A Critical Appraisal of Initial Coin Offerings

Abstract

AbstractInitial Coin Offerings (ICOs) emerged in 2017 as a revolutionary form of raising capital by technology companies and investment vehicles. ICOs enable start-up companies to issue blockchain-based assets (‘digital tokens’) to the public in return for a payment in cryptocurrencies or fiat money. The fundraising objective is to finance technology projects carried out by the ‘ICO issuer’. The ICO funding model represents a financial revolution as it provides additional pools of liquidity for capital formation purposes and a powerful tool for incentivizing communities through network effects. More importantly, the latent value of ICOs lies in the usage of the raised funds to develop cutting-edge distributed ledger technologies (DLTs). The advent of ICOs mushrooming worldwide promises to democratize financing, yet the commonly unregulated space in which ICOs operate, opens up a Pandora’s Box of investment and legal risks. The present paper argues that regulation needs to be goal-orientated and for that purpose, it is crucial to identify the nature of the ICO funding model, the cryptoeconomics behind it and the legal nature of digital tokens. With ICOs, academia, economists and regulators are at ground zero. Practitioners’ first instinct is to apply the knowledge of capital markets, but ICOs are a fundamentally new model of raising funds that have spawned different dynamics from ‘traditional’ capital markets. If we can establish how to approach ICOs within their own right, then choosing the correct regulatory stance will become a matter of identifying how ICOs and markets interact and how the investment risks can be allocated. Keeping with the spirit of ICOs as a financial innovation, the paper proposes self-regulation by ICO issuers to be a suitable regulatory approach, while limiting the role of regulators to policing the secondary market of crypto-intermediaries. For the purpose of fully rationalizing this position, the paper outlines the process of carrying out an ICO, relevant benefits and risks to the model, the current state of ICO regulation, digital token characterization and merits of different regulatory approaches.