What is an Initial Coin Offering (ICO)? – Part II

[Continued from What is an Initial Coin Offering (ICO)? – Part I]

Online Platforms that Facilitate Trading in ICO Tokens are Not Registered Exchanges

There are no ICO platforms currently registered as exchanges. Further, the SEC has stated that it neither regulates these platforms as exchanges nor reviews the digital assets that may be listed or traded on these platforms. Many fraudulent platforms refer to themselves as exchanges to provide a sense of legitimacy and make investors assume they are regulated entities or meet the regulatory requirements and standards of a national securities exchange.

ICO Theft

According to one study, approximately $400 million in funds raised in ICOs in 2017 were either lost or stolen. In addition to money and tokens, private and personal information of investors such as addresses, phone numbers, bank details, and credit card numbers have been stolen. There are many touchpoints where such personal information can be compromised, such as digital wallet providers. Investors must be aware of possible cybersecurity vulnerabilities, especially as many of the entities involved in ICO-related activities might be operating internationally and without any regulatory oversight or recourse for fraudulent activity.

Future Tokens

Receipt of future tokens is often viewed as an incentive to participate early in an ICO but is not in any way guaranteed. An investor’s ability to receive future tokens is typically contingent on certain triggering events occurring at some later date, such as the development of a new enterprise or a related future public sale of tokens. Events which may never actually come to fruition. Additionally, even if investors do receive tokens in an ICO, they may be worth nothing or may only be redeemable for goods and services provided by the actual token issuer. Finally, though it may be promised by the issuer, there may be no ability for investors to ever trade or exchange tokens.

Simple Agreements for Future Tokens (SAFTs) Don’t Make ICOs Safe

Some market participants have begun to use SAFT contracts to offer their tokens to the public. Simple Agreement for Future Equity (SAFE) contracts emerged with securities-based crowdfunding, and SAFT investment contracts appear to be modeled after SAFE contracts. However, investing in a SAFT contact does not mean that the offering is compliant with applicable federal and state securities laws and regulations. In a SAFT, the issuer typically advertises that the token an investor purchases will start out as a “security token,” offered subject to federal securities laws and regulations, and then be transformed over time into a “utility token” that operates outside of federal securities laws and regulations. However, no matter what a company claims about a token’s ability to change characteristics from a security to a non-security, there is no guarantee that the SEC or the courts would agree with the company’s assessment.

ICO Valuations and FOMO

ICO valuations are often based on a fear of missing out (FOMO), rather than on market fundamentals, project development forecasts, or the nature of the actual tokens being offered. Investors are not in a position to make informed choices, since little is known about the companies that undertake ICOs. Many ICO issuers publish a whitepaper containing details about an offering (for example, a description of its blockchain technology), team member bios, and token information. However, it can be difficult for investors to verify the claims and information in such white papers. And some papers may be misleading or fraudulent. Even the most comprehensive ICO whitepaper tends to lack the features of prospectuses or other forms of offering documents and the disclosures required by federal securities laws: audited financial statements, disclosures about the company and its officers, and risk factors to be considered by investors prior to actually investing.

For more on investments in digital assets, see our previous blog on Cryptocurrency and The Securities Industry.