ICOs - reality check and perspectives

Initial Coin Offering or simply put ICOs have been created because of the pre-existence of blockchain and cryptocurrencies. The acronym ICO is very close to IPO or Initial Public Offering but is very misleading. While an IPO represents the sale of shares of a company to the public, an ICO is a sale of tokens that represents something else so you don’t own part of the company.

As tokens can take different forms, it is difficult to classify and regulate them. Regulation of ICOs is still a work in progress and may vary widely from one country to the next so you have to be careful when you prepare one if you don’t want regulators to come at you with a vengeance. A token can be characterized as follows but it may change in the future as regulators start understanding what it can be:

? payment token – these tokens are similar to cryptocurrency that can be used to make payments. Examples are Bitcoin or Litecoin.
? utility token – these tokens are used to access an application or a service. Examples are Ether or ERC-20 based tokens.
? securities token - these tokens represent assets such as participations in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, the tokens are analogous to equities, bonds or derivatives.

This classification is shared by FINMA, the Swiss regulator in charge of Financial Markets. FINMA is basing its guidelines on two major regulations: the Anti-Money Laundering and the securities regulations. The securities regulation applies only to the third type of tokens, securities tokens.

The SEC, the US regulator, has a very different approach. They started regulating ICOs, in the second part of 2017, before giving their guidelines, going after what they considered pure and simple fraud or disrespect of basic investment rules. If you were advertising that buying your tokens was a way to make money quickly, you were in for big troubles that varied from substantial fines to giving back the integrality of the money you raised in the ICO. They even stopped the ICO of Munchee in December 2017. Since the beginning of 2018, the SEC has made it simpler (a way of speaking).

Securities regulation apply to all tokens raised in ICOs.

It would be out of the scope of this article to detail all the elements of the securities regulation but in short I will summarize. You have to be licensed or work with parties that are licensed. You should understand the difference between accredited investors and non-accreditors investors. Regulators consider that accredited investors know the risk of investing while non-accredited investors may be easy victims of scams. The last element is disclosure and compliance. You have to be ready to be audited and give all documents regarding your fund raising efforts and marketing communication initiatives. There is more of course but if you take care of this, you are already in the right path.

The consequence is that all ICOs should be registered with the SEC and follow their compliance. The SEC is not kidding and the number of companies being fined is growing rapidly: BitConnect, REcoin, DRC World, RMTN, Tomahawk Exploration to name a few. This will have an impact on the number of ICOs registered in the US unless the situation changes.

When you do your due diligence, as you should for all investments, you will be interested in the structure of the company you invest in. Often, ICOs are created by companies whose teams are spread around the world, incorporated in one country with the CEO in another. Originally, the profile of companies doing an ICO was focused on blockchain infrastructure. Now, it is easier to find a company that knows well blockchain and that can develop for you the platform you need to deploy your application. I even have been contacted by companies that had a business idea and tried to “fit in” the ICO model. This demonstrates hype and greed.

I personally think that the SEC approach is too constraining and not realistic in the long run.
Ether, the Ethereum cryptocurrency, for example was issued in a crowdsale mid-2014 to be used to power the platform. Considering Ethers like securities is not the right approach but I understand the stance as there is a lot of catch up and cleaning to do. I am sure we will see changes once the market settles.

Many of the ICOs that happened in the last 2 years will fail like what happened with the early stage investment in Bitcoin or Internet companies. This is not specific to ICOs but is intrinsic to the business of early stage investing. All angel investors will tell you that their investments are high risk no matter how well you know the founders, the market, or the technology behind it. Look at the return of most VCs and you will realize that even professional investors like them take risks and want to see big returns but don’t always get it. Now though, we have companies like Amazon, Google, Facebook, or Coinbase, Ethereum, Ripple or Stellar. With USD 2.4B raised in over 600 ICOs in Q3 of 2018, the industry is very active (20 of them got 40% of the total amount).

The priority now is to provide a regulatory framework that is supportive of the creation of new businesses while still protecting consumers and investors. Getting fraud out of the way will be a huge help for the industry.

The US investment market is very mature with structures that work with seed funding, Series A, B, C, etc but I think ICOs provide the capability for anyone to participate in projects that otherwise wouldn’t exist because maybe they are not big enough for the VC community or because there is a lack of angel and early stage funding in a particular region or country. Europe has a huge opportunity now in this regard. I will provide more details in our next article in The Paypers, therefore stay tuned for the 10th of December edition.

About Daniel Chatelain

Daniel Chatelain is a payment and fintech industry executive focused on innovation and sitting on the board of directors or advisors of emerging companies. He started The BayPay Forum and he is the CEO of PayKademy. Prior to that, Daniel was CEO, President & COO of companies he started as an entrepreneur or within the Lagardere (Elle, Woman’s Day, Car & Driver, Hachette, Canal Satellite) and EADS group (Airbus, Ariane, Eurocopter) and Vice President of a VC backed companies giving him a wide experience of growing companies domestically and internationally in the banking, telecom and interactive media industries as an entrepreneur, corporate or VC backed senior executive. Daniel is a Mentor at 500 Startups, Plug&Play and French Tech.

About PayKademy

PayKademy is the new school to learn Payments. Payments are more and more an integral part of a business and few people understand the competitive advantage that you get when you understand the complete ecosystem, how it works and its pricing models PayKademy provides courses in-person, on-site and online with a careful selection of instructors, experts in the industry and a particular attention to keep the students engaged with their instructors being face to face or online as well.