Digital assets such as cryptocurrencies, as well as other crypto coins and tokens, may be offered to investors in the form of an Initial Coin Offering (ICO). But what is an ICO? And why are they such a regulatory hot topic in the securities industry currently?

What is an Initial Coin Offering?

An ICO involves the creation of a new virtual coin or token by a company looking for alternative methods to make money from outside investors generally without selling stock or other forms of ownership in the company. Most ICO issuers use an open, verifiable, and permanent ledger of transactions known as blockchain technology for a portion of their business, to provide a particular service or product that may or may not be developed at the time of the ICO. These companies disseminate new tokens specific to the ICO to buyers via a blockchain network, as well. As indicated earlier, ICO investors typically do not get a stake in the company the way investors do if they purchase an equity share in an initial public offering (IPO).  Investors can contribute as much or as little money as they want in these ICO offerings, which are largely structured similar crowdfunding campaigns popular on platforms like Indiegogo and Kickstarter.

Risky Business

While some ICOs may be legitimate attempts for their issuers to raise money, many may be fraudulent in nature. With ICOs, in can be difficult for investors to verify information about the products and/or service to be developed to make informed investment decisions. Additionally, the markets for digital assets continue to involve high volatility, speculative risk, and potential fraud, all of which vastly increase the risk to investors.

ICOs Offer Little Investor Protection

Since ICOs do not fit neatly into existing securities or consumer-protection laws, regulators are concerned that ICOs may present new opportunities for exploitation or fraud.  ICO promoters and issuers may be offering the tokens or coins to investors outside of existing regulatory systems. This means they are offered without typical disclosures and customer access to documents required by U.S. regulators like the Securities and Exchange Commission (SEC). These disclosures and documents help investors make informed investment decisions. The lack of regulation increases the risk of fraudulent behavior and leaves investors with little recourse should fraud occur.  Funds that are lost due to fraudulent initiatives may never be recovered.

How to Spot a Fraudulent ICO

Criminals will always try to create money from nothing and ICOs are no different. Fraudulent ICOs often use methods including:

  • lying about relationships with well-known and respected organizations;
  • including fake customer testimonials;
  • using fake profiles of executives with impressive resumés;
  • posting false or misleading marketing materials; and
  • paying celebrities to promote the ICO.

Here is an example created by the SEC of what the website of a fraudulent ICO might look like.

[Continued in What is an Initial Coin Offering (ICO)? – Part II]