05 Dec 2017 15:48 IST

All you wanted to know about Initial Coin Offerings

ICOs raise money from public investors to bankroll a start-up

Worried that the Indian IPO market is warming up too quickly? Well, global regulators have been issuing warnings about another market that’s already sizzling hot – the one for Initial Coin Offerings or ICOs.

A couple of weeks ago, the European Securities and Markets Authority, Europe’s SEBI, alerted investors that there was ‘high risk of losing all their capital’ on ICOs. A week before that, the US Securities Exchange Commission cautioned celebrities on endorsing ICOs after Paris Hilton and professional boxer Floyd Mayweather plugged them on Twitter.

What is it?

More accurately known as token sales, ICOs raise money from public investors to bankroll a start-up. But instead of the shares you acquire in an IPO, ICOs allot digital ‘tokens’ which represent an informal ownership share in the business they fund.

Two kinds of ICOs are active in the market. One type raises money to fund a new virtual currency or blockchain project that aims to mirror the runaway success of the Bitcoin or Ether. These ICOs hold out the lure that the tokens can be exchanged for the new virtual currency, once it takes off. The other set of ICOs simply raise money to fund tech start-ups. Here, token sales replace traditional capital sources such as angel funding, crowdfunding, venture capital funding or even IPOs. The expectation is that the tokens will appreciate in value with the underlying business.

The word ‘informal’ is key to understanding ICOs. While your rights in the case of shares bought in an IPO are legally protected by the elaborate securities market regulations of your country, the legal status of ICO ‘tokens’ is up in air because many countries, including India, haven’t yet framed any regulations for them.

Companies that raise money through IPOs are required to file and get approval for a detailed prospectus from regulators and provide ongoing disclosures to investors. ICOs, however, skirt all these rules and simply issue a white paper sketching out business plans.

Why is it important?

Globally, there has been a silent boom in ICO fund-raising, with much of the action focussed on Europe and North America. A recent report by Atomico, a European venture capital firm, noted that coin offerings had raised over $3 billion since 2014, with the bulk of the money raised in the last one year. One of the reasons for the recent interest in ICOs is of course, the runaway rise in prices of virtual currencies such as bitcoins, which is up ten-fold this year. Then, of course, there’s hope that the recent crop of ICOs will replicate past success stories such as Ethereum. The Ethereum project launched an ICO in 2014 to develop smart contract applications based on the blockchain technology. It has seen the value of its digital token — Ether — shoot up from $1 to over $480.

Why should I care?

India is also seeing a flurry of startup action around the virtual currency and blockchain ecosystem. But if your interest is piqued, do note that ICOs operate in a regulatory limbo in India. The RBI has warned investors of the risks of dabbling in virtual currencies and is looking into whether it should regulate them. SEBI is yet to express its official views on ICOs. Given that SEBI’s global counterparts are still grappling with the issue of whether to treat digital tokens as ‘securities’, it may be some time before there is any kind of regulatory framework for ICOs in place.

The bottomline

Sure, virtual currencies and ICOs are a red-hot trend. But keep in mind that it’s your real money that you’d be betting on them.

(The article first appeared in The Hindu BusinessLine.)