Recent developments in the ICO ecosystem are good for weeding out the scams and establishing trust among investors

Did you just read that someone with a business idea and a white paper can do an ICO to raise millions of dollars? Well that might have been true back in 2016 or early 2017, but the ICO market has undergone tremendous changes this year.

That said, it doesn’t mean that it has become very difficult — now fundraising via ICO route is all about navigating the regulations. This is a good news for the crypto ecosystem since it will have greater impact on weeding out the scams and establishing trust among investors. Also, this might attract the flow of institutional money into crypto space.

In this post I’ll highlight the five most important factors that needs to be considered when someone is looking to raise capital via ICO.

1. Security token vs. utility token

The very first thing that you need to establish is whether the token for your project will be a security token or utility token. So what’s the difference between these two? For instance, you are building a decentralized app which would allow time travelling and people would be able to use the token acquired during ICO to pay for the travel, then it would be an utility token. Quite obvious that the token has an use or utility in buying a product or service.

Security token would be basically a tradable asset which can be backed by petrol, gold or real estate, etc.  If you are still not clear about the token type, try the Howey Test, which has been established by the U.S. Supreme Court. In a nutshell, an investment instrument can be considered as a security if a contract, transaction or scheme entails monetary investment from a person in a common enterprise and the investor is expected to gain profits from the efforts of the promoter or a third party.

Bonus token — there is also something called as equity token which is similar to how stocks work in companies. Traditionally startup companies have issued stocks to investors and early employees to get funding and solve employee retention problems.

2. Jurisdiction

Next up is the jurisdiction — where would you set up your company? Here are the popular countries that are attracting companies treading the ICO path: Singapore, Switzerland, Cayman Islands, and Malta. If you are going to sell tokens to U.S. citizens, then in order to avoid SEC’s regulations you need to choose a country that has clear regulations on ICOs, i.e., established local laws. This is important since SEC will respect the local law and won’t apply the U.S. laws on your company.

In case of Singapore, the government has neutral stance and the guidelines clearly define when tokens would be considered security. This makes it a lot easier to launch ICO projects. In fact, in August 2018 Singapore surpassed the U.S. in terms of the number of ICOs launched.

Also read: Singapore Central Bank clarifies ICO regulations in Singapore

Cayman Islands, a British overseas territory has solid framework for blockchain-based projects and according to their definition, ICO tokens don’t fall in the security category (which results in simple token sales process). Switzerland’s Zug has has been rechristened as Crypto Valley and this shows the country’s commitment towards crypto projects. This is undoubtedly one of the most ICO-friendly nations with solid ground in the global financial market.

Coming to Malta, this European nation’s central financial watchdog, i.e., Malta Financial Services Authority (MFSA) has been highly supportive of ICOs. This Blockchain Island has enacted a law called Virtual Financial Assets Act to provide a robust framework for ICOs and cryptocurrency exchanges. It has also established a Financial Instrument Test which helps in identifying security and utility tokens. Moving further, company structure can also be a factor for saving tax which has been discussed in the next section.

3. Company structure

Structuring the company right way for savings in taxation is crucial, otherwise you might end up paying more than 30% of the ICO proceeds. In any case, the rule of the thumb is to apply taxation on income and VAT (many jurisdictions are still not clear about this).

One of the common company structures involves residency considerations, i.e., setting up different units of the same company in two different countries. This usually means that the country from which tokens will be issued will be different from the country in which team will develop and support the project. And the country from which token will be issued will have friendly policies for taxation. In this case, Malta is a great choice since the effective tax can be minimized to 5% level for this domicile.

Apart from this, some companies can form not-for-profit entities to issue tokens and avoid tax. This is a slippery slope since the company will come under heavy scrutiny and the entrepreneurs would lose the ability to drive to the project as they deem fit.

4. Attracting institutional and accredited investors

Being able to attract accredited investor goes a long way since you want a largely successful ICO. Hence, you should consider incorporation of Simple Agreement for Future Tokens (SAFT) which can be viewed as a “postponed ICO” in simple terms.

Essentially, the startup company gets into an agreement with accredited investors who would receive tokens from the company at a discounted price once the blockchain network becomes functional in future. So, the company develops the project by using the capital from investors and once the project is fully developed, the tokens are considered as utility tokens  (thereby getting away from the regulations of securities).

Note that this framework is only useful for utility tokens, not the tokens which are intrinsically securities during public sale.

5. KYC norms

Know Your Customer is a win-win proposition for both the investor and the token issuer or any business entity for that matter. Voluntary KYC compliance cements the ICO as a legitimate business practice, improves public image and makes it easier to work with banks. Also, it would be really useful to work with the regulators in large markets such as the US, the UK and Canada where the regulators are inclined to classify ICOs as securities.

Also read: dApp accelerators are apparently an “in” thing now, with blockchain apps going mainstream

Currently there is no standard or centralized process for KYC/AML in the ICO market. Hence, different companies adopt different methods to capture identity information, criminal and financial history. Apart from that there are some upcoming projects focused on KYC in decentralized world — for example, uploading the KYC data to the blockchain to avoid any tampering and encrypting/decrypting the data on demand.

This sums up the 5 key elements to consider while doing ICO. Do you believe some other crucial factors can also be looked into? Post them in the comments section!

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Preetish leads marketing at PromptCloud Technologies, a data-as-a-service provider that leverages cloud computing to deliver alt-data solutions.

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