ICO Market Watch: What Tokens Actually Represent
Part 1 of 2 (Read Part 1? Skip to Part 2.)
Co-Written by Mick Emmett
It’s pretty hard to avoid bumping into stories about initial coin offerings (ICOs), even if you barely follow business news, never mind news about cryptocurrencies like bitcoin and ether. They are seemingly everywhere as companies look for an easier — and less regulated — means of raising capital. We’re not talking chump change here, either. According to CoinDesk’s ICO Tracker, cumulative ICO funding has surpassed $2B, with more than three quarters of that total just in 2017 alone. Based on current trends it looks like $3B well before the end of year is a pretty safe bet. There’s growth…and then there’s that.
Sort of like a stock IPO but with some important differences, ICOs leverage blockchain technology to deliver digital “tokens” (i.e., units of payment) to investors as opposed to shares in in a company’s ownership like an IPO. The term “crowdsale” is also used in these instances. And, like a stock, if the business does well then the value of the tokens will likely increase. For a lot of startups the ICO route is more effective than going hat-in-hand to venture capitalists begging for money (if you can even get in the door, that is). It’s a twist on the open-source approach that has been turning tech and other industries upside down for years.
It’s Complicated
What a great idea! Right? Well…it’s complicated. For all the hype and attention ICOs have gotten, the murkiness with many of them coupled with the lack of regulation means that investors don’t have the protections they would if they owned stock (at least in most countries, including the U.S.). In fact, a recent article in Wired called them, “…the equivalent of coupons for a supermarket under construction.” After all, there is no comprehensive regulation framework for tokens and they can represent everything from shares to…nothing. It’s no wonder regulatory bodies are struggling.
We go into detail about ICOs and the regulatory issues they generate in Part 2 of this article. Here we’re going to dive into token sales and what goes into designing a token.
How Much For That Token On The Blockchain?
A lot of people need to get involved in a token sale. At the very least: engineers with blockchain expertise, token designers, financial and accounting folks, and, of course, lawyers. Well, that’s for a legitimate ICO, which not all of them are. As an investor, you ideally want the ICO to comply with both the letter and spirit of applicable laws and regulations, limited though they might be. You want some degree of purchaser protection against fraud.
The sale itself typically takes the form of an auction. Investors generally buy in via a cryptocurrency like bitcoin or ether (though ~10% comes in from fiat currency). The value the investor receives depends on what he/she is investing in. It could be access to a new SaaS application or some kind of hardware or physical product or time on a gaming platform or…lots of things. In many cases the tokens can also be traded on blockchain marketplaces for cryptocurrency or even dollars and other government-backed currencies.
If Something Sounds Too Good To Be True…
With real momentum now in play, ICOs are gaining wild popularity. Unlike private blockchain-based investments that large financial institutions like JPMorgan Chase offer only to a select group of uber-wealthy investors, most ICOs are public and open to anyone (though there are pre-sales to select investors, and large investors usually account for a disproportionate amount of the tokens). This has helped fuel speculation. And speculation is bad for everyone other than the speculators who have already cashed in. This is a trend that bears watching as the ICO funding total climbs higher and higher at breakneck speed.
That’s one big knock against token sales, but it’s far from the only one. Fraud. Poorly designed companies and products. Token issuers and investors who don’t have a solid understanding of blockchain (not to mention ICOs in general). The fact that most ICOs will fail. There’s a lot to not like once you get past the big numbers and breathless hype.
Not All Tokens Are The Same
One of the intriguing elements of token sales is the “design” of the token. As mentioned above, tokens do not always represent ownership in the issuing company. While that can be the case, it’s not common. Instead, tokens usually represent some other representation of value that supports the issuing company’s goal. Examples include: pre-purchase of a product or service, early access to an online game, a new “coin” that will theoretically be worth something, etc.
Based on ICO activity thus far, exchanging the new tokens for something else of value — maybe back to bitcoin, ether or another cryptocurrency; maybe fiat currency like US dollars — not long after the ICO is proving to be a popular strategy.
So that’s what usually happens with token design. But what should happen if everything’s on the up and up? According to David M. Otto in a recent article co-written with Andrea K. Louie, attorneys who specializes in cryptocurrency activities like ICOs and private token sales:
“Companies should grant token holders the right and/or ensure purchasers have an obligation to perform the following functions:
- Participate in the creation, operation and expansion of designated “nodes” that will help run the network;
- Program, develop, or create various functionalities and features on the new blockchain network;
- Access, sell and/or license various features on the network;
- Contribute labor or effort to the network;
- Use the network and its outputs;
- Sell products on the network; and
- Vote on additions to or deletions from the network in terms of features and functionality.
By completing and implementing these practices in the token sale, an issuing entity has a better chance of ensuring that its token will be designated as an asset and not a security.”
With that background in all-things-tokens, let’s dive into the regulation morass in Part 2.
— — — -
DISCLOSURE: We wrote this article ourselves, and it expresses our own opinions. We are not receiving compensation for it. Views shared here are our own and cannot, under any circumstances, be interpreted as an official account of any companies we are associated with — currently or in the past.
