A friend of mine, a big fan of the Harry Potter series, recently planned to launch an initial coin offering (ICO) to fund a new Quidditch sports league. His new “Quidcoins,” valued at 0.009 bitcoins (BTC), would be exchangeable for discounted admission and food at select National Quidditch games around the country. He hoped to raise a maximum of 2,000 BTC ($11,000,000) over a 28-day offering period.
Unfortunately, before my friend could organize his company and raise money, he discovered that a group in Britain was in the midst of offering their own QuidCoins, named after the slang word for the British pound. While my friend was disappointed to find the name taken, perhaps it was for the best; despite sponsors’ hopes, QuidCoins traded for less than three months in 2014, according to CoinMarketCap.
ICOs promise big profits to investors, but with a failure like QuidCoin’s possible at any time, are they worth the risk? If you’ve been considering participating in an ICO, here’s what you need to know.
What Is an ICO Financing?
Entrepreneurs have historically financed their ideas by offering equity interests — or investment securities — in their ventures to external investors. Due to the abuses and corruption of financiers in the 1920s, Congress passed the Securities Act of 1933 and created the Securities Exchange Commission (SEC) the following year to enforce the Act.
In the decades since, the process of raising money from the public through an initial public offering, or IPO, has become well-established. Regulations dictate how the offering process must proceed, who is eligible to participate, when an offeror must provide information to potential investors, and what information they must provide. Failure to follow regulations can result in severe financial liability for the sponsors of an offering, including civil and criminal penalties.
An ICO is a similar fundraising tool in which an offeror sells futures in a cryptocurrency that does not yet exist. ICOs are designed to avoid the regulations that protect investors when buying or selling traditional investment securities. While an IPO must include an extensive prospectus, there are no regulations outlining what information must be provided to prospective investors in an ICO. Each offeror determines what, if any, details will be delivered and when.
Most ICOs have a website or white paper justifying the benefits of the investment, but they do not have an existing product. Offerers are startup operations, and the funds raised through the ICO will finance the development of the product — in this case, the cryptocurrency.
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