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Are initial coin offerings legal?

Already in 2017, ICOs have raised $3.6 billion. In 2016, the total was $96 million. So, it would be easy to assume that 2018 will see Initial Coin Offerings reach record numbers, wouldn’t it?

ICOs are seen by many as the future of fundraising. In a world of digital startups, they offer an alternative to the time-consuming and complicated traditional routes of borrowing or issuing shares in the company.

An ICO sells tokens to investors who have read up about the project through its white paper. These tokens are in bitcoin, or some other cryptocurrency, and is converted back into fiat money to pay for any costs.

The project sets a target, that if reached, increases the token’s values significantly – and the project’s worth quickly goes up too. What’s more, these tokens can be traded between investors, at any point, leading to increased liquidity.

So, why are ICOs controversial?

The risk factors associated with ICOs have attracted criticism. These include:

Lack of regulation – most ICOs are done outside of FCA regulation or carried out overseas.

No investor protection – very few ICOs will be covered by regulatory protection like the Financial Ombudsman Service or the Financial Services Compensation Scheme.

Documentation – an ICO’s white paper could be misleading or unbalanced – and there are fears it could lack the regulation of a traditional prospectus.

Risk of fraud – There is a fear amongst some parties that ICOs provide a great opportunity for fraudulent activity. Firstly, there is no centralised control – and no legal entity around the fundraising. There are also cybersecurity issues around cryptocurrencies. And on top of this, there is, in many cases, no contractual protection in the agreement.

But, ICOs are in their infancy. And the practices and terminology are changing month by month. There are ongoing debates about various aspects – are coins the same as tokens? Are token sales the same as crowd sales? Should fiat currency be avoided completely?

The one thing everyone interested in ICOs can agree on is trying to strike a balance that provides a safe, effective alternative to traditional capital raising processes.

ICOs have been rumbling around since 2013, but 2017 was the year when they first learned to walk – and experienced some major stumbles.

In July 2017, the Securities and Exchange Commission (SEC) in the USA published a report on the controversial DAO sale. This was an ICO that was hacked a month after the sale closed, with $50 million worth of ether lost. The SEC have now taken over the regulation of token sales in the States. As a result of this, many ICOs have refused to take on any US investors.

Then just days after, the People’s Bank of China announced that all ICOs carried out in the country would be regarded as illegal. The government then demanded that all Chinese investors who have been involved in ICOs are to be refunded.

In the UK, the FCA issued a consumer warning that ICOs are “very high risk speculative investments.” According to the regulatory body, ICOs must be weighed up on a case-by-case basis – in some situations, the tokens are equal to transferable securities and therefore fall under the prospectus regime.

It was also recommended that any businesses who are involved in an ICO should seek advice on whether their activities need to be authorised by the FCA – a fairly ambivalent point of view, in comparison to other countries.

What is clear with ICOs, however, is that the rules are in constant flux. Anything that breaks the traditional funding mould is bound to cause schisms while it works itself out. While ICOs continue to refine processes, the authorities are reaching for the panic button. What is clear, though, is with the right legal and financial advice, ICOs can be an incredibly attractive prospect for the investor and a game-changing way to raise funds for a business.

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