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ICO Fundamentals: Empowering or Misleading Investors?

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ICO Fundamentals: Empowering or Misleading Investors

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The year 2018 saw the dramatic decline of the initial coin offering (ICO) market. January began with an outstanding USD one and a half billion invested into ICOs, with this figure trickling down to less than USD 200 million per month as the year closed. 

So, what killed the booming ICO industry? In large part, the US government crackdown and the relatively poor performance of the cryptocurrency market seemed enough to scare off investors last year.

Token offerings are an innovative way for startups with solid proof of concept to raise capital should the option of collateral needed to take out a business loan be lacking, or the lack of contacts or skills needed to secure capital from institutional investors.

Through the examination of recent studies from both academics and journalists, it can be observed that the biggest threat to the industry is posed by irresponsible startups that are either reluctant to keep investors fully informed, or purposefully misleading them. If the ICO market can be regulated in a way that avoids stifling innovation, it is suggested that the token model can become the most dominant form of venture capital financing.

Transparency, Truth, and What ICOs Need to Survive

One theory presented by Jiri Chod and Evgeny Lyandres suggests that investors have as much to gain as do the entrepreneurs holding the ICO – as long as there is no disparity of information available to the investors, however. And that would seem to be one of the most predominant issues cited against startups holding ICOs; offering false or exaggerated promises of returns, or whitepapers full of fraud and plagiarism.

Indeed, the Wall Street Journal investigated the details of 3,291 whitepapers pertaining to ICOs, finding that over 2,000 of them included terms “nothing to lose, guaranteed profit, return on investment, highest return, high return, funds profit, no risk, and little risk,” language that has previously led US state and Federal regulators to issue cease and desist orders or file charges. Some 16% of the whitepapers were found to show evidence of either plagiarism, identify theft or the promise of ”implausible returns.”

Many see government regulation of the sector as an appropriate way to manage the risks posed to investors and hold startups accountable to their claims. Chod and Lyandres theorize that if this is the case, ICOs have the chance to ”dominate traditional venture capital (VC) financing.” Others, however, argue that too much intervention would likely stifle innovation in the sector. US-based cryptocurrency exchange Kraken has said that the cost of handling subpoenas is becoming a ‘‘barrier to entry” for new exchanges. 

Chod and Lyandres concludes: ”An implication is that while regulating ICOs is desirable, banning them outright is not.”

The Role of Tokenomics

Another academic paper that delves into tokenomics is authored by Lin William Cong, Ye Li, and Neng Wang entitled Tokenomics: Dynamic Adoption and Valuation. It outlines a model that can be used to predict the future growth of tokens that act as a means of payment on their native blockchain platforms, with the premise of an argument centered around the notion that the expected popularity and technological progress of the project renders the token as an ”attractive store of value,” .promoting further adoption.

Again, during the ICO stage, a parity between investor and startup in terms of the project’s realistic roadmap is required in order for this model to successfully play out.

The paper also outlines some of the benefits blockchain platforms can enjoy by using a token economy: ”Tokens… can accelerate adoption, reduce user-base volatility, and improve welfare.”

The US SEC Crackdown: Warranted or Not?

While the US Securities and Exchange Commission (SEC) has received criticism for its actions against ICOs last year, examining several of the public cases individually shows that perhaps the actions of the government agency were necessary in order to keep investors fully informed on their decisions, as the research shows that it is required to promote a healthy ICO market.

In the case of AriseBank, the SEC halted the ICO after proving that the startup had falsely claimed to be FDIC-insured bank which would have allowed the decentralized bank to offer customers FDIC-insured accounts. The SEC cited that AriseBank had ”used social media, a celebrity endorsement, and other wide dissemination tactics” to raise a claimed USD 600 million of its USD 1 billion goal in two months.

One of the benefits of ICOs cited by Chod and Lyandres is the unique ability of tokens to allow entrepreneurs to shift some of the venture risks onto investors without compromising their own control rights. This could be the biggest benefit of token offerings for startups, but for it to revolutionize venture capital financing in a way it is capable of, investors need to be made aware of the risks by entrepreneurs.

2019: What to expect

The future of ICOs in 2019 depends on three major factors: US regulation, transparency from startups, and the market performance of major cryptocurrencies.

Chairman of the US SEC Jay Clayton himself has said ”ICOs can be effective ways for entrepreneurs and others to raise capital,” so long as you adhere to the regulations set by his agency at least.

Tokenomics is a cutting-edge theory with the potential to revolutionize the structure of business development and entrepreneurship, but for it to live out these prospects, right now, startups would be advised to professionalize their whitepapers and start playing by the rules at least until the industry can prove it has matured.

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