What is an ICO?
The world of cryptocurrencies is continuously expanding, and it is showing no signs of slowing. According to the industry’s go-to crypto tracking website, CoinMarketCap, there are over 1,600 separate listings.
Sifting through all of these projects is no small feat, and to make matters more complicated, there are even more coins that are not even listed yet. This is because these projects might still be in a pre-trading stage known as an initial coin offering, or ICO.
As a recent development in the fundraising world, an ICO is a path that many new tech startups are choosing to pursue. Funds are raised for a new cryptocurrency, usually sold to interested parties in exchange for fiat currency or other cryptocurrencies such as ethereum or bitcoin.
When preparing for an ICO, a company will lay out its goals on a whitepaper which will include the project’s plan, the needs the project will fulfill, the cost of the venture, how many tokens (or shares) will be issued, the owner’s stake, payment method and the length of the ICO campaign. The company will then move forward with the offering, typically in several stages. A private sale, pre-sale and the public coin offering.
Private sales typically occur with little-to-no public advertising. These sales target high level investors who may even have a minimum ‘buy in’ that purchasers must fulfil in order to be involved. Private sales often give would-be investors a very generous discount on the cryptocurrency they purchase – sometimes even cents on the dollar.
Pre-sales are usually the first opportunity that public investors have to get involved in a new project. Most of the time, these also include a significant discount on the cryptocurrency being purchased, though not quite as much as during the private sale stage.
Public sales are the final round of sales before the product launches. This round is typically heavily advertised and may even include Airdrops or Bounties to further entice customers to get involved. Airdrops are essentially free cryptocurrency giveaways wherein customers must provide an email address or join a social media platform in order to be eligible for the Airdrop. Bounties are similar, though they might include social media sharing, writing articles about the company, or finding bugs in the program in order to receive some of the cryptocurrency.
Ethereum was arguably the most important ICO in history because it facilitates the creation of new blockchain applications, and in turn, new cryptocurrencies. Raising over 25,000 bitcoin, Ethereum made the ICO process easy for ambitious startups looking for a new way to raise funds.
Telegram, the popular messenger app, completed its ICO in late March 2018, raising $1.7 billion between only 200 investors. Telegram even chose to forgo the public sale of its tokens citing growing scrutiny of the ICO space from regulators.
EOS is another big ticket ICO. Unlike Telegram, the blockchain project offered a public sale of its tokens and no cap on the funds raised. Its ICO period also took place over a full year. The project was a point of significant controversy in the process due to its growing valuation and lack of product, though it finally wrapped up its ICO period in early June, raising a staggering $4 billion total. Shortly after, the EOS blockchain went live.
ICOs have gained a lot of attention, both positive and negative, from the sheer amount of money being raised and the incredible returns investors have seen in the process.
And with the incredible amounts of money being generated, the SEC has obviously taken notice.
Until recently, cryptocurrency purchasers were not technically "investors." Though many cryptocurrency projects promised purchasers significant gains, and in some cases, followed through with their promises, the crowdfunding strategy was caught in a gray legal area.
Following the high-profile hack of the DAO which nearly brought down Ethereum, and in turn, the ICO world, the SEC began scrambling to sort out some necessary regulation on the space.
Because cryptocurrencies exist in many forms, from a means of interacting with a potential blockchain product to a currency or an investment that can grow or fall in value, regulators have struggled to find a path that is fair to the companies and would-be participants.
In 2017, the SEC took on the DAO, a German project that fell victim to a hack which lost investors millions. The ruling in the case led the SEC to begin leaning towards the stance that many offerings should be considered securities, and must pass what is known as the "Howey Test." This term comes from a famous ruling from 1946, SEC vs. W. J. Howey Co. The takeaway from this case is this:
A transaction will be classified as a security if:
It’s an investment of money
There is an expectation of profit
The investment of money is a common enterprise
The profit comes solely from the effort of the seller or third parties
What does this mean?
Essentially, ICOs can be considered a security in the U.S., and those projects can be subjected to a higher level of scrutiny than those that aren’t. Everything from the promotion of the cryptocurrencies to actually investing in the cryptocurrencies must remain in line with securities laws.
One of the biggest takeaways from this ruling is that only accredited investors are allowed to participate in private and pre-sales. "If you have an ICO or a stock, and you want to sell it in a private placement, follow the private placement rules," SEC head Jay Clayton explained. “If you want to do any IPO with a token, come see us.”
While the public sale of a cryptocurrency is still being mulled over by regulators, many ICOs, such as Telegram, are choosing to mitigate their risk, allowing only accredited investors the opportunity to get in.
What are accredited investors?
Accredited investors are players who must meet certain financial requirements.
For individuals to meet these requirements, they must earn over $200,000 for two years straight before applying. Additionally, an individual may be accredited if their net worth exceeds $1,000,000.
For entities to become accredited, the company must possess over $5,000,000 in assets.
The purpose of these requirements is to protect companies and individuals from the inherent risks of investing in unregistered securities or private placements.
What’s next for ICOs?
Classifying cryptocurrency offerings as securities drastically changes the ICO landscape, removing the ‘little-guy’ from the playing field. Though the laws are in place to protect retail investors, critics suggest that it gives ‘big money’ a huge advantage.
While some suggest that the end of ICOs is nigh, others argue that regulations will actually help potential investors in the long-term.
ICOs are still a relatively new kind of fundraising and investing, and as the space grows, it will undoubtedly face new challenges. Scams and schemes have fueled a lot of negative publicity, but not all is lost just yet.
Some countries are taking extremely supportive regulatory measures, offering more leniency, even promoting supportive tax incentives to draw promising new companies and new sources of revenue into their jurisdiction. Like cryptocurrency itself, ICOs are still young and still have a long way to go.