A friend of mine, a big fan of the Harry Potter series, recently planned to launch an Initial Coin Offering (ICO) to fund a new Quidditch sports league. Its new “Quid coins,” valued at 0.009 bitcoins (BTC), would be redeemable for discounted tickets and food at select national Quidditch matches across the country. He was hoping to raise a maximum of 2,000 BTC ($ 11,000,000) during a 28-day offer period.
Unfortunately, before my friend could organize his business and raise funds, he found out that a group in Britain was offering their own Quid Coins, named after the slang word for the pound sterling. Although my friend was disappointed that they had adopted the name, perhaps it was for the best; Despite lenders’ hopes, Quid Coins traded for less than three months in 2014, according to Coin Market Cap.
ICOs promise big returns for investors, but with an issue like Quid Coin possible at any time, is the risk worth it? If you are considering participating in an ICO, here is what you need to know.
What is ICO funding?
Historically, entrepreneurs have funded their ideas by offering shares, or investment securities, in their businesses to outside investors. Due to financial abuse and corruption in the 1920s, Congress passed the Securities Act of 1933 and created the Securities and Exchange Commission (SEC) the following year to enforce the law.
Over the decades that followed, the process of raising funds from the public through an initial public offering, or IPO, was consolidated. Regulations dictate how the bidding process should play out, who is eligible to participate, when a bidder should provide information to potential investors, and what information they should provide. Failure to comply with regulations may result in serious financial liability for the Sponsors of an Offer, including civil and criminal penalties.
An ICO is a similar fundraising tool in which a bidder sells futures contracts in a cryptocurrency that does not yet exist. ICOs are designed to bypass regulations that protect investors when buying or selling traditional investment securities. While an IPO must include a long prospectus, there are no regulations outlining what information must be provided to potential investors in an ICO. Each bidder determines what details, if any, will be delivered and when.
Most ICOs have a website or white paper that justifies the benefits of the investment, but they don’t have an existing product. The bidders are start-up operations and the funds raised through the ICO will finance the development of the product, in this case the cryptocurrency.
Potential investors in an ICO should recognize that a cryptocurrency is different from an investment security, such as common stocks or real estate. Regulators cannot classify a digital coin or token as an investment security at all, but rather as a simple contract between two parties. In 1936, the Supreme Court decision in SEC v. Howey Co. has established a test to determine what is and what is not an investment guarantee. According to the test, an investment contract is a guarantee if:
- It’s an investment of money
- There is an expectation of return on investment.
- The investment is in a joint venture.
- Any profit comes from the efforts of a promoter or a third party; profit is out of the investor’s control
Before ICOs, entrepreneurs sought venture capital from friends, family, and sophisticated venture capitalists who could assess the business prospects of the product or service to be produced. An ICO allows an entrepreneur to bypass traditional funding sources and obtain funding from less informed and less discriminatory members of the general public looking for a track from the next Facebook or Google.
To avoid regulatory scrutiny, some ICO sponsors choose to use an “accredited ICO” to take advantage of exemptions from SEC registration requirements. For example, under Regulation D, a business can raise an unlimited amount of money if it meets the following standards:
- Limit on the number of investors. The law distinguishes between investors based on annual income or net worth, and those with higher income or net worth are considered to be better able to value an investment appropriately. A person with earned income greater than $ 200,000 (or $ 300,000 with a spouse) in each of the preceding two years and net worth of more than $ 1 million (excluding residence) is called an “approved investor”. Bidders can sell their securities to an unlimited number of accredited verified investors.
- General ban on solicitation. A bidder cannot use publicity or general solicitation to market a reputable ICO. However, they can solicit and widely disseminate the offer if all potential buyers are qualified investors.
- Disclosure Information. An Offeror can decide what information to give to accredited investors, as long as it does not violate anti-fraud prohibitions in federal securities laws.
- Access to the management of the company. Bid managers should be available to answer questions from potential buyers.
- Financial situation requirement. Audited financial statements are required if available.
- Limits on resale of securities. Any currency purchased under an exemption from Regulation D is limited to sale for one year after purchase, unless it is registered with the SEC.
Only a small minority of current ICOs are accredited, largely due to expense, preparation time, and information requirements. Accordingly, every investor in an ICO should be able to judge whether the funded project makes sense as a business, whether the experience and knowledge of the directors justifies the trust, and whether the completion of the project is likely to become a viable and successful project. growth. before you invest your hard earned dollars.
