Initial Coin Offerings, or ICOs, have become an innovative way for projects to receive funding and for speculators to potentially make impressive returns on their investments.
According to icodata.io, last year saw approximately 900 ICOs launch, with just over $6 Billion raised collectively. And this new trend in capital raising has only increased in 2018, as Q1 has already surpassed the numbers achieved last year. With some ICOs having provided massive returns for investors in the past, it’s common to be blindsided to the risks involved when investing in an ICO. That said, there are some important details to consider before investing in an Initial Coin Offering.
Perhaps the best way to understand the risks is to compare ICOs to a traditional Initial Public Offering (IPO).
ICO vs IPO
In simple terms, an IPO is a stock launch in which shares of a company are sold to institutional investors and usually to retail (individual) investors as well. This process, commonly known as ‘floating’ or ‘going public’, transforms a privately held company into a public company.
In comparison, an Initial Coin Offering (ICO) is a form of crowdfunding where a cryptocurrency is sold to investors in the form of tokens in exchange for legal tender or other cryptocurrencies such as Bitcoin or Ethereum. These tokens are promoted as future functional units of currency if or when the ICO’s funding goal is met and the project launches.
Buying into an Initial Public Offering legally transfers shares of a company to the investor. Companies involved in an IPO are heavily regulated by government bodies and corporate regulators, and the directors of the company are accountable to their shareholders. Funds raised from an IPO are spent in accordance with the Prospectus, and the company’s performance must be reported and audited in their Annual Report.
In contrast, Initial Coin Offerings are for the most part unregulated, and therefore in many instances, in violation of securities law. The unregulated territory can attract ICO scams which make misleading statements or falsely claim to have partnered with reputable companies and individuals.
Tokens, not shares
With ICOs, investors do not own a share of the project, but rather a token which the project plans to use in its ecosystem if successful. Furthermore, the heads of the project are not accountable to their token holders and are under no obligation to perform or create a viable project. Funds raised from a token sale can be misspent on Lamborghinis and helicopters, or blatantly stolen by the project leaders with no recourse for the token holders.
In addition, because digital bearer assets (usually Bitcoin or Ethereum) are used to finance ICOs, they are susceptible to loss or hacks. Even when dealing with a reputable, legitimate ICO, investment funds can be irreversibly sent to the wrong address by accident, and ICO websites and social media pages can be hacked to display the hacker’s crypto address in place of the official address.
Perhaps this is a bleak picture of how risky ICOs can be, but I believe it is warranted. A recent article from bitcoin.com stated that of the 900 ICOs which launched last year, 142 had failed at the funding stage. A further 276 have since failed, and an additional 113 have stopped all communications with their token holders. This means that close to 60% of last year’s ICOs have already failed or are about to fail.
In conclusion, Initial Coin Offerings are a great innovation for the crowdfunding of an idea or project, and have been known to return huge multiples to investors. But they are incredibly high risk investments, and these risks must be fully considered before making an investment in an ICO.