As the market capitalisation of crypto-currencies continues to rise (despite a 20% correction earlier this week), so too do the possibilities of what crypto-currencies can be used for. We have already seen the rise of the smart contract platform offered by Ethereum, which uses coding to define the movement of money through its decentralised system of nodes. Now, the exciting rise of the Initial Coin Offering (or ICO) is providing start-ups and existing firms with a new way to publically raise funds.
An ICO is similar in some ways to an IPO, but has several critical differences. Like an IPO, an ICO is made when a company wants to raise funds publically, in this instance through crypto-currencies.Â Companies will offer a new crypto-currency, a coin or token, for sale in an initial offering. The value these coins or tokens provide to investors differs dependent on the nature of the company and the ICO. However, as Forbes notes, the most common value of the new crypto-currency comes from a claim to the specific goods or services provided by the funded project. For this reason, the coins do not represent a security, but rather are a new asset class in themselves.Â
Why then are these tokens something special? One of the major reasons is the liquidity in the market. Once the tokens are listed on crypto-currency exchanges, they can be bought and sold similarly to any regular security from publically listed companies, in exchange for other crypto-currencies. This prevents one of the major issues with investing in start-ups, which is getting locked in. And although the tokens donât usually represent equity in the company, the prices of tokens change according to market perception of the company as well as the value of the goods and services that the tokens can be exchanged for. As Brian Evans, the founder of BDE Ventures notes, the average ICO receives returns of 1000% in their first year.
These ICOs arenât just beneficial for investors though, theyâre also beneficial to companies. As Michael Terpin (a regular investor and advisor for ICOs) stated in an interview with Forbes, one of the key advantages of this new system is that companies donât have to give up any equity. Since, in most cases, the tokens are linked directly to their products, the tokens become âa product with a resale valueâ.
However, the decentralised nature of the blockchain software platforms underpinning ICOs creates inherent risks for investors. The market is almost entirely unregulated, with only the incentives and disincentives from Ethereumâs self-fulfilling contracts acting as a guard for uninformed investors. Â Timothy Lea of the Financial Review refers to the market for ICOs as being reminiscent of the âcavalier, Wild Westâ, with scammers preying on the naive and greedy. As mainstream interest continues to rise in the benefits of ICOs, it is likely that governments worldwide will have to find new ways to regulate this burgeoning market.
In the US for example, the Traffic Monsoon case has indicated that ICOs may be governed (in the US at least) by regular US Securities legislation. A Federal Court in that case found that Traffic Monsoonâs Tokens (Adpacs) were a security, and that although 90% of the purchases were by international investors, the SEC was able to enforce US law as long as the sales had a substantial effect in the US (ICOâS: Where the SEC Might Stand, Coindesk). It will be interesting to see how this case develops on appeal in higher courts, and the international influence it may exert over future decisions on how ICOs will be regulated in other countries.