What Is An ICO?
An Initial Coin Offering, or ICO is an unregulated means by which funds are raised for a new venture through the process of issuing a brand new cryptocurrency token in exchange for the promise of being able to exchange that token for Bitcoin once the startup company becomes profitable. ICOs have been used by startups to bypass the rigorous and regulated capital-raising process required by banks, funds, and venture capitalists. ICO campaigns have several different forms, but usually a percentage of the new tokens are sold to early backers of the project in exchange for either a national currency (US Dollars, Euros, etc.) or other cryptocurrencies (usually Bitcoin).
In an ICO, the tokens that are issued are similar to stocks in the funding of a traditional startup using an Initial Public Offering or IPO. If the money raised does not meet the minimum funds required by the new startup, then the money is returned to the backers and the ICO is deemed unsuccessful.
Similar to IPOs and stocks, early backers of ICOs are motiviated by the idea that at some future date the crypto tokens will have greater value once the startup project becomes successful. An example of a highly successful ICO is the cryptocurrency Ethereum, now the number three most valuable cryptocurrency by market capitalization. When Ethereum was announced in 2014, it raised $18 million in Bitcoins.
Along with every success story, however, there are also tales of disappointment. This past December, the U.S. Securities and Exchange Commission filed charges against Quebec residents Dominic Lacroix and Sabrina Paradis-Rpyer, the organizers of the PlexCoin initial coin offering. Plexcoin was based on the Ethereum blockchain, and distributed marketing materials that promised investors could net a 1,354 percent profit in less than a one month time frame. According to the SEC statement, the Plexcoin ICO had raised $15 million but has since had its assets frozen while the case is litigated. Lacroix has run afoul of the law in the past, as he pled guilty in 2013 to six counts of "illegal placement, illegal practice, and transmission of false or misleading information" for a previous venture. Other noteworthy scam ICOs include "RECoin" and "DRC World", for which Maksim Zaslavskiy was charged with fraud by the SEC in September 2017.
There have been many instances of scammers using ICOs to execute "pump and dump" scams where the value of the tokens are inflated to generate interest and then the owner quickly "dumps" the coins and cashes out for fiat profit. Often, the developers themselves are guilty of these tactics. The prevalence of this practice has led the SEC to issue multiple warnings to investors.
It should be noted that there are no protections for investors in ICOs. Even when an ICO is lawful and does indeed provide a fair investment opportunity, more often than not the funded projects are in an early and therefore high risk development stage, thus making any investment in even these ICOs very high risk and speculative.
As a result of the perception that ICOs are scams, the People's Bank of China officially banned ICOs in September of 2017, citing them as disruptive to economic and financial stability. The central bank said tokens may not be used as currency on the market, and banks were barred from offering services related to ICOs. The PBOC ban also penalized offerings that had already been completed. This action led to a dramatic sell-off of both Ethereum and Bitcoin. It took over two months for the currencies to fully regain their value.
In July of 2017, the US SEC indicated that it could wield the authority to apply federal securities law to ICOs. The SEC indicated that not all tokens would be considered securities, but instead that determination would be made on a case-by-case basis. The SEC has further ruled that celebrity ICO endorsements must disclose any amount of compensation paid for the endorsement, regardless of form (tokens, cryptocurrencies, or fiat).