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Party's over for ICOs!

A new way for companies to raise funds, ICOs boomed in 2017. But the speculative bubble is about to close as the market starts to come under regulation.

It is the latest chapter in a book that is still on everyone’s lips. On Thursday, 26 July, the Swiss financial market supervisory authority (FINMA) announced that it had initiated proceedings against Envion. The young, Zug-based crypto mining company launched an initial coin offering (ICO) in late 2017. This new fundraising option, halfway between an initial public offering (IPO) and crowdfunding, landed the company nearly 100 million Swiss francs from 30,000 people in one month. This record-high amount surpassed all expectations and raised a lot of hopes.

Alas, in February 2018, the dream turned into a nightmare for investors. On the back of suspicions of fraudulent practices within the company, Envion’s value came crashing down. FINMA has information indicating that Envion may have breached financial market law over the course of its ICO. The investigation by the financial markets authority has only just begun, but investors who believed in the project lost everything, or almost.

 

"A variety of unprofessional deals were conducted in 2017"

Matthias Weissl, co-founder and CEO of Verum Capital, a Zurich-based ICO and blockchain advisory firm

 

The case is hardly exceptional. For example, in Vietnam, the founders of the company Modern Tech vanished after pocketing more than $600 million via two ICOs. In the United States, Dominic Lacroix, the former CEO of PlexCoin, is behind bars following a fraudulent ICO ($15 million raised), while another $2.9 million vaporised with the start-up Opair and Ebitz.

SUPERVISORY AUTHORITIES CRACKING DOWN

“A variety of unprofessional deals were conducted in 2017, including in Switzerland”, says Matthias Weissl, co-founder and CEO of Verum Capital, a Zurich-based ICO and blockchain advisory firm. “And many cases around the globe have raised millions, but turned out to be scams.”

How could that be? To answer that question, we have to understand how capital is raised using cryptocurrencies and blockchain technology.

Basically, what happens is that a company in need of financing can launch an ICO. Interested investors take part by paying in cryptocurrencies (usually Bitcoin or Ether). And, exactly as with an IPO, the offering is public, so anyone can invest. One key difference is that, in exchange for their money, investors do not receive an interest in the company in the form of shares, but rather in tokens. Similar to crowdfunding, most of the time these tokens grant rights to use the company’s products or services.

“A lot of people think of ICOs as regular fundraising,” says Jonathan Llamas, co-founder of Verum Capital. “But they’re much more than that. As with crowdfunding, you have to convince a community why they should invest in your project.” Yet there is a slight difference, in that tokens can often be sold, hence the speculation. A Token Report study stated that only 10% of the tokens issued are used by buyers to enjoy the issuer’s services. The other 90% are kept purely for speculation in a totally unregulated market, the perfect setting for deception.

SWITZERLAND PAVING THE WAY

The figures are dizzying. In 2017, nearly 350 ICOs took place worldwide, bringing in $5.5 billion, compared with $256 million raised by 43 companies the previous year, says the US website Coindesk ICO Tracker, a leading ICO resource. Even though these fundraising rounds often end up a failure – a Morgan Stanley report estimates that a third of ICOs never get anywhere – the trend is nowhere near dying down. Quite the opposite, in fact. More than 400 ICOs were completed over the first seven months of 2018, raising a grand total of $14 billion.

That rapid growth resulted in governments taking a closer look. China’s central bank decided to flat out ban ICOs. Financial market supervisory authorities in the United States, United Kingdom and France have officially warned citizens of the risks involved in these deals and are working to introduce appropriate regulations.

 

"Having clear rules will reassure investors deterred by the many scandals in 2017"

Jonathan Llamas, co-founder of Verum Capital

 

But the swiftest to act were the market authorities in Switzerland, where one third of the biggest ICOs took place in 2017. In February 2018, FINMA published a guide explaining how it deals with ICOs, thus confirming that oversight and sanctions do apply to this nascent business.

“Things were totally chaotic in 2017. Little investor protection, hype-driven and risky, because it was too easy for companies to raise a lot of money through ICOs. And that means ICOs will be used by some in the wrong way.” says Weissl. “Fortunately the bubble is over. The market is being cleaned up, in part thanks to FINMA’s efforts. It’s a very positive signal for the future. This year, we have noticed that the projects are more viable than before, and that lots of ideas are rejected in the first stages of ICOs.”

However, could FINMA’s regulations stifle the Swiss-made ICO before it really gets off the ground, sending deals to places that make less of a fuss, such as Malta or Gibraltar? “On the contrary,” Llamas says. “Switzerland remains particularly attractive, and having clear rules will reassure investors deterred by the many scandals in 2017.”

It would certainly be a pity if investors shied away from ICOs, as this system of financing seems to work. In June 2018, the US company Block.one raised a record $4 billion via an ICO, and investors are likely to reap the benefits.

But one should take heed. “ICOs are not currently designed for mainstream investors. People have to understand how blockchain technology and tokens work before getting started,” warns Weissl. “The market is risky, and amateur investors could get swindled. People still have a lot to learn about these technologies.” To prevent scams, thorough due diligence is required.

 
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