The last four years have seen the appeal of ICOs (Initial Coin Offering) skyrocket as an alternative to traditional fundraising methods.
An ICO is similar to an IPO, with the potential to raise significant funds very quickly. Successful ICOs have reported gains in value of between 100% and 500%. For investors, the temptation to maximise their investment therefore often overrides the careful consideration of the risk attached to backing such projects.
How does it work?
ICOs are increasingly popular with digital start-up companies. Initially, a stake of the business is sold to raise capital for a project. In exchange for digital legal tender (such as Bitcoin) investors purchase an allocation of “tokens” representing their investment in a business.
These tokens become functional currency once the ICO reaches its funding goal objectives and launches its product/service.
Like any capital investment, investors are motivated by the possibility that once a business is established and successful, their cryptocoin currency value will be higher than the sum they purchased it for at the project outset.
The term ‘Crowdsale’ is synonymous with ICOs. The “tokens” acquired are not sold as typical financial assets/securities, but rather as a ‘digital product’. This differs to ‘Crowdfunding’ where the funds raised are essentially donations from individuals who support a particular project or mission.
The risk to investors is that ICOs are not regulated and as a result, funds lost due to fraud are never recovered. The lack of regulation of ICOs avoids the costs associated with regulatory compliance and the use of financial intermediaries, making this attractive to certain cost conscious start-ups.
Cryptocurrency (such as bitcoins) can be quickly and easily transferred across geographical and jurisdictional boundaries. This inherently makes them difficult to trace. No central record of ownership exists in respect of cryptocurrency, and approximately 10% of all ICOs may be fraudulent.
In some jurisdictions like China and South Korea, ICOs as a funding method are banned entirely. This is because of the risks attached, lack of regulation and potential for economic instability due to the millions of currency which can be raised almost instantaneously.
In May 2017, an ICO for a web browsing platform reportedly generated approximately $35 million in under 30 seconds. This evidences the sheer scale which can be achieved through this funding mechanism.
ICOs and other avenues of cryptocurrency funding are a grey area at present and likely will become regulated in future. This may directly affect the perceived ‘benefits’ of an ICO. The cost and time spent to comply with regulatory requirements could reduce the advantages of an ICO over traditional funding methods.
At the end of January 2018, US regulators The Securities and Exchange Commission (SEC) intervened when Arise bank raised $600 million through fraudulently selling its own cryptocurrency.
The action was taken to “halt an ongoing, fraudulent and unregistered offering of securities and to protect investors who are being actively defrauded”.
This was the first case where a regulator had appointed an independent receiver to seize assets, to take steps to protect investors’ funds which had been acquired through illegitimate means.
This supports a broader crackdown on unregulated cryptocurrency and existing warnings from regulators about the rising use of ICOs. It indicates that this complex and contentious area is likely to be subject to further scrutiny in future.
When considering financial investment, it is always recommended to take independent advice from a financial adviser in order to protect your personal wealth and business interests.
For further advice please contact our Forensics team.