In other words, will the coins or tokens reasonably deliver something that is lacking or desired in the market for which the public, or a significant portion of the public, is willing to pay? Would you be willing to use the coins as currency or to make a one-time profit that would not be available otherwise? Are you considering investing in the hope that later on someone will buy your investment for more than its cost, even if you don’t know how it works or why someone would use it? If so, it is speculation, not investment.
Risks of an ICO investment
Initial coin offerings have exploded since the first Mastercoin offering in 2013. ICO backers raised over $ 1 billion for startups in 2016, $ 5.6 billion in 2017 and over $ 1 billion in during the first two months of 2018.
Supporters of ICOs claim that the technology is changing the way startups raise funds. An ICO costs less, is often faster than relying on venture capital firms or banks, and keeps decision-making and capital ownership in the hands of the founders. Proponents claim that ICOs are “a democratizing financial force that provides capital for projects that are unlikely to obtain it from established sources, such as banks or venture capital firms,” as the magazine puts it. WIRED.
Reviews focus more on the potential drawbacks. CNBC reports that Elliott Wave stock analyst and theorist Elliott Prechter wrote in a July 13, 2017 newsletter that “[the] price activity and manic sentiment that has led to current prices [ bitcoin] have even eclipsed the tulip craze of almost 400 years ago. The success of [b] itcoin has spawned over 800 clones (altcoins) and counting, most of which are pumping schemes and high-tech dump. ”
If you are considering participating in an ICO, you should be aware of the following risks.
1. Probability of failure
The lack of understanding and skepticism about digital currencies, combined with the inability to accurately assess the likelihood of long-term success, results in a high failure rate for new coin offerings. Fortune Magazine reports a 59% failure rate for 2017 transactions in the first half of 2018, with losses totaling $ 233 million.
2. Illiquidity and volatility
Cryptocurrencies are incredibly volatile and have limited liquidity, or the degree to which an asset can be bought and sold quickly without affecting its price. Cryptocurrencies like bitcoin are designed not to be liquid, instead focusing on value.
Additionally, cryptocurrency prices fluctuate wildly, with major buy orders increasing bids and sell orders causing bid prices to fall. This volatility prevents them from becoming a conventional payment system.
3. Uncertain value
On May 22, 2010, Laszio Hanyecz made the first bitcoin transaction by buying two pizzas from Jeremy Sturdivant for 10,000 BTC. At the time, that was equivalent to $ 100. Today, the same coins would be worth around $ 60 million, which leaves one wondering:
- What was the quality of the pizza?
- Why would a sane person use or accept an asset with such volatility in a business transaction?
In order for an asset to have real value, someone has to have a use for it. Since bitcoin is not widely used or accepted for payments, it is of less value than other more accepted currencies.
4. Lack of supervision
The lack of regulation or professional oversight of cryptocurrencies opens the door to fraud. Steemit, a high-quality content site initially funded by an ICO, posted a tongue-in-cheek article titled “How to Create an ICO Scam in 5 Easy Steps,” which is both humorous and oddly precise.
As the Harvard Business Review puts it, the ICO market has seen “its fair share of scams, pumps and dumps, and blatant Ponzi schemes.” The SEC filed fraud charges in September 2017 against two ICOs, REcoin and DRC, operated by California businessman Maksim Zaslavskiy. Zaslavskiy criminally claimed that the operations were fully functioning businesses with staff, lawyers and retail relationships. According to the SEC, promotional literature for REcoin and DRC claimed that the coins were backed by real estate and diamonds purchased respectively with $ 2-4 million in internal investment, although only $ 300,000 was collected and that there was no real estate or diamonds. Although the criminal charges have yet to be resolved, the presiding judge called Zaslavskiy’s conduct a “flagrant misrepresentation.”
Even though this is not fraud, investors should be careful of:
- Regulatory uncertainty
- High valuations and overcapitalization
- Lack of investor control over finances, strategy and operations
- Lack of business use cases
Lack of supervision also makes stupid and impractical ideas possible. Dogecoin (DOGE) has a market cap of nearly $ 119 million, but Dogecoin creators Jackson Palmer and Billy Markus admit they created the cryptocurrency without much thought or effort, let alone a master plan. Users have no real way of exchanging Dogecoin for goods and services except to “tip” other Dogecoin enthusiasts when they do something cool or fun, which brings us back to about the questionable value of cryptocurrency.
