The murky world of cryptocurrencies has exploded into the mainstream lately. That tends to happen when an investment like bitcoin BTCUSD, +4.44% surges almost fourfold over the past year.
Understandably, there’s been a gold rush to uncover more of these kinds of returns, which has led to massive growth in the crypto market. In fact, there are more than 800 different cryptocurrencies out there right now, according to CoinMarketCap.com.
Many of these digital currencies boast odd names like “psilocybin” and “the vegan initiative.” Sounds ridiculous, and maybe it is, but the total crypto market cap now stands at a whopping $87 billion.
So how did these come to be? ICOs. Lots and lots of ICOs.
What is an ICO?
An ICO, or initial coin offering, is sort of like an initial public offering, but with a crypto twist and without the regulatory hoops to jump through, although this could be changing in a big way (more on that in a bit).
In the simplest terms, an ICO is a fundraising means in which a company attracts investors looking for the next big crypto score by releasing its own digital currency in exchange, typically, for bitcoin.
You’ve probably never heard of most of these, but there have been a few ICOs in recent years you most certainly have read about by now.
Take ethereum, for example. Back in 2014, the ethereum ICO raised $18 million in bitcoin, or the equivalent of 40 cents per ether. After a huge spike, ethereum is now trading above $200 with a market cap of approaching $19 billion.
One ICO startup recently attracted more than $150 million in just three hours, and more than $1.3 billion reportedly has been raised overall so far this year. The number of ICO sales concluding each week has almost doubled from an average of 1.5 sales a week in 2016 to 2.75 sales a week for the first four months of 2017, according to Smith and Crown data.
The demand is there, but so are the risks.
What’s the downside?
While it’s been great for ethereum, Charles Hoskinson, ethereum network co-founder, says it’s just a matter of time before it all blows up.
“It’s a ticking time-bomb,” he told Bloomberg. “There’s an over-tokenization of things as companies are issuing tokens when the same tasks can be achieved with existing blockchains. People are blinded by fast and easy money.”
ICOs tap into that thirst for the “fast and easy” and attempt to raise money quickly by bypassing the regulated fundraising process typically required by banks or venture capitalists. Obviously, that sounds extremely dicey for the uninitiated, and that’s why the Securities and Exchange Commission on Tuesday said it’s entering the fray.
The SEC’s report states that “tokens offered and sold by a ‘virtual’ organization known as ‘The DAO’ were securities and therefore subject to the federal securities laws.” The DAO raised more than $100 million in a crowdsale last year before a hacker managed to steal tens of millions of dollars worth of digital currency, leading to the DAO’s collapse.
The SEC is looking to prevent that from happening again.
“The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, co-director of the SEC’s enforcement division.
What are the red flags?
Here’s the SEC’s warning list of fraud signals, which applies to much of what you might across in the ICO market at this point:
“Guaranteed” high investment returns. There is no such thing as guaranteed high investment returns. Be wary of anyone who promises that you will receive a high rate of return on your investment, with little or no risk.
Unsolicited offers. An unsolicited sales pitch may be part of a fraudulent investment scheme. Exercise extreme caution if you receive an unsolicited communication—meaning you didn’t ask for it and don’t know the sender—about an investment opportunity.
Sounds too good to be true. If the investment sounds too good to be true, it probably is. Remember that investments providing higher returns typically involve more risk.
Pressure to buy RIGHT NOW. Fraudsters may try to create a false sense of urgency to get in on the investment. Take your time researching an investment opportunity before handing over your money.
Unlicensed sellers. Many fraudulent investment schemes involve unlicensed individuals or unregistered firms. Check license and registration status on Investor.gov.
No net worth or income requirements. The federal securities laws require securities offerings to be registered with the SEC unless an exemption from registration applies. Many registration exemptions require that investors are accredited investors; some others have investment limits. Be highly suspicious of private (i.e., unregistered) investment opportunities that do not ask about your net worth or income or whether investment limits apply.
While some fear that the SEC report could kill the ICO boom, Carol Van Cleef, a fintech lawyer at BakerHostetler, offers up a different view.
“The SEC’s announcement… is not a surprise and definitely does not mark the end of the road for tokenizations,” she said. “In fact, it should have a very positive effect on the token market. It removes uncertainty in the market and clarifies the SEC will not consider all tokens to be securities.”
Spencer Bogart, head of research for Blockchain Capital in San Francisco, agrees with Van Cleef.
“I don’t think this is bad for the future of ICOs, we all knew the SEC would exercise authority where appropriate,” he said. “In a lot of ways, the regulatory uncertainty is worse for the industry than any actual regulatory outcome.”
That doesn’t mean you should jump right in, of course.
“Retail investors should tread carefully with ICOs if not avoid them altogether,” Bogart warned. “This entire ICO model is still very much experimental. We spend all day every day parsing the opportunities and, even then, it’s very challenging so I think its very difficult for retail investors to separate the good from the bad.”
Any of those will link you up with the company promoting the initial coin offering. But from there, it’s important to do your own deep dive before even contemplating putting any money in the game.
”At a minimum, investors should try to learn as much as possible about the projects themselves across all the various mediums (forums, social media, etc),” Bogart cautioned. “Also, be wary of what the team themselves claim about the potential and viability of what they’re trying to build.”