What is the issue?
- Globally, there has been a silent boom in ICO fund-raising, with much of the action focussed on Europe and North America.
- With global regulators issuing warnings about this sprawling market, it is essential to understand its working and the risks associated with it.
What is an Initial Coin Offering (ICO)?
- An Initial Coin Offering (ICO) is used by the startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.
- More accurately known as token sales, ICOs are unregulated means of raising money from public investors, to finance a startup.
How does it work?
- When a startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper.
- It specifies the following:
- what the project is about
- what need(s) the project will fulfil upon completion
- how much money is needed to undertake the venture
- how much of the virtual tokens the pioneers of the project will keep for themselves
- what type of money is accepted
- how long the ICO campaign will run for
- During the ICO campaign, interested public investors buy some of the distributed cryptocoins with fiat or virtual currency.
- These coins are referred to as 'tokens'.
- These are much similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction.
What are the different kinds?
- 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 reflect the success of the Bitcoin or Ether.
- These ICOs are attractive with the fact 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 startups.
- Simply, a percentage of the cryptocurrency is sold to early supporters of the project.
- This is in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin.
- It represents an informal ownership share in the business they fund.
- The expectation is that the tokens will appreciate in value with the underlying business.
How is it different from the IPOs?
- Essentially, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project.
- The word ‘informal’ is key to understanding the concept of ICOs.
- In an IPO, the rights in the case of shares bought are legally protected by the elaborate securities market regulations.
- On the other hand, the legal status of ICO ‘tokens’ is uncertain because many countries, including India, haven’t yet framed any regulations in this regard.
- Also, companies that raise money through IPOs are required to file and get approval for a detailed prospectus from regulators.
- They are also required to provide ongoing disclosures to investors.
- ICOs, however, evade all these rules and simply issue a white paper sketching out business plans.
What is the concern?
- One of the reasons for the recent interest in ICOs is certainly the multifold rise in prices of virtual currencies such as bitcoins.
- India is also seeing a spell of startup action around the virtual currency and blockchain ecosystem.
- However, the regulatory status of ICOs is not firmly established in India.
- The RBI has warned investors of the risks of experimenting in virtual currencies and is considering regulating crytocurrencies.
- On the other hand, SEBI is yet to express its official views on ICOs.
- Notably, even SEBI’s global counterparts are still grappling with the issue of whether to treat digital tokens as ‘securities’.
- Given the absence of any kind of regulatory framework in place, venturing into ICOs would be risky for the public investors.
- Notably, funds that are lost due to fraudulent initiatives may not be recoverable.
Source: BusinessLine
