In light of recent news of an arrest for alleged fraudulent activity in an Initial Coin Offering (ICO), it's worth taking a step back and considering the legal status of ICOs as a method of raising money.
First, a quick word on ICOs. One way for a company to raise funds is to issue stock that may be offered to private investors or to the public. If private investors are involved, the company will go through an equity round often denominated as part of a series, with the first round being called Series A. If it’s the latter, the first public offering is called an Initial Public Offering or IPO.
An ICO works on the same principle of taking in money from several investors for a single company, but instead of issuing shares in the company, pieces of cryptocurrency called coins are offered.
There are several models for ICOs. One model is for investors to trade one cryptocurrency (such as Bitcoin) for the ICO’s coins. Another is to simply pay for the coins with cash.
Popular… But Why?
ICOs have blossomed in popularity over the last few years. As shown in this article, in the last quarter ICOs have raised 32% of the money raised by Series A startups. So, a relatively new and somewhat untested method of raising money is approaching the dollar amount raised using techniques with decades of history. What’s behind this?
A couple commonly-cited main drivers behind the ICO boom are their ease of implementation and the perception that ICOs subject fundraisers to less regulatory scrutiny.
On the ease of use point, running a Series A funding round or an IPO requires a fair amount of paperwork and coordination, with whole legal disciplines built around negotiating and papering up the deal. At its simplest, running an ICO requires the use of computer code (much of which can be acquired for free online), including the tracking of who’s investing and what amount of coins they’re getting. Easy.
On the regulatory side, one popular idea for ICO fundraisers is that coins might be categorized as something other than securities, skirting regulations on the exchange of securities. Another perception is that ICOs exist online and issue coins that exist only as digital assets, creating a jurisdiction-free asset that cannot be appropriately regulated by any state or litigated in any courtroom.
Reality Intrudes; What Next?
The arrest of a businessman accused of fraudulent activity connected to an ICO stands in contrast to the idea that ICOs shield their users from the legal impacts of their actions. Likewise, the idea that ICOs create a sphere of protection shielding their users from action by investors seems short-sighted.
What the future holds for ICOs isn’t clear, but there are a couple good guesses. It seems likely that regulatory bodies in the US and abroad will take a closer look at this fundraising mechanism and draw parallels to long-standing ways of raising money that are similar in many ways to ICOs. It’s also likely that, regardless of regulatory action, individual investors will be disappointed by failed ICOs and seek to act against issuers.
This shouldn’t be surprising. And while the ICO craze may see a leveling-off as a result, it’s not exactly doom-and-gloom outlook. We foresee ICOs taking a place alongside traditional funding mechanisms, with their own strengths and weaknesses better understood over time, as both regulatory agencies and courts turn a sharper eye toward their use.
Article by Zach Smolinski