IMAGE: Denys Rudyi — 123RF

What are ICOs and why is China banning them?

Initial Coin Offerings, or ICOs, are a way of financing based on publicly requesting investment in a company or project, along the lines as crowdfunding, but using blockchain as a mechanism of transactional control, the same mechanism used to support crypto-currencies such as Bitcoin or Ethereum — and increasingly, for transactional schemes of all kinds.

The “coin” in an ICO is a symbol of interest in the property, a certificate of digital shares in a company. In an IPO or initial public offering of shares, investors obtain ownership interest in a company: in an ICO, investors buy “coins” from the company and register their property through blockchain, and those “coins” can appreciate in value if the business is successful.

The rise crypto-currencies and the expectations of high returns many associate with them, have made ICOs an easy way to obtain financing for companies or projects. In comparison to traditional rounds of financing or complex and expensive IPOs, ICOs are considered as a more open alternative, allowing more participants to enter, circumventing circles restricted to large investors, and allowing people who want to invest small amounts the hope of high yields.

Of course, these advantages for those who launch an ICO have their potential downside for those who invest in them, fundamentally because they have less control. Since practically anyone can create an ICO, dozens of ICOs are being registered each month: in the first half of 2017, a total of $1.2 billion was raised, although there were a number of fraudulent operations. It is not unusual, for example, that popular ICOs get completely sold out in mere minutes and attract phishing schemes through all sorts of channels, whereby criminals supposedly offer stakes in the offer, but redirect payments to different accounts taking advantage of many people’s lack of knowledge of crypto-currencies.

The big issue with ICOs is the lack of control over them. The long and the short of it is that ICOs should be subject to the same regulation and controls as any other similar operation, because they are exactly the same, as defined by the so-called Howey Test, an investment of money due to an expectation of profits arising from a common enterprise which depends solely on the efforts of a promoter or third party, which is used in the United States to determine whether an instrument qualifies as an “investment agreement” for the purposes of the Securities Act.

Now, the Chinese government is to ban ICOs on the grounds they are illegal means of financing, while launching an investigation into sixty Chinese platforms dedicated to managing them. Should this be seen, as in the case of the VPN ban or the restrictions on anonymous online participation, a step toward the development of an all-encompassing system of control over the internet by the Chinese Communist Party? For a government obsessed with control initiatives of this kind are a concern, but in this case it seems more like to be a response to a major source of instability or an easy way out of the country for black money in the enormously dynamic Chinese capital markets. The Chinese government, in whose territory a total of 65 ICOs worth 2,620 million yuan (about $400 million) from about 105,000 investors, have taken place, has taken the lead with its “ban first, then regulate” approach, compared to the warnings from other countries, such as the US, which is trying to find a balance to preserve possible innovation in this hot area while trying to protect investors.

Either way, it is more than possible that, depending on where you live, you may receive news or offers from various companies regarding ICOs. If you do, the best approach is to treat such investments exactly as any other in your usual currency, basing your decision on the information available. Avoid being unduly influenced by stories of the crypto-currency market and that before the arrival of ICOs, investment opportunities of this type where only available to certain kinds of investors, and instead evaluate the company, its team and its chances of success as you would in any other type of investment.

(En español, aquí)