Not so long ago, we wrote a brief primer on Bitcoin to bring some clarity to those unfamiliar with cryptocurrencies. In the year since then, we’ve seen an incredible surge in awareness and availability of cryptocurrencies, spurred at least in part by the value of a single Bitcoin surging to a peak of nearly US$20,000.
One thing that hasn’t changed much is the messy combination of excitement, confusion, opportunity and greed that continues to characterize the cryptocurrency space.
With initial coin offerings (ICOs) generating lots of buzz in recent months, we figure it’s time to address this development in the crypto world to explain what it is and why you should be wary of the hype.
What is an ICO?
An ICO is a means of raising funds for a project, much like an initial public offering (IPO) is a means of raising funds for a business. But that’s where the similarities end.
With an IPO, a company sells shares in exchange for money, and those who buy the shares receive an ownership stake in the company. While rules vary by jurisdiction, an IPO typically occurs in a highly regulated manner, with mandated transparency in the form of a prospectus and clear recourse for buyers the event of fraud.
An ICO is an entirely different beast, as the tokens purchased in an ICO do not confer ownership. Instead, they give the buyer the right to a product or service that the issuer plans to offer in the future.
While many people buy into an ICO as an investment, betting on future appreciation of the cryptocurrency tokens, many issuers go to great lengths via fine print and disclaimers to avoid the ICO being portrayed as a financial security. Why? To avoid the regulatory burden – including the transparency and recourse – that comes with issuing a new security.
What’s all the fuss?
ICOs have been booming recently – especially since mid-2017 – and with this boom has come a surge of hacks and fraud incidents that have cost investors millions of dollars.
One of the key pitfalls of ICOs from an investor’s perspective is that there is virtually no regulation. Cryptocurrencies are typically anonymous and designed to operate across borders, outside the confines of national laws and regulatory structures. This raises two main concerns.
First, it is difficult to know who or what is behind a particular ICO. While ICOs are typically launched with a website containing information about the proposed project and the team driving it, it is difficult to verify the trustworthiness and motivations of the people involved. With ICOs booming, you can be sure that some of those behind new projects are simply aiming to get rich quick.
Second, there is little regulation around what an issuer must do to ensure its ICO is secure. So even if the team behind an ICO is honest and well intentioned, all it takes is one security vulnerability for millions of investor dollars to disappear into a digital abyss.
While there is currently little to no regulation of ICOs, this will likely change in the future – and we think that’s a good thing. Central banks, national finance ministries and other key regulatory bodies around the globe are busy examining the opportunities and risks related to cryptocurrencies, and sooner or later regulatory frameworks will emerge. Until then, however, this will remain a relatively lawless financial frontier.
Skepticism is key
When it comes to ICOs, your skepticism may be more valuable than the “investment” opportunity being offered.
Innovation is a wonderful thing, and there is undoubtedly a time and place for being a risk-taking early adopter. However, the world of ICOs is currently wild and lawless, so the potential to cash in on the next big thing must be balanced by the risk that you’ll be handing over your money to a con artist.
Based on the current ICO environment, we believe the risk is acute. If you’re a client with an opinion on this topic and would like to discuss it with us, please give me a call.