Now that we've examined the various regulations applicable to cryptocurrencies,
I'd like to discuss a variant of cryptocurrency,
known as Initial Coin Offering or ICO,
which is the process whereby a digital token is created on
a blockchain is part of a de-centralized software protocol.
ICOs rose to prominence in 2017,
and continue to be a prominent source of
fundraising for startups that have yet to launch their product or service.
We will discuss the regulations applicable to ICOs in the next lecture.
But we first need to understand what ICOs are and how the market has evolved.
Initial Coin Offerings allow companies to raise money by creating and
selling a digital token on a blockchain in exchange for cryptocurrency,
typically Bitcoin or Ether.
Some blockchain tokens function as a digital currency.
Other tokens can represent our right to tangible assets like gold or real state.
Blockchain tokens can also be used in new protocols
and networks to create distributed applications.
These tokens are sometimes referred to as AppCoins,
utility tokens or protocol tokens.
Then there are some Initial Coin Offerings that are
intended to be nothing more than a speculative venture.
Most Initial Coin Offerings are conducted on
the Ethereum blockchain which was designed to support decentralized applications.
Why would a company issue an ICO?
Well, the biggest benefit is that it provides an economic incentive
for your network to get off the ground and overcome the classic chicken and egg problem.
In other words, it gives all users of your app or software the ability to
own a little piece of your network
incentivizing them to start using it from the beginning.
This gives the network a higher chance of success with a lot less initial capital needed.
There are essentially two types of ICOs; pre-release and post-release.
Pre-release ICOs have historically been the more common and can be conducted in VR,
digital currency or some combination of the two.
As the name implies,
pre-release ICOs occur when a project needs funds to develop a product or service.
Post-release ICOs occur when a project has launched an initial version of
their protocol and corresponding token
and wants additional funds to continuous development.
Now, let's review the steps that should be followed if a company wants to issue an ICO.
Note that I said should,
not all ICOs will follow these exact steps,
but doing so will help maximize the funds raised while also staying on
the right side of the applicable regulations
which we will discuss further in the next lecture.
Step one is to publish a detailed white paper that
describes a network you are trying to build and what it will be used for.
The white paper should provide a clear and compelling reason
for the digital token to exist,
provide a detailed technical description of
the proposed project implementation and set
clear expectations for total token supply and distribution.
Step two is to provide a detailed development roadmap
that will include estimates of time and costs
for each stage of the project and the names
of key members of the development team and their advisors.
The roadmap should allocate funding for each stage of
development and consider restricting access to funding until milestones are achieved.
Step three is to use an open public blockchain and publish all the code for your project.
This provides transparency and enables
real participation from token holders and independent developers.
Step four is to use clear,
logical, and fair pricing and the token sale.
This includes setting the maximum number of tokens to be sold in
a crowd sale and using a pricing mechanism which is not increase over time.
Step five is to determine the percentage of tokens to be set aside for
the development team to reward them for the work they put into the project.
The final step or warning if you
will is to refrain from marketing the token as an investment.
Tokens promoted as investments most likely
qualify as securities subject to SEC registration.
We'll talk more about this in the next lecture.
But for now, just know that most token issuers do not want to register with the SEC.
Prior to 2017 Initial Coin Offerings were essentially unheard of.
As we can see in this chart at the beginning of 2017,
there had been $300 million raised all time through ICOs.
By the end of 2017,
$5.86 billion have been raised through ICOs.
In December 2017 alone $1.4 billion was raised through ICOs.
This remarkable growth on ICOs is hard to explain.
Certainly, the massive increase in the value of
cryptocurrencies that occurred in 2017 played
a big role as a greater familiarity with and adoption of blockchain technology.
However just like with cryptocurrencies,
human psychology has played a major role.
Many people have been buying ICOs simply because they think they can sell it for
a higher price later and could care less about the tokens underlying utility.
Thus, it is possible the ICO market could be in the midst of a speculative bubble and if
the SEC were to dip all ICOs to be Securities subject to SEC registration,
the bubble would quickly burst.
But as we will talk about in the next lecture,
thus far the SEC has taken a more measured approach to regulating ICOs.
Lee Reiners, CFAExecutive Director, Global Financial Markets Center
