Are Initial Coin Offerings the Brave New World or Hello, Wild West?

Ava Chisling
August 14, 2017

In simple terms, an Initial Coin Offering (ICO) is when companies create their own digital currencies and sell them to users who can either redeem them later for services or sell them on a coin exchange at a later date. (TechCrunch). The successful Canadian start-up Kik, a messaging app with 15 million users per month and valued at $1 billion, has created its own cryptocurrency, the Kin, and these tokens can be traded for goods and services, and more importantly, for cash, as well.

There are many compelling reasons behind choosing an ICO and one of them is cutting out a whole bunch of middlemen. According to Padraig Walsh of Bird & Bird, “An ICO sidesteps the typical business model development — raise money, build product, build business model, drive to liquidity with angels, venture investors, advisers and bankers along the way. Instead, in its purest form, projects funded by an ICO represent funding by users in proportion to their usage, and rewards early adopters, network operators and developers.”

Initial Coin Offerings with Kik founder and CEO Ted Livingston

Kik founder and CEO Ted Livingston recently explained his reasoning for his cryptocurrency on CNBC: “It’s getting increasingly difficult to compete with these huge centralized companies. They’re the only ones that have the necessary scale to monetize advertising so they give everything else away for free.” Livingston says that as a developer, there isn’t enough scale to earn money only from advertising, and at the same time, users expect everything for free because that’s how it works elsewhere. “So this is a new way to build a new ecosystem where we can use the cryptocurrency as a rewards engine to pull in other developers to build great services for consumers.”

A second compelling reason for an ICO is money, plain and simple. Robert Hackett writes in Fortune, “So-called token sales […] have raised hundreds of millions of dollars, creating substantial fortunes out of little more than ones, zeros, and pitches. In the coming months [Kik] is set to kick off a grand monetary experiment, one that will put to the test a new model for business that could prove to be either the web’s next great economic engine, or a multibillion-dollar bubble that’s as combustible as the Hindenburg.” Kik will mint “a total of 10 trillion Kin tokens, selling a trillion to the public, holding on to 3 trillion for itself, and setting aside 6 trillion for a nonprofit that will manage a rewards program for loyal users.” (Fortune)

Another company raising funds quickly via ICO is the Estonia-based, Agrello. “In [late July] a smart contract start-up (which also offers an AI assistant) has raised 5,098 Bitcoins’ worth of capital, which is approximately $11,134,732, by selling its own digital currency or ‘token’ on the open market via an ICO… That token is called DELTA,” reports Artifical Lawyer. “It is making an entirely new platform for the creation, use and management of legally binding smart contracts. It’s all a very compelling package, but what is especially striking is the way they have avoided the need to gain traditional external investment, at least in the form of handing over a big chunk of equity to a VC fund, or even a law firm that wants to dabble with legal tech ownership and development and fancies a piece of legal AI action.”

“If [Kik is] successful, we think we’re going to see more growth-stage companies disrupt their entire models and move to token models. And if these companies are raising hundred-million-dollar token rounds, this can get large really quickly.”

Initial Coin Offerings - Bitcoin phsyical coin

At the same time, “one San Francisco-based firm is barreling full steam ahead into the world of ICO investing: Pantera Capital, founded 14 years ago by Tiger Management […], whose team was among the first to launch funds focused exclusively on bitcoin and other digital currencies.” Says Pantera partner Paul Veradittakit in TechCrunch , “Right now, the token economy is estimated to be around $4 billion. We think Kik is a seminal moment in that it’s a well-funded company that’s disrupting its whole business model and moving over to a token model. If it’s successful, we think we’re going to see more growth-stage companies disrupt their entire models and move to token models. And if these companies are raising hundred-million-dollar token rounds, this can get large really quickly.” Says Livingstone, “It’s a new way to compete, it’s a new way to monetize, and it’s potentially a new way to exit as well.”(Fortune).

On July 24, Reuters reported: “The day when VCs were the elusive elite and primary source of capital for startups has ended,” said Jamie Burke, founder and chief executive officer of VC firm Outlier Ventures, which specializes in blockchain and other technology investments. “When a startup can raise $35 million in 30 seconds without any dilution, the genie is out of the bottle and it isn’t going back in,” he said, referring to Brave, an open source web browser that blocks ads and trackers, which sold its Basic Attention Token in June.

However, there is a call to make sure these new forms of currency are regulated sooner, rather than later. In a recent op-ed in Bitcoin Magazine, Gray Sasser and Josh Rosenblatt, co-chairs of Frost Brown Todd LLC’s Blockchain and Digital Currency team, state the following: “Initial Coin Offerings (ICOs) are where cryptographic computing and federal securities laws collide. As investors lacking the technical expertise of early market entrants throw their money into cryptocurrency presales, regulatory agencies like the U.S. Securities and Exchange Commission cannot be expected to sit on the sidelines much longer.”

And indeed, on July 25, the Securities and Exchange Commission published a report stating that ICOs are subject to securities laws. According to The Verge, “What the new SEC report means for future ICOs is unclear. Some ICOs might be found in violation of securities law, and some might be different enough to be in the clear.”

So it seems that investor beware is definitely the advice of the moment: “Until more clarity emerges around the seminal question of whether digital currencies are securities,” according to Sasser and Rosenblatt, “expect a continuing creep of legalese into the formally technical documents used in ICOs. It is incumbent on all participants in the process to perform due diligence and understand all risks in order to protect themselves.”

Says Padraig Walsh, “ICOs presently are commonly launched at a very early stage of development, sometimes barely past the concept stage. Any investment into an early stage enterprise is inherently highly risky. Blockchain is a nascent and developing technology. There is a lack of sophisticated investment coverage over the blockchain sector.”

But Walsh concludes with: “ICOs are a wild west of financing. But, previous frontiers have been tamed and civilised. The careful and proper development of capital raising by ICO’s hold the prospect of less friction and more participation and liquidity in blockchain protocol ventures. This could be a brave new world.”

Ava Chisling

Ava is an award-winning lawyer and editor who counsels creative types, writes about pop culture/tech+law and sometimes creates ad campaigns. She is Quebec counsel for Momentum Law.