Initial Coin Offering (ICO): life, death and regulation

In this life we must die several times to then reborn. And the crises, although frightening, serve to terminate an epoch and inaugurate another.

Eugenio Trías [1]

English Version:

I. Introduction

Within an unclear legal framework — and even believed non-existent — , the challenging Initial Coin Offering turned into an increasingly prominent fundraising mechanism for new companies and a great investment opportunity for retail investors, reaching overwhelming numbers all over the world during last years.

However, while the global market for ICOs became «Too big to ignore», many cases of unwanted behavior and scams occurred, generating some alarm in the participants and attracting the attention of regulators. And, along with it, at the end of the 2017 year, the "crypto winter" began.

In this context, we have been witnessing an abrupt downtrend of the ICO market from the second half of 2018, where there was no lack of experts who declared the ICO’s death. But before taking that step, it is necessary to go beyond all the frenzy period and analyse the performance of the ICO as a financial vehicle from its origins, as well as the benefits and features of the ICO, which includes face the scope of its regulation.

II. The rise and fall: a death foretold?

The advent

In the financial world reigned by intermediaries, when the efforts of regulation were focusing on crowdfunding[XNUMX], the market of capital raising were impacted by the revolutionary blockchain[XNUMX], which — from the wave caused in the payment system with cryptocurrencies — brought a new mechanism to raise funds, named by the blockchain community as Initial Coin Offering (ICO).

Following the technology on which it is based, the ICO was conceived to finance blockchain projects through the sale of tokens[XNUMX], which involves get funding with cryptocurrencies from a group of investors who believe in a specific project, in exchange of a piece of the new protocol that such project will develop in the blockchain.

As noted[5], the idea of ​​an ICO was to disintermediate the entire traditional financing process faced by new companies, and move directly from "inspiration to realization", thus leaving aside traditional financing vehicles, such as seed capital, capital of risk, private equity and Initial Public Offering (IPO).

The spread

After the launch of the first ICO in 2013 with Mastercoin, ICOs were deployed only in the blockchain ecosystem; but soon, as the cryptocurrency market grew globally with rampant speculation about its value, without a clear applicable regulation — and for that reason, without entry barriers — , the ICOs became the incredibly quickest and simplest instrument to obtain exorbitant funds and profits.

Thus, the ICOs attracted all kinds of investors (retail and institutional lately) and entrepreneurs (mostly startups and SMEs, including those with businesses that do not depend on blockchain) around the world[6]. Like the far west, but in the digital world - where the freedom of its participants prevailed - the so-called "ICO Gold Rush" broke out.

Thereby, in the pursuit of incredible[XNUMX] high investment returns on the side of investors, and large amounts of financing with only whitepapers and advertising pitches on the side of entrepreneurs, the ICO industry grew by leaps and bounds becaming an industry of billions of dollars[XNUMX], and in just XNUMX months between late XNUMX and early XNUMX— following the bullish trend of cryptocurrencies — , the ICO market boomed reaching about $ XNUMX billion[XNUMX], where for instance only Telegram raised $XNUMX billion, while EOS $XNUMX billion.

The flaws

Operating as a free market due to the lack of clear legal frameworks, its flaws easily brought investor lawsuits. The doors were opened not only to legitimate innovative business developers, but also to bad actors, who took advantage of the ICO boom, making scams or frauds (such as ponzi schemes)[XNUMX].

Indeed, while the phenomenon of ICO is new in the financial world, its market flaws are the same as always (moral hazard, adverse selection, insider trading, market manipulation, etc), and the fact that its participants acted outside existing regulatory frameworks caused these flaws were deployed throughout the ICO market, generating huge losses for investors.

The level of simplicity (KISS)[XNUMX] to raise funds was going against the standards required for an investment decision, which are guided mainly by the integrity and transparency principles in Securities Regulation.

