The current state of affairs begets the question whether some measure of regulatory oversight would be a deal breaker in the long term

The entry of cryptocurrency and its underlying blockchain technology onto the global stage has forever altered the investment landscape with the mass adoption of Initial Coin Offerings (ICO).

The appeal of the ICO lies in its ability to democratise access to growth capital. Any individual armed with a business idea could potentially raise capital from interested parties within the cryptocurrency community via an ICO, which is currently not under the purview of overly stringent regulatory and statutory measures inherent in traditional fundraising from Venture Capitalists (VC) or banks that makes it difficult for many promising projects to see the light of day.

Apart from financial investment, the nature of ICOs’ small ticket allocations helps businesses acquire a community of investors right from the beginning who have a vested interest to spread the good word.

In theory, ICOs could be the investment utopia that we’ve dreamed about if executed correctly, democratising access to capital for fundraisers and investment opportunities for every individual.

The Dark Side of ICOs

With seemingly every man and his dog jumping onto the ICO bandwagon these days, the absence of regulation that has fuelled the meteoric rise of ICOs is paradoxically threatening to derail its success. While a compelling argument exists for the absence of regulatory oversight, it does not mitigate the potential for less-savvy investors to be exposed to significant risk and consequently preyed upon.

Utility and Security Tokens

Two distinct token classes exist, yet many emerging ICO opportunities hold a hybrid/dual classification:

Utility tokens provide investors with future access to a product or service. Though not designed as investments, many investors continue to invest in utility tokens in the hopes that its value will appreciate over time as demand for the product or service increases. Significant examples of utility token issuers include Ether and Telegram.
Security tokens represent ownership of an asset, such as debt or company stock. Through the use of blockchain technology and smart contracts, businesses could forgo a traditional IPO, and instead issue shares and voting rights through distribution of equity tokens over the blockchain. In markets such as the United States and Singapore, classification as a security token comes with regulations and limitations on who can invest in these tokens, and how they can be exchanged.

The lion’s share of ICOs today are represented by utilities as businesses try to avoid being bound by the regulations and compliance applicable to securities, making their ICO less susceptible to launch failure. Being classified as a utility also means that the business running the ICO can reach out to non-accredited investors, and are exempt from the high costs associated with regulatory compliance.

Also read: Planning to ICO? Here are 10 top lists that can help you get more visibility

Observers believe an imminent paradigm shift towards securities – or at least, a market where ICOs (regardless of utility- or securities-based status) are subject to some form of regulatory oversight, similar to the regulatory oversight accorded to securities – is on the horizon. While there are definitely legitimate utility token projects in the market, a study found that 90% of utility tokens supposedly served no real purpose, instead deriving value by leveraging the hype around their products and services – in essence, a cash grab that brings no benefits to investors.

The State of the ICO Landscape

The very concept of the ICO is quickly becoming synonymous with fraud, with a recent study suggesting that as much as 80% of ICOs are fraudulent in nature. An innocuous Google search easily turns up numerous well-documented instances where ICOs raise millions before simply vanishing. Considering that 59% of all ICOs in 2017 – constituting a staggering US$233 million – ended in failure, these claims might not seem too far-fetched.

The recent volatility in the cryptocurrency market does little to aid the current state of affairs. With the value of tokens pegged to major cryptocurrencies, adverse developments in the cryptocurrency space are expected to have a knock-on effect on ICOs. In addition to widely reported price manipulation, insider trading, and even money laundering, cryptocurrency valuation remains volatile due to a lack of widespread adoption, whereas large scale adoption is hindered by the wildly fluctuating prices – with Bitcoin losing 48% of its value in Q1 2018.

An increased scrutiny on cryptocurrencies and ICOs by authorities across the world has also led to the introduction of geographically-specific regulations that further increase complexity and uncertainty for potential adopters and investors. A case in point would be how numerous utility tokens in the US have been re-designated as securities under the guidelines of the US Securities and Exchange Commission (SEC), leading to many ICOs simply opting to exclude the US from any outreach.

A Regulated, Safe Space for ICOs

The current state of affairs in the ICO landscape begets the question whether some measure of regulatory oversight to safeguard the interests of investors would truly be a deal breaker for ICOs in the long term. The attention that authorities are currently focusing on ICOs and cryptocurrencies could be viewed as a silver lining, providing much-needed structure and legitimacy.

As regulations around cryptocurrencies become more clearly defined, this is expected to give rise to proper use cases which will in turn spur adoption rates and stabilise valuation. It is also driven by a growing trend of institutional money – from the likes of JP Morgan Chase and Goldman Sachs – flowing into cryptocurrencies as major financial institutions begin to make bolder moves in the ICO space to create another means of raising capital and engaging their stakeholders.

Taking a cue from the assertive stance Singapore’s MAS has taken on the issue, worldwide regulators should consider clamping down on outright fraudulent token raises where issuers sometimes disguise securities tokens as utility ones with a little dressing up. The wider industry and especially the investor population stands to benefit from improved KYC and AML practices, ensuring the longevity of a truly revolutionary medium of investment that doesn’t run afoul of established securities laws.

As regulations and value around cryptocurrencies become clearer, so will the value of ICOs. In the long term, a stable ICO ecosystem can play a significant role in the future of investments, providing businesses yet another avenue to reach out to potential investors and further increasing access to growth capital.

Also read: While the hype has died down, data suggests ICOs are racing ahead faster than ever

The Future of ICOs

It is clear that while ICOs are able to solve the challenges to raising growth capital, it has simultaneously raised new issues for regulators and the market. ICOs will need to evolve into a more regulated ecosystem to allow fundraising to take place in a safe environment undergirded by trust with proper due diligence processes.

Akin to how crowdfunding has existed alongside VC firms, I’m also anticipating ICOs and traditional VCs developing a symbiotic relationship, each playing on the competitive advantages offered by the other. A key issue faced by businesses taking the VC route is the time required to realise actual returns (via an IPO or acquisition). With ICOs, investors are free to trade their tokens for other promising projects after the brief lock-in period. On the other hand, while ICOs are able to address the issue of growth capital for the business, they are unable to provide the level of guidance typically available from VC firms.

On our part, Fundnel will be expanding its focus to include ICOs within the investment opportunities on our platform. We want to help create that safe and regulated space for ICOs that I touched on in previous paragraphs, as we believe blockchain technology has a lot more to offer in the future as a mainstay in the financial landscape.

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