Understanding ICOs

The advent of blockchain technology and cryptocurrency have opened up new possibilities for industries in every sector for the way that information is stored and translated and how value can be exchanged online. Likewise, crowdfunding has brought about a revolution in how entrepreneurs can look to fund their businesses and projects. The initial coin offering (ICO) has brought the idea of fundraising into the blockchain world in an effort to provide a new means of seeking investment outside of the IPO.

In an ICO, a company is able to offer tokens for sale to investors in exchange for cryptocurrency or fiat money. Many instances of an ICO are new cryptocurrencies looking to raise money by offering tokens representing units of the new cryptocurrency, often at a discount, which the investor is speculating will increase in value. For other businesses using the ICO to raise capital, a utility token is issued. That utility token can then be traded amongst investors, and once available, the service of the fundraising company. In either instance, the ICO differs from an IPO in that shares in the company itself are not being offered for sale; investors are either speculating on the new cryptocurrency or investing to gain access to the service or software being created.

Much of the ICO boom is being enabled by the Etherium blockchain. The Etherium blockchain and smart contract system make it relatively simple for users to generate a token to exchange with investors. Investors can then easily store that token in their wallet to trade or redeem. That ease of use has made Etherium the blockchain of choice for most ICOs. And with the decentralized nature of blockchain, ICOs offer much the same appeal that crowdfunding does in the realm of what might be termed “regular” fundraising: the ability to bypass venture capital firms and banks and appeal directly to investors with your pitch.

Another similarity shared with crowdfunding is that the ICO market was initially without oversight or interference from the Securities and Exchange Commission (SEC). But in recent months the SEC has begun to take notice of ICOs, issuing an Investor Bulletin in July outlining what they identify as the potential risks to investors and stating their belief at the time that many of the tokens sold in ICOs may be considered securities under the law and therefore subject to regulation. This belief stemmed from the findings in the SEC report on their investigation into the failed DAO ICO, wherein investors lost $50 million. These issuances from the SEC have led to an increase in the number of regulated ICO offerings involving only accredited investors, taking advantage of a securities law exemption in Rule 506(d).

While the recent SEC guidance has added a bit of uncertainty to the marketplace, interest in ICOs remains strong as companies and investors continue to do business on this new frontier of investing.