In many cases there was an absence of due diligence, standardised financial reporting, prospectus (containing the main risk factors of the company and its businesses, the limit and destination of the resources raised and the applicable regulations for example) and corporate governance[XNUMX]. Instead, several funders of the projects released whitepapers with poor information — they even did not mention the name of the company or its address [XNUMX] — focusing on marketing techniques (using even celebrities[XNUMX]), and they did not establish or disclosure anti dilution practices (like Gnosis in April XNUMX)[XNUMX], as well as limits that indicate financing plans for their projects that justify the amounts raised (Tezos in July XNUMX[XNUMX])

Likewise, many of the investors participated in ICOs not because they believed in a specific project or the intrinsic value of one token, but because of FOMO (fear of missing out) and the greed emotion, encouraged to buy in short time periods (minutes or seconds) to obtain better bonuses, but falling in pump-and-dump schemes[XNUMX]. Thus, it has been pointed out that ICOs presented unsustainable increases away from its fundamental value[XNUMX].

The call of regulators

Evidently, this exuberant growth did not go unnoticed. Besides cryptocurrencies, the ICO market called the concern of regulators. The first responses from national regulators around the world were given: from warnings and guidances in most of the cases, to investigations with reports and shutdowns (e.g. DAO and Munchee cases from United States, published in July and December XNUMX, respectively), and outright bans (e.g. China in September XNUMX)[XNUMX].

Most regulators coincide that, although ICOs are currently not governed by specific regulations — with some exemptions like Bermuda recently — , depending on its characteristics, the tokens offered in ICOs may constitute securities or financial instruments, as well as the activities involved in ICOs may be regulated financial investments activities, and therefore, ICOs may fall under existing legal regimes.

Therefore, some ICOs may fall within the scope of initial public offerings (IPOs), private securities placement, crowdfunding or even collective investment plans, for example; whose determination will depend on the case-by-case evaluation of the financial regulators of each jurisdiction in which the ICOs are carried out, where, for example, the criteria of the famous «Try Howey" from United States[20] - which analyzes whether any transaction is an "investment contract", will be considered.

These messages warned the general public about high risks of participating in ICOs and due there are actually legal frameworks applicable to ICOs, those who are involved in conduct and activities without complying the applicable rules would constitute a breach, being subject to enforcement proceedings.

The expected fall

Considering all of the above, many analysts (among them, Jamie Dimon and Warren Buffett) announced that the rise of cryptocurrencies and ICOs represented a bubble — comparing it with dot-com and tulip bubbles[XNUMX] — that would burst at any moment[XNUMX].

Then, after Bitcoin reached a historical price of $XNUMX in December XNUMX (from $XNUMX in January XNUMX), the value of bitcoin and all other cryptocurrencies declined in volatile operations in the following months, what was called the ‘crypto winter’ [XNUMX].

And so finally, the fall expected happened: from mid-year XNUMX the downtrend of the ICO market started and, comparing the XNUMX billion raised in the QXNUMX of XNUMX with the XNUMX million raised in QXNUMX of XNUMX, the ICO market down in XNUMX%[XNUMX].

"The party is over," "the ICO is basically dead," he told himself.[25].


[1] Philosopher (Barcelona, ​​1942-2013).

[2] For regulatory responses around the world on the crowdfunding phenomenon, see: The Board of the International Organization of Securities Commissions, Statement on Addressing Regulation of Crowdfunding, December 2015 <>

[3] Blockchain is a type of distributed ledger technology (DLT) that records transactions in a synchronized network using cryptography and consensus mechanism, characterized by transparency, immutability and security, making possible exchanges between two parties (peer-to-peer ) without the need for a “trusted third party”, which means a drastic reduction in the cost transaction. For an analysis of the legal and regulatory issues of DLT, see: Dirk A. Zetzsche, Ross P. Buckley, and Douglas W. Arner, 'the distributed responsibility of distributed Ledgers: legal risks of blockchain', SSRN Electronic Journal, 2017 <>.

