An Initial Coin Offering (ICO) is a fundraising method that became popular with the launch of Ethereum in 2015, and grew to its height in 2016/17.
The Ethereum blockchain provided an easy way to launch a crypto-currency with the introduction of the concept of a programmatic functional way to execute computer programs using the underlying blockchain miners. The concept of a global computer / operating system was born, and these programs were christened “smart contracts”. Although the name suggests a legal contract, the programmatic functionality essentially enabled programs to be executed with persisted data state.
Buyers of tokens could buy into company offerings and receive a their respective new crypto-currency token, without the traditional overhead associated with IPOs or cross-border transactions. The popularity was underpinned with the birth of Web 3.0- a move towards decentralisation. It offered a glimpse into the future and many start-ups embraced the technology as a way to open new markets, disrupt corporate encumbrance, and offer the next generation of products and services.
The regulators’ segway
Many regulators were confused by how the market operated, and in several jurisdictions including China and Japan ICOs were banned. The US has evolved its approach from an extension to Reg D to full blown “Howey Test” IPO qualification. The US SEC has been wary of allowing a disruption of traditional markets (especially given the USD $ is the world’s currency) through crypto-currencies, as witnessed by the recent crack down on Facebook’s Libra. China, similar to the US, wants to control the space. However, it has taken a more bullish approach by actively trying to control it, through accelerating its plans of turning the Renminbi (which ironically translates to “the people’s currency”) into a crypto-currency and allowing exchanges to essentially do what they want (so long as they aren’t caught).
Meanwhile, the UK and Europe have taken a more pragmatic approach. The UK hasn’t explicitly banned ICOs, but the FCA recently asked companies to register crypto-currencies and is starting to use existing regulation such as MiFID II to determine whether they are securities.
So what’s happening in Europe and UK ? Well, who knows really given Brexit but the EU’s Fifth Money Laundering Directive (5MLD) came into force on 10 January 2020. From that date, all UK businesses involved in crypto-assets-related activity need to be registered with the FCA for AML supervision.
Essentially:
• Cryptoassets firms must apply to be registered for AML/CTF purposes before 10 January 2020 (including those already registered or authorised for other activities)
• Any new business intending to carry on cryptoassets-related activities after 10 January 2020 must obtain FCA registration before doing so
• Any business already carrying on cryptoassets-related activities may only continue doing so (in compliance with the MLRs) if it has registered by 10 January 2021. If you are in the UK, you’ll need to register with the FCA for cryptoassets supervision, which includes:
• Completing the online application form
• Providing the FCA with the information they request
• Paying the registration fee of £5,000 (followed by annual fees based on income. God knows how they came to the amount of £5,000 and what benefit it actually returns to the business. It appears to be merely a taxation and ill-considered form of unwanted control)
Switzerland cashed in on crypto-currencies by offering what it claims to be a clear regulatory framework and a shiny branded Swiss bank account. The territory offers Securities, Non-Security Utilities and a Hybrid regulatory tokenisation framework. The Zug valley has become known as Crypto-Valley, although crypto is taxed heavily if not incorporated as a non-profit organisation, and to even push the paperwork around to form a company or “AG” as it is known in Switzerland costs a minimum of CHF 50,000 deposited.
Livetree’s view towards regulation is that fundamentally it is a good thing. We need to learn from the past, protect people and also stop markets from being manipulated. However, there does need to be a line. To simply copy and paste securities laws and enforce the exact same regulation as prescribed for existing securities markets would be an opportunity missed.
The ICO’s promise was to break free of the costly, rich-only exclusive world of security offerings to a decentralised vision. The pendulum swang too much away from regulation and we had a lot of dubious projects and a lot of pumping and dumping, but should we be now worried it is swinging too much toward regulators and just replicating the same broken system?
Back to the ICO explanation
A whitepaper, true to hacker form, and in homage to Satoshi, was produced for the ICO. This detailed the project’s goals aims and innovation, the needs that will be met by this project, the length of the campaign and the number of tokens the sale aimed to raise. More often than not the blockchain or distributed ledger technology (DLT) was ill-considered and misunderstood. It was used to represent the demise of all things bad in the world instead of practical solutions only afforded by DLT.
There are pros and cons to launching an ICO. First of all, it is decentralised. It offered a way to introduce decentralisation or the promise of Web 3.0 technology. It rewrote the rule book for what an IPO could be. Being relatively easy to launch, there was a potential for everyone to participate. However, there are also challenges and risks- ICOs are largely unregulated and many turned out to trick token buyers by fancy advertising and false claims. This is commonly known as a ‘pump and dump’: the scammers heavily promote a token to new, unsuspecting buyers in an effort to wow them with technological wizardary and false promises, then dump/sell the token at valuation that leaves buyers wondering what had happened. Often the token represented no real value, or creditable business return. The price is artificially pumped up, and when the buzz is at a high the promoters dump the token simultaneously and leave with a profit. This sends the price tumbling and leaves the other buyers stranded.
This is not to be confused with an Initial Public Offering (IPO) where traditional companies sell securities such as stocks to the public for the first time. This is a lengthy process, where the company hires an investment bank to underwrite the IPO and will be listed on a stock exchange. These are highly regulated, and only a limited selected few “sophisticated” investors receive a share of the business. Nicely keeping the rich — well, rich and the those without access, without.
The ICO offered a cheap and decentralised relatively low cost version of this but moreover promised Web 3.0. The promise is now starting to be technologically realised, but was abused by the pump and dump and false, unrealistic projects.
An Initial Exchange Offering (IEO) is the latest 2018–2020 variant of the ICO, conducted on the platform of a cryptocurrency exchange on behalf of the company wanting to raise funds.
IEO participants will have to create an account on the exchange and purchase some digital currency to fund their investment. There are several benefits to this, including tapping in to the exchange’s existing user base for the company. However, this is also a way for trust to be abused, as many exchanges also engage in internal ‘pump and dumps’ and market manipulation.
The token issuers have to pay a listing fee to the exchange, as well as a percentage of the tokens sold during the IEO. The exchange is therefore incentivised to help the token issuer with its marketing operations.
Listing on the exchange where the IEO has been carried out would be the natural next step.
Livetree has experience with ICOs and has been investigating various exchanges and IEO processes and practices of exchanges. We will talk about our experience in more detail in our next post.
