There’s been a lot of talk lately about initial coin offerings, known as ICOs. Enthusiasts tout ICOs as the future of venture investing in the blockchain world.
“The precedent we’re about to establish will be the future of the entire sector. VC as an asset class has delivered good returns historically, but they’re locked up for five or 10 years and people aren’t happy with that level of illiquidity.” said Brock Pierce, chairman of the Bitcoin Foundation and managing partner of Blockchain Capital.
Despite that, the idea has its skeptics. We break it down.
Wait, so what is it?
It’s basically a source of funding for new blockchain-based business endeavors. When the decentralized network is created, the startup behind it can sell tokens early in the process for an amount based on what it thinks it’s worth at that stage, all in order to raise money for the continued development of that network or application.
ICOs are similar to any other investment and often likened to IPOs in that the investors hope to make good returns on their investments and in that the startups behind the ICOs are trying to raise money to grow their endeavor. It’s becoming more typical for startups to produce some sort of documentation that describes their background and plan for their initiative, according to Angela Walch, associate professor at St. Mary’s University School of Law and research fellow at the Centre for Blockchain Technologies at University College London.
A new investment vehicle? Big deal.
Revolution by democratization of course. ICOs allow entrepreneurs to raise money from retail investors – so any Joe Schmoe that wants that want exposure to the early stage ecosystem can diversify his investment portfolio. (Okay, not just any interested investor, but more on that in a sec.)
Also, the tokens are liquid assets. You can convert them to cash or other cryptocurrencies quickly instead of having your money tied up for a number of years.
“The problem most startups have is a general lack of liquidity and all the market ecosystem participants are negatively impacted by that lack of liquidity,” Pierce said. “If you’re an early founder, the likelihood of being able to sell any of that stock prior to the business becoming very successful or very large is low.”
Sounds kinda sketchy…
There’s been a lot of debate about whether the tokens sold in an ICO legally constitute securities. There are different ways you can structure them to make them look more like a security, or less. The Securities and Exchange Commission hasn’t issued any formal guidance on crypto-tokens as securities. Regulators don’t typically jump in to regulate new business concepts and technologies when they haven’t had significant traction done any “real” harm, said Carol Van Cleef, a partner at law firm Baker & Hostetler LLP.
“In such circumstances it becomes increasingly difficult for policy makers not to pay attention to how current laws may apply and consider what steps, if any, they need to take,” Van Cleef said.
There are many unknowns: are the people buying these tokens considered investors under the securities laws? That would depend on whether the token is determined to be a security. Is there someone that can be identified as the one organizing and executing the ICO? Who is responsible for the ICO?
“Those organizing ICOs over the years have been increasingly mindful of U.S. laws and the uncertainty as to whether they apply,” she said. “They have taken steps to make sure they don’t run afoul of those statutes in the event ICOs are determined to involve the offering of securities. A primary technique for doing that is offering securities outside the U.S. to non-U.S. residents.”
Is someone actually doing this?
Blockchain Capital is aiming to be the first in the world to do it “the correct way,” in compliance with regulation, Pierce said. That means it’s acknowledging the tokens as securities and investors will hand over all the Know Your Customer information required to show they’re accredited investors – that mostly matters in the U.S.
“Instead of creating these convoluted structures to circumvent securities law, why not just face the regulation head on?” Pierce said.
So it’s incorporating its $10 million ICO in Singapore. The sale begins April 10 and there are 99 seats. U.S. users will have tokens locked up for one year; international users will have their tokens locked up for 40 days.
Who cares and why should I?
Developers, mostly, unless you’re a crypto enthusiast eager to invest.
Historically, open source software projects succeeded in people’s own time because no one paid developers to build – and that model of innovation has been celebrated. Bitcoin changed that thinking when it entered the scene, Walch said, and now ICOs are a way developers can demand compensation for what they do.
“Bitcoin as an open source software project is high stakes in that it is transferring and managing things that have real value,” Walch said. “Bitcoin had the luxury to grow up before a lot of people noticed it. Now blockchain is accepted as a value transfer system and anyone building one now is doing it for that reason. The ICO model isn’t anything revolutionary, it’s people trying to do something in a loosey goosey way for a high stakes endeavor.”
And as the ecosystem grows it gets harder to ignore how much developers of these public blockchains function like fidicuiaries, she added.
“You’re putting a lot of trust in [developers] to make sure it keeps operating, essentially to do things right and not cheat you,” she said. “It’s the same situation with these ICOs: you can’t escape accountability for doing something high stakes with other people’s money. But that’s what’s happening with ICOs and regulators won’t overlook it for very long.”
C’mon. Is this really a thing?
Who knows. Marco Santori, a partner at law firm Cooley LLP., said in the last two months, 60 percent of inbound interest in his lawyering services has been related to token sales.
“It could be a whole new way to raise money,” Santori said. “The last new way of fundraising we saw was Kickstarter; this could be Kickstarter for decentralized networks. It is a significant development in the course of private finance and frankly public finance for that matter.”
This may sound like the earlier days of bitcoin Ponzi schemes and pump-and-dumps (when the “real world” corporations realized bitcoin had a PR problem they moved the conversation away from crptyo-anything to “real world” applications) but blockchains in the broadest sense of the word have come a long way in just three years. So when you take into account how many people are actually building, investing in and using these decentralized networks, it’s probably a bigger number than it seems.
But not all business models are amenable to the token sale approach, he said. For some business models there’s really no way to avoid the securities laws.
“For a lot of business models you really have to go and raise venture capital,” he said. “You can’t just bolt on a token to your business model and try to raise money by selling it and trying to avoid securities laws.”