[4] The token is a unit of value of the project developed in the blockchain, which serves as an entry in said blockchain and incorporates a package of rights, privileges and obligations.

[5] JR Willet, developer who wrote «the second white Bitcoin book»For the launch of mastercoin in 2013, he is recognized as the creator of the ICO. For more information, see: 'the history of origin of the token sale history of the initial coin offer (ICO). Newconomy '<https://newconomy.Media/News/the-Origin-Story-of-the-Initial-Coin-Offering-ICO-token-sale-History/>

[6] For a study on the evolution of ICOs, see: Dmitri Boreiko and Navroop Sahdev, to ICO or not to the ICO-empirical analysis of the initial offers of currencies and the sales of tokens < = 3209180Electroniccopyavailableat:> Abstract

[7] 'Top 10 ICOs with the highest ROI' < # 4-Ethereum- -279843-ROI>.

[8] See: quarterly reports | ICORating '<>

[9] See: 'ICOdata-ICO 2017 Statistics' <https://www.icodata.IO/stats/2017>

[10] Dirk A. Zetzsche and others, 'the gold rush ICO: it's a scam, it's a bubble, it's a Super challenge for regulators', SSRN Electronic Journal, 2017 <>.

[11] 'KISS - Keep the ICOs Simple, Stupid - Keep the Inventory' <>

[12] Chris Brummer, Trevor Kiviat and JAI R. Massari, 'what should be revealed in an initial offer of coins? ', 2018. < abstract_id = 3293311>.

[13] As indicated in a study, for example, for many cases the whitepapers did not mention the name of the company or its address: see: Zetzsche and others.

[14] 'Initial celebrity offer: these 7 celebrities want you to invest in your ICO' < -in-their-ICO-86a1b7372a9c>; SEC. Gov | SEC statement urging CAUTION around celebrity-backed ICOs <>

[15] 'Top 3 ICO scam in history-ICObuffer' <>

[16] 'Why do we need a hat in each ICO-watching you Tezos' < tezos-90d412f34b88>.

[17] Jiahua Xu and Benjamin Livshits, the anatomy of a cryptocurrency pump and dump scheme <>.

[18] Nathan J Sherman, a behavioral economics approach to regulate initial offers of currencies, 2018. The author emphasizes that unlike the previous bubbles, these at least had commercial values. On the contrary, ICOs in many cases had raised millions without a legitimate purpose, such as "Trumpcoin" or "Dogcoin" < = 3243028>.

[19] see: Regulators' statements about the initial offers of currencies here: < subsection = ICO-declarations>.

[20] See: SEC. Gov | Framework for "investment contract" Analysis of digital assets <>

[21] For a description of these speculative bubbles, see Nathan J Sherman, a behavioral economics approach to regulate initial offers of currencies, 2018 < = 3243028>.

[22] See: "We are waiting for ICO bubble to pop: Binance Chief $ 1 billion fund" < Head-of-binances-1-Billion-VC-Fund>.

[23] See: 'Do ICOs survive the crypto market crash? - Tokentarget.Com '<>.

[24] Quarterly market analysis ICO Q1 2019, 2017.

[25] 'Mercado ICO is dead: investor Crypto Barry Silbert' <>; 'Opinion: the ICO are dead, killed by the regulations-Bitcoinist.Com' <>.

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Jacqueline Escobar
Jacqueline is a specialist in Fintech, Legaltech, Financial Regulation and Capital Markets. Fellow in financial services by the International Bar Association (IBA) and ITEC Scholarship Training Program. He has worked as a Legal Analyst in the Superintendence of Banking, Insurance and AFP (SBS), in the Superintendence of Securities Market (SMV) and as an Associate of the Banking and Finance area of ​​the Rebaza, Alcázar & De Las Casas study. Currently, he is In-house Legal Counsel of Finsmart Peru and Legal Counsel of Fintechlab.


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