“Get rich quick!” has been the siren call for people since we used shells and feathers for currency. Efficient, regulated marke ts encourage competition, which is great for buyers. However, it introduces friction for sellers and makes it harder to profit from playing by the rules.
Naturally, wily humans look for shortcuts. From early Initial Coin Offerings (ICOs) to pyramid and Ponzi schemes, the crypto space has seen its fair share of shortcut attempts.
The ICO craze was a time of explosive growth and speculative frenzy in the cryptocurrency space that peaked in 2017 and early 2018. During this period, thousands of startups and blockchain projects raised billions by selling tokens to investors. By 2019, crypto ICOs for crypto, platforms, and business services had earned US $31.7 billion.
Unsurprisingly, billions of dollars raised outside conventional channels included high-profile fraudulent activity. Some issuers also saw ICOs as a way to get around SEC oversight of the IPO process.
Regulators began to take note. Some countries banned ICOs outright, while others introduced guidelines and requirements to protect investors and combat fraud. Following the peak of the ICO craze, the market witnessed a significant cooling-off period. Many ICO projects failed to deliver on their promises, leaving investors with worthless tokens. This result increased scrutiny and skepticism within the cryptocurrency and investor community.
The aftermath of the ICO craze has led to increased regulatory scrutiny and a shift toward more compliant fundraising methods, such as Security Token Offerings (STO), as the cryptocurrency industry continues to evolve.
This blog post will explore ICOs and STOs. Whether you’re an experienced crypto investor or a newcomer, understanding these options is crucial to making informed investment decisions. It is not financial advice. Please seek independent legal, financial, tax, or other advice specific to your situation.
What are Initial Coin Offerings?
ICOs are a fundraising tactic. For example, startups use ICOs to secure capital to develop their projects while giving early investors access to potential future value. These tokens represent ownership or utility within a blockchain project.
The ICO Process
Launching an ICO involves several key steps. First, developers create a detailed document, or whitepaper, outlining their project, technology, and tokenomics. They then create the tokens on a blockchain platform using smart contracts.
The team markets the project to investors who may purchase tokens with cryptocurrencies like Bitcoin or Ethereum. The tokens are then listed on cryptocurrency exchanges to enable trading that hopefully increases the token’s value over time.
Benefits and Risks of ICOs
On the positive side, ICOs may grant investors access to early-stage investments that were previously the domain of venture capitalists and accredited investors. What does that mean?
Apart from friends and family money or small bank loans, the SEC considers most large early-stage investment offerings securities investments and regulates them accordingly. The SEC says that only accredited investors may participate in securities offerings.
An accredited investor is someone with a net worth of over $1 million, excluding primary residence (individually or with spouse or partner) and an income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years.
The assumption is that accredited investors are more sophisticated and can withstand financial loss more easily than people with less money.
Critics of the accredited investor rule maintain that it narrows opportunities for all investors and has the effect of helping the rich get richer by limiting access to lucrative opportunities.
As long as an ICO doesn’t meet the criteria of a security in the eyes of the SEC, anyone can participate in the ICO. Some see ICOs as a democratization of investment opportunities that have allowed retail investors to participate in innovative blockchain projects early, potentially reaping substantial rewards if the project succeeds.
An additional allure of ICOs lies in the possibility of achieving remarkable returns on investment, similar to early Bitcoin investors who saw exponential growth in their holdings.
However, outsized potential usually corresponds to significant risk. A primary concern is the lack of regulatory oversight. The absence of clear guidelines and accountability made it easier for unscrupulous individuals to launch fraudulent schemes, leading to significant investor losses.
After the ICO bubble burst and regulators cracked down, ethical players in the ICO space intensely focused on utility, governance, and investor protection.
Utility tokens emerged with ICO that serve practical purposes beyond speculative trading, increasing their real-world value and adoption. Secondly, governance models with ICOs offer tokens that give holders a stake and a voice in project decisions, promoting transparency and community involvement. Lastly, many ICO projects now implement advanced security features to safeguard investors’ assets and build trust in crypto.
ICOs and the SEC
The current position of the US Securities and Exchange Commission (SEC) is that ICOs may be securities offerings and fall under the SEC’s jurisdiction. If so, they likely need to be registered with the SEC or fall under an exemption. In addition, calling a token a “utility” token is not an automatic stay-out-of-jail-free card. A utility token may still be a security subject to SEC regulations.
In other words, it all depends on the details of the ICO. Not all ICOs must register, but if an unregistered ICO meets SEC criteria as a security, the issuers run the risk of legal action and fines for securities violations.
ICO Volatility Risk
ICOs are highly volatile. The prices of ICO-issued tokens can fluctuate wildly, driven by market sentiment and speculation rather than the fundamentals of the project. Volatility exposes investors to significant risk, so careful research and risk assessment are essential when considering ICO investments.
Investors should conduct thorough due diligence before participating in an ICO. Research the project team, whitepaper, and community sentiment. Familiarize yourself with common scam models and be cautious of projects with anonymous teams or vague documentation. Consider participating in ICOs that prioritize investor protection. Or, if you can qualify as an accredited investor, you might consider STOs.
Understanding Security Token Offerings (STO)
STOs are a fundraising method similar to ICOs but with critical differences. STOs offer tokens that represent ownership in an underlying asset. Examples of STOs include tokens in gaming, NFTs, stablecoins, real estate, commodities, and established businesses looking to scale.
STOs don’t dwell in SEC limbo; they are subject to securities regulations. As such, they are available to a smaller pool of investors and offer enhanced protection.
Benefits and Challenges of STOs
STOs offer a range of benefits for investors and businesses alike. Firstly, they provide investors access to traditional assets such as stocks and real estate through innovative tokenization processes. Secondly, STOs prioritize enhanced investor security and legal protections, offering peace of mind to participants through compliance with existing securities regulations.
Finally, STOs hold the potential to increase liquidity and reduce transaction costs by streamlining the trading process, making it more efficient and cost-effective.
Challenges of STOs
While STOs offer several benefits, they also come with challenges. Firstly, the costs and complexity for issuers associated with regulatory compliance can be substantial. Navigating the intricacies of securities laws and regulations requires expertise and resources.
Secondly, because STOs are only available to accredited investors, some say they contribute to income disparities by providing more lucrative investment opportunities for wealthy investors.
Additionally, STOs face market adoption and liquidity hurdles, as the ecosystem is still nascent, resulting in limited trading activity for some tokens. Educating investors and regulators about this relatively new fundraising method is a challenge in building understanding and trust in STOs.
Moving Ahead
ICOs and STOs represent two token-based yet distinct approaches to fundraising in cryptocurrency, each with benefits and risks. Conducting thorough research, staying informed about regulatory developments, and considering your risk tolerance when participating in these offerings are crucial as a cryptocurrency investor. By understanding the nuances of ICOs and STOs, you can make informed investment decisions in this ever-evolving landscape.
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This material has been prepared for informational purposes only and should not be interpreted as professional or legal advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
