Alongside Bitcoin’s meteoric rise in global interest and
price has been a frenzy of activity around initial coin
offerings (ICO).

 

According to the online coin offering tracker Coinschedule,
in 2017 alone there have been nearly 250 ICOs collectively raising over $3
billion. This heightened interest combined with the potential for lucrative
returns has prompted fears in some investment circles that we are facing a
bubble. Indeed, the bubble seems to have already popped to some extent, with
far fewer ICOs hitting their target raises than they were a few months ago.

 

Today’s ICOs are being initiated by funding-hungry startups,
often with a blind eye toward any sort of regulatory due diligence. As a
result, this wild and reckless approach has raised the eyebrows of the U.S.
Securities and Exchange Commission (SEC) among other regulatory bodies
worldwide. The SEC, in fact, has opened a new cyber unit for cryptocurrency
violations to address the proliferation of these campaigns.

 

What’s problematic here is the lack of compliance guidance
with respect to ICOs relative to crowdfunding regulations or federal securities
law. This prevailing environment has ignited calls for stricter oversights
addressing scams and “pump and dump” schemes that are now infiltrating this
space.

 

Startups have an enormous amounts of wiggle room when
forming an ICO token. Unfortunately, many of these campaigns are launched with
little more than a hastily constructed website and white paper with the
company’s core product rarely battle-tested by real users. This heightens the
notion that reaching cash rich startup status does not ensure product success.

 

Once acquired by investors, ICO tokens can then be exchanged
in a secondary market for liquid value. In the meantime, shareholders (mostly
founding members and lead developers) often lay claim to 10 or 20 percent of
the initial tokens tied to a vesting schedule. It’s the outside token investors
that are often at risk as they, at times, find themselves subjected to “pump
and dump” and other nefarious schemes, harming the overall integrity of the
crypto landscape.

 

Navigating the Ever-Evolving ICO Landscape

 

Wally Xie, CEO of Qchain, an emerging digital
marketing, advertising and analytics platform seeking to leverage the strengths
of both NEM and Ethereum blockchain protocol, said that that while
know-your-customer (KYC) compliance really hurt his company’s recent ICO, he
felt that it was a necessary sacrifice to make in terms of long-term legitimacy
and the safe development of Qchain in the U.S.

 

“We are finding that we perhaps made the wrong move by
targeting the cryptocurrency community at large, rather than negotiating with
‘whales’ from the outset,” Xie said. “We’ve also faced lots of legal
challenges, such as having to do stringent KYC to comply with U.S. regulations,
since lots of money laundering is also happening in the space.”

 

Xie noted that similar issues involving integrity and
credibility are plaguing the industry his company is taking aim at, namely,
native advertising. He said that as that industry’s expansion leads
to improved conversion rates compared to traditional web display ads, that
has come at the cost of trust found in traditional media outlets. This erosion
of trust, he added, has helped drive a flood of people toward “fake
news” websites that make their money in confirmation biases.

 

Xie is worried that a similar scenario may be emerging in
the high stakes game of ICO funding.

 

“The ICO space is definitely changing as it is becoming
more of a pay-to-play environment,” Xie said. “Successful ICOs now typically
already receive massive pre-ICO investment from folks like Draper, so the
feasibility of an ICO for all parties involved has definitely changed. In some
ways, it’s become a less democratic process. ICOs are becoming less accessible
and stratification is starting to happen in a manner similar to what occurs in
any maturing space.”

 

Jordan Valentine, an expert specializing in emerging
technologies at Spitzberg Partners — a boutique corporate advisory and
investment firm headquartered in New York — believes that we are fast
approaching the end of the frontier days in the ICO space, if we haven’t gotten
there already. He noted that in 2017, we had seen four nine-digit coin
offerings and billions raised through ICOs. That, he said, is simply too much
money changing hands for regulators to allow this bubble to grow unfettered.

 

“Going forward, government agencies will certainly look to
be more present in the crypto world as they develop an institutional
understanding of the issues at hand,” Valentine said. “My personal hope is for
a regulatory framework that reins in some of the more reckless activity in
crypto without unduly burdening legitimate innovation.”

 

Valentine believes that this reaction is already in motion
in the U.S. In July 2017, the SEC clarified its stance on ICOs, warning that coin
offerings would be subject to U.S. securities laws. This means that coin
offerings will be judged by the Howey Test — a legal precedent for determining
whether a financial instrument is an investment contract. For U.S. investors,
this distinction connotes strict income or net worth requirements, restricting
the pool in the U.S.

 

“Digital coins can be used to confer a wide range of rights
in addition to value, so their application under securities law isn’t exactly
straightforward,” said Valentine. “Interest in coin offerings will likely be
tempered a bit in the short term, as would-be investors wait for further
regulatory clarity and watch as the first penalties are doled out. However, the
allure of finding a big win will be enough to keep this fundraising mechanism
relevant, barring a serious clampdown from Washington.”

 

When asked about the prevailing trend toward launching
an ICO campaign without a demonstrated product or service, Valentine is
skeptical.

 

 “An ICO backed only by a white paper and a webpage is,
in the best case, an incredibly questionable gamble; in the worst cases, these
raises are outright predatory, with the organizers bailing as soon as
possible,” he said. “Even in the case of a ‘good’ white paper ICO, buyers are
taking on huge risk, as they generally do not acquire any right to information
or managerial discretion.”

 

But Valentine offers this reminder:

 

“While most coin offerings are very much a long shot bet to
the buyer, they’re not all scams. There are a number of potentially
paradigm-changing ideas supported by a token that merit the attention of the
savvy and adventurous.”  

In response to sceptics, Xie said that Qchain made sure to have a fully-tested,
ready-to-employ platform in advance of launching its ICO campaign to avoid
giving the crypto industry a bad name.

 

“In terms of our product, we didn’t want to espouse a ‘break
first/fix later’ ethos that has come to dominate Silicon Valley, made infamous
by such companies as Uber and Zenefits,” he said. “Funding is critical, but the
quality of what we are delivering will always come first.”