Initial Coin Offerings Provide Opportunities For Investors, But Caution Is Advised

Written by Tom Jackson

Whatever you want to call them, initial coin offerings or token sales are big right now.

If you’re unfamiliar with the subject, initial coin offerings are when a creator of a digital currency makes coins available for public purchase to raise money for a project. It is kind of like raising venture capital investment, but a much newer and less regulated space.

It is proving popular. Companies have raised as much as $230 million (Tezos) and $153 million (Bancor) using this method. Africans are getting involved too, with South African entrepreneur Vinny Lingham raising $33 million in a recent initial coin offering run by his U.S.-based company Civic, which is building a digital identity verification platform.

Back in Lingham’s home country, South African startup Ekasi-bucks is set to launch its own initial coin offering to raise funding to take blockchain-based financial systems to businesses in South African townships.

What is undeniable is that the unregulated and digital aspect of initial coin offerings make it far easier for people to “invest” in companies, and for companies to raise money.

Chris Edington is chief technology officer at South African digital agency Made, and not a full-time investor or trader, but he has participated in a number of initial coin offerings over the past few months, including that of Civic.

“The reason for my involvement in the space is two-fold: a long-term investment into some new technologies and companies which I think could have a viable product, as well as a keen interest in the blockchain and cryptocurrency space,” he said.

“The whole initial coin offering space is by some considered a bubble, within the cryptocurrency ‘bubble’, and has shown potential to be very profitable.”

Initial coin offerings deal in hype

However, he notes it is “extremely fast and loose” at the moment.

“A large contribution to the value of the initial coin offerings at the moment is speculation and hype, with people “investing” money into something which they do not fully understand and products that are no more than a concept with a good looking website and a white paper,” Edington said.

“That being said, there are some really exciting and well managed companies that are already releasing early-stage products to the market that are worth the investment from the community.”

For Michael Marcovici, director of the Digital Developers Fund, which is itself now going through an initial coin offering in order to raise money to invest in blockchain startups, the main benefit of initial coin offerings is that companies are able to move asset allocation into a whole new area, and invest in upcoming technologies much faster than before.

“There are very high risks involved. The lack of regulation has great advantages, however. It is now up to the investor to make his own due diligence,” he said.

“I think it is a huge step and a very important one. The investment market is totally overpopulated. Initial coin offerings are a way to bring back the freedom to people to invest in where they want and how they want.”

Protecting yourself

The risks come from the lack of regulation in the space, with no country so far having come up with clear legislation on initial coin offerings. This will inevitably change, and there were small steps this week with a release from the U.S. Securities and Exchange Commission which said initial coin offerings might represent the sale of securities under applicable U.S. law.

“Depending on the facts and circumstances of each individual initial coin offering, the virtual coins or tokens may be securities,” the Securities and Exchange Commission said.

While it makes up its mind, the Securities and Exchange Commission released a raft of advice for people thinking about participating in an initial coin offering, warning over the possibilities of fraud or hacking.

“Virtual currency exchanges and other entities holding virtual currencies, virtual tokens or coins may be susceptible to fraud, technical glitches, hacks, or malware. Virtual tokens or virtual currency may be stolen by hackers,” it said.

“Investing in an initial coin offering may limit your recovery in the event of fraud or theft.  While you may have rights under the federal securities laws, your ability to recover may be significantly limited. If fraud or theft results in you or the organisation that issued the virtual tokens or coins losing virtual tokens, virtual currency, or fiat currency, you may have limited recovery options.”

It advises, before investing in an initial coin offering, asking whether the virtual tokens or coins are securities and whether the persons selling them have registered the offering.

“If a promoter states that an offering is exempt from registration, and you are not an accredited investor, you should be very careful – most exemptions have net worth or income requirements,” the Securities Exchange Commission said.

“Although initial coin offerings are sometimes described as crowdfunding contracts, it is possible that they are not being offered and sold in compliance with the requirements of Regulation Crowdfunding or with the federal securities laws generally.”

It also recommends asking what your money will be used for and what rights the virtual coin or token provides to you.

“The promoter should have a clear business plan that you can read and that you understand. The rights the token or coin entitles you to should be clearly laid out, often in a white paper or development roadmap,” the Securities Exchange Commission said.

“You should specifically ask about how and when you can get your money back in the event you wish to do so. For example, do you have a right to give the token or coin back to the company or to receive a refund? Or can you resell the coin or token? Are there any limitations on your ability to resell the coin or token?”

It also recommended asking whether the blockchain is open and public, whether the code has been published, and whether there has been an independent cybersecurity audit.

“Fraudsters often use innovations and new technologies to perpetrate fraudulent investment schemes,” the Securities Exchange Commission said.

“Fraudsters may entice investors by touting an initial coin offering investment “opportunity” as a way to get into this cutting-edge space, promising or guaranteeing high investment returns. Investors should always be suspicious of jargon-laden pitches, hard sells, and promises of outsized returns.  Also, it is relatively easy for anyone to use blockchain technology to create an initial coin offering that looks impressive, even though it might actually be a scam.”

Tom Jackson is the co-founder of tech news and research platform Disrupt Africa and a journalist covering innovation on the continent from the Cape to Cairo.