An initial coin offering (ICO) is a concept that has been getting increased airplay in recent times, with estimates that more than $1 billion has been raised globally via ICOs.
With some key decisions being made by regulators globally (including the US and China) – and with guidance from ASIC released last week – we thought it timely to provide an overview on the concept.
So what is an ICO?
ICOs generally operate as a blockchain-based funding process, allowing investors to use cryptocurrency (such as bitcoin or ether) to purchase coins or tokens relating to a specific product or project via the internet for a set period of time.
The relevant coins or tokens are typically linked to the specific business model of the company running the ICO, providing the holder of the coin or token the right to use the company's product or participate in the relevant project as a customer at a future date.
Rather than being viewed as an alternative to an initial public offering (IPO), ICOs are more akin to a crowd funding campaign, but noting that they are not the same.
...and what do the regulators think?
Initially, ICOs were considered to be outside the scope of fundraising regulations.
Earlier this year, however, the US Securities Exchange Commission made its position clear that certain coins and tokens can amount to a security and, therefore, be subject to the remit of the existing fundraising framework for US IPOs.
ASIC Information Sheet 225 released last week continues this theme, noting that it will ultimately depend on the circumstances and the rights attaching to the coin or token. ASIC's guidance includes explanations of when an ICO:
- may amount to an offer of a security in a company – e.g. if the bundle of rights, such as voting rights or an entitlement to a future share of profits (dividend) attaches to the coin or token, potentially triggering the requirement for prospectus type disclosure
- may constitute a managed investment scheme – e.g. if the value of the coin or token is linked to management of an arrangement, and
- could become a financial market or crowd-sourced funding platform subject to regulation.
Most recently, China made the decision to ban the funding method, with the People's Bank of China declaring ICOs illegal, flagging specific concerns in respect of money laundering and economic disruption. This has included requirements for companies that have completed an ICO to refund funds raised.
The potential risks of an ICO
US regulation followed a particularly high profile example of an ICO undertaken by the 'Decentralised Autonomous Organisation' (DAO). The DAO had an objective to provide a new decentralised business model for organising various commercial enterprises. It operated using the ethereum blockchain, and had no conventional management structure or board of directors. It raised approximately $150 million in ether, but was unfortunately hacked within a relatively short time period following the raising (to a value of approximately $50 million).
While many new technologies are to be welcomed, the DAO is an example on needing to proceed with caution, and also flags that cybersecurity is a major live issue.
More broadly, while coins and tokens may increase in value following an ICO, they are subject to extreme price volatility, which makes an ICO an inherently risky investment.
There is also the added complexity of anti-money laundering, privacy and data protection laws to consider.
Recovering funds that may be invested in such schemes (including fraudulent schemes) may also be problematic.
It is certainly a developing area and, with the above risks in mind, we recommend you seek further advice if you are seeking to undertake, or participate in, an ICO.
We will continue to watch this space.