Should you participate in an ICO?
Investment professionals are entering the ICO market to capture their share of the good times and the easy money before they’re over. The Autonomous website found 251 existing hedge funds that invested in ICOs in mid-2017, while Hedge Fund Alert had 62 other open ICOs.
Should you invest in an ICO? It depends. Consider the following statistics compiled by Mangrove Capital Partners:
- Blockchain projects are dominant in ICOs. The largest ICOs, those over $ 10 million, focus on services to support the blockchain economy or the financial services industry. Any coin offering that is not blockchain-based should be carefully assessed to determine its viability.
- Most companies that use an ICO to fund their operations don’t have a product before the offer. In other words, ICO buyers buy start-ups similar to venture capitalists, with a low probability of success for a specific currency. Most venture capitalists diversify their risk by investing in many companies or currencies.
- The most successful ICOs already have a base of venture capital investment. An ICO with a group of professional investors has probably been carefully analyzed and found to have an above average probability of success.
- The average return on ICOs through mid-2017, including those that failed, was 1.032%. In the second and third quarters of 2017, the amount of funds raised through ICOs was more than four times the amount raised through traditional venture capital ($ 2.08 billion versus $ 507 million). Even bad business can make money if you are nimble and not overly greedy.
Reasons to invest in an ICO
The potential returns from an ICO investment can be staggering. According to Quartz, the average price increase of the three top performing cryptocurrencies (Ripple, NEM and Ardor) in 2017 was 27.556%. An investment of $ 100 in each of these in early 2017, for a total investment of $ 300, would now have a market value of over $ 7.4 million.
Regulators around the world are exploring the best way to civilize the cryptocurrency markets. Ten countries, including China, have banned ICOs and threatened severe penalties for those who continue to participate in the market. Other countries, recognizing the potential value of blockchain technology and the benefits of the new funding mechanism, are poised to regulate the technology rather than destroy it. Ridding the industry of fraudulent players will increase the likelihood that ICOs will become mainstream and have more market participants.
Reasons to avoid an ICO
There is no doubt that the cryptocurrency bubble will eventually burst. The unregulated ICO market encourages a dangerous mix of quick cash promoters, scammers, and unsophisticated investors ill-equipped to assess the underlying business proposition of an ICO.
The lack of liquidity of most cryptocurrencies is ideal for pumping and dumping systems, even when the coin or token has a legitimate purpose. Existing currencies and the exchanges they trade on have been the target of multi-million dollar hacks and thefts. Finally, investors who do not respect the security procedures required by their crypto-currencies will lose all or part of the value of their crypto-currencies.
Cryptocurrencies captured the imaginations of investors around the world, as did the dot-com frenzy of the late 1990s. At the time, virtually every business associated with the Internet was attracting speculators and investors. investors eager to profit from it. . The names Pets.com, Webvan.com and eToys.com will not be forgotten anytime soon by investors who suffered losses during the bursting of the bubble: over $ 1.755 trillion at the end of 2000 (over $ 3 trillion). dollars to 2017 dollars) on 280 Internet. stocks, according to CNN Money.
However, while some dotcom companies have failed spectacularly, the enthusiasm for the impact of the Internet was not misplaced. The number of messages sent by e-mail and online messaging eclipse physical mail traffic today, social media has changed the global culture, and online shopping is growing twice as fast as on-site shopping. Investors who selected the surviving Internet pioneers have enjoyed tremendous benefits. Many technologists believe that blockchain technology will have an even greater impact on businesses and the economy; The question is, which ICOs will survive the inevitable bubble burst?
There are unparalleled potential returns for those who watch and react quickly to market events and limit their cryptocurrency investment to no more than 1% to 2% of their portfolios. Remember that a winning lottery ticket also has a great ROI, but the 292 million non-winning tickets purchased for that same draw are worthless.
Do you own bitcoin or another cryptocurrency? If so, have you locked them up in hopes of getting a big reward, or have you used them for your daily shopping? Would you recommend cryptocurrency to aspiring investors?>