send postcards from the Caribbean. Many have been burned and even more will be, but also in the meantime helping set up few projects that might actually change the world.
Regulator position as of today
Recently the US Security and Exchange Commission issued an opinion (https://www.sec.gov/news/press-release/2017-131) that the now infamous DAO tokens were considered a security. A closer look at the whitepaper (https://download.slock.it/public/DAO/WhitePaper.pdf) reveals why: token holders received proportional ownership and voting rights, a dividend, and the minority enjoyed some protections against majority exploits. What DAO did differently, besides uniquely solving the Principal-Agent problem with what were basically periodic shareholder meetings, was to avoid the use of Dollars. The SEC saw directly through it, and issued the aforementioned opinion implying that changing a letter in the abbreviation does not change the rules companies have to play by. It is, however, to be noted that the US is ahead of other jurisdictions. In India, for example, the regulatory bodies are shifting responsibility to each other, with the Reserve Bank of India considering crypto currencies commodities, which are regulated by the Exchange Board of India, and it treating them as money, in turn overseen by the Reserve Bank of India, making ICOs a particularly grey area not likely to be cleared anytime soon.
The SEC opinion was the moment when the ICO model dropped equity-like tokens and started considering utility tokens. The legal risk is smaller – a utility token is conceptually the same as an in-game currency (with the only difference being the variable exchange rate), where the legislation is developed and pretty clear regarding the use, issuance and spending of the tokens. This is likely to curb outright fraud, but not likely to offer equity market-like investor protection and legal recourses against the scammers.
ICO as venture financing
The median amount raised in an ICO is about 2 millions, rivaling the capital raisings of the initial seed rounds in traditional venture capital financing (https://www.smithandcrown.com/token-sale-market-performance/). An argument could be made that the token crowdsale is displacing the traditional forms of capital raising, this position is not supported by the lack of transparency in some projects, limited regulatory oversight, and limited investor due diligence. These conditions have created an environment, where some valuations are fueled by the fear of missing out rather than careful consideration of the project’s merits and market potential. This combination of factors have given rise to projects that could be implemented perfectly fine with an Excel table, but because an ICO is more profitable, they are done through distributed ledgers.
How to spot a scam: a case study
Plexcoin is a well known scam, catching so much attention, that the Autorité des marchés financiers (Quebec financial regulatory body) issued a warning to potential investors and a cease and desist order for the territory of Quebec (https://lautorite.qc.ca/en/general-public/media-centre/news/fiche-dactualites/monnaie-virtuelle-plexcorps-plexcoin-dl-innov-inc-gestio-inc-et-dominic-lacroix-sont-vises-pa/). Besides a fancy webpage, the project delivers nothing of value. The red flags include:
Misuse of Visa logo
No team names, history
The website uses Domains By Proxy, allowing actual owners to remain hidden.
No whitepaper until AFTER the pre-purchase and refunds only allowed WITHIN the pre-purchase (Plexcorp claims the reason is the trade secrets of their revolutionary technology).
Poor product description, even in the later published whitepaper, no technical summary, just nice-sounding phrases with an occasional “blockchain”, “distributed ledger”, “revolutionary”, “world-changing” etc.
Presence of either online bots or paid trolls, parroting the same answers to doubting questions, introducing themselves as Professor Anton De Mel (https://www.quora.com/Is-PlexCoin-legitimate).
Remember, if it seems too good to be true, it probably is.