Initial coin offerings

Initial coin offerings (ICOs) are a recent phenomenon used for funding companies that are developing new digital currencies and associated technologies. However, companies offering ICOs are often eager to skirt securities regulations and disclosure requirements, leaving potential investors with vague or misleading information — and fraudsters with new opportunities.

Imagine a company gives an opportunity to pre-purchase a new kind of digital token that’s similar to bitcoin. It doesn’t actually exist yet, but the company will use the money raised from early investors to finance its ongoing development. Also, because the token doesn’t exist there’s no economic use for it. The company’s hope is that once it releases the token, people will adopt it to purchase various goods and services. The company  releases a 20-page white paper primarily comprised of vague promises regarding its revolutionary potential. It doesn’t divulge much information about the proposed business model, the background of the company’s employees or the company’s financial health. Do you have any concerns?

This hypothetical is a simplified, though not inaccurate, portrait of an initial coin offering (ICO). Largely due to the rising interest in cryptocurrencies among investors, ICOs (also called coin/token sales) enjoyed a notable swell in popularity during 2017. While ICOs are a novel way for tech-focused startups to raise money, they’re also fraught with fraud risks.

What’s an ICO?

Startups use ICOs to raise funds to support their businesses and to generate excitement about their proposed products or services. During an ICO, a company sells the underlying cryptocurrency to investors in exchange for other, more established cryptocurrencies like bitcoin and ether. By selling these tokens during a specially designated window, a company ensures that it has a built-in userbase for its eventual product. Unlike an initial public offering (IPO), ICO investors aren’t purchasing shares of a company. Instead, they’re purchasing a virtual product offered by the company with the hope that it will materialize and appreciate in value.