The Wild West of Initial Coin Offerings

February 11, 2018

Companies are taking advantage of the new cryptocurrency trend to raise capital through a new kind of investment. Initial Coin Offerings, or ICOs, have allowed companies to raise almost $3.7 billion through investors, some at a breakneck pace such as the Useless Ethereum Token Project that raised more than $40,000 in just three days.
The noteworthy use of ICOs by companies, as well as the considerable interest in ICOs by investors, is due in part to the lack of regulation by the SEC. The SEC provides consumer investor protection by regulating the trade of securities. Currently, ICOs are not recognized as securities and the SEC has not set forth any regulations for them, resulting in “substantially less investor protection than in… traditional securities markets.” The SEC maintains that ICOs are not securities and can not be regulated due to the variances in markets that they can be traded on, including international exchanges.
The risk for investors is building as companies are using ICOs where the coins (or “tokens”) that are being offered have little to no value of their own, and the companies are built on ideas with no actual assets. While some of these companies may be just bad investments, other companies release an ICO based on thin “white papers” that include very little information about themselves or the project. In addition to these scams, ICOs are susceptible to security breaches and theft. Additionally, hackers are targeting ICO investors. Phishing is a hacking technique that hackers use to trick investors into revealing personal information used to steal their money. Phishing is being used with ICO opportunities where the companies do not have to divulge the information typically available in SEC reports.
Recently, however, organizations have begun to push back on the wild west of ICOs. In December, the SEC stopped an ICO due to the company’s coins being considered a security, requiring regulation similar to an Initial Public Offering (“IPO”). The SEC in January also stepped in to stop one of the largest cryptocurrency mobile system ICOs alleging that it was a scam. The ICO, which had raised $600 million, was not registered with the SEC as a securities transaction, included several false claims and omitted multiple disclosures in communications to investors. Facebook has also taken action to protect its users by banning ads for companies offering ICOs in a policy that:

“Prohibits ads that promote financial products and services that are frequently associated with misleading or deceptive promotional practices.”

There are ICOs that offer a viable investment opportunity. Because they are not regulated by the SEC and do not have to comply with reporting requirements, it takes a little more due diligence to avoid fraud and identify the ICOs with potential upside. The underlying technology in cryptocurrencies and ICOs, blockchain, is a powerful tool and it is possible for companies to leverage its power to create valuable investments.
While the United States has not yet established ICO regulations, other countries have taken more affirmative steps. The Japanese government recognized bitcoin as legal tender in 2017, but have recently issued warnings concerning ICOs as they can be extremely risky investments, if not complete scams. On the other end of the spectrum, China has already banned cryptocurrencies and ICOs, and is working to incorporate a firewall to block internet access to any domestic or foreign services for ICO exchanges. The UAE’s regulating body, the Securities and Commodities Authority, has taken a similar stance as the SEC by not recognizing, regulating, supervising ICOs, although they have just issued a warning to investors against fundraising through ICOs due to their volatility.