A small but growing number of companies are turning to initial coin offerings (ICOs) tied to Bitcoin and other cryptocurrencies to attract capital for US-based projects – much of it from foreign investors.
They are part of a booming global fund-raising phenomenon. Between January and mid-July 2018 alone, $16.9bn was raised worldwide in cryptocurrency ICOs, according to the UK tracking website Coinschedule. In June alone, more than $550m poured into ICOs, compared with $300m in early venture capital funding.
Simultaneously, in Washington, DC, London and other global capitals, legislators are wrestling with whether or how much to limit an upstart industry that most experts see as holding both promise and pitfalls for investors and consumers.
A global phenomenon
Cryptocurrencies offer the ability to make international payments without an intermediary bank at a lower cost, with transaction traceability that could deter corruption while ensuring personal anonymity, and with settlement finality. And while there is a perception that they are most useful in countries with inefficient banking systems or to evade strict capital controls, their use in financial transactions in developed countries is increasing – despite the risks that exist.
ICOs, like crowdfunding, are most often used by early-stage business ventures to raise capital. In exchange for cryptocurrencies, dollars or other currency, an investor receives a digital asset called a coin or token. All that is necessary is for a prospective investor to go the particular ICO website and follow its instructions.
“A pre-initial purchase offering company can often raise five times as much through an ICO as through traditional venture capital raises,” says Anthony RG Nolan, a finance partner in the international law firm K&L Gates’ New York office. Nevertheless, because ICOs are often issued before a real product exists, they are considered highly speculative and risky.
In fact, even though the firm has an active practice of clients with ideas for projects based on an ICO, Nolan says K&L Gates has been “very circumspect” about taking on such engagements, and only does so after approval by its own general counsel.
Indeed, 81% of ICOs worth more than $50m were fraudulent, a Satis Group analysis has found. A Wall Street Journal investigation uncovered multiple examples of plagiarised investor documents, promises of guaranteed returns and missing or fake executive teams. Fraud is so widespread that, to demonstrate, the US Securities and Exchange Commission (SEC) created a separate website, www.HoweyCoins.com, to make a purposely fake ICO offering; clicking for more information dispenses SEC investor education material.
In the money
In the US, ICOs have been issued to raise money to make movies and launch video games, among other ventures. One law firm is working on an ICO that would fund a US manufacturer seeking pre-orders for its product before setting up a production line in China.
Major global players are also getting into the act. For example, Rochester-based Kodak and Delaware-based Wenn Digital have launched KodakOne, a blockchain-based image rights management platform, and KodakCoin, a proprietary cryptocurrency to manage payments. A ‘simple agreement for future tokens’, open only to accredited investors, gives them the right to receive a set number of tokens sold in an ICO, with the goal of raising $83.5m. Non-accredited investors will be able to buy KodakCoins in a public ICO or earn them through other means.
In another example, the Danish shipping company Blockshipping has set up a global shared container platform to streamline container shipping. In addition to traditional venture and other forms of capital, it is using an ICO to raise supplementary funds.
Rogelio J Carrasquillo, a member of law firm Cozen O’Connor’s New York office, has helped a foreign client launch an ICO to develop a time share-like condominium project in Florida. Investors may use Bitcoin or other cryptocurrencies as part of their capital contribution. The goal is to raise between $15m and $20m for the first of five or six phases. Another is to monetise revenue streams using cryptocurrency awards that investors or guests could redeem for additional rewards.
The developers will issue their own ICO tokens and they have applied for a process patent to protect the technology involved. Mr Carrasquillo says that while they are still going after traditional senior financing and private equity, using the ICO method offers additional flexibility to monetise assets. “The main focus of the fundraising has been overseas, so there are a large number of foreign investors,” says Mr Carrasquillo, who adds that these investors are even coming from China – even though the Chinese government has cracked down on cryptocurrencies.
Since the US dollar value of cryptocurrency can fluctuate wildly, setting parameters for the valuation of the Bitcoin is important, according to Mr Carrasquillo.
A 'stable coin' developed by IBM using blockchain technology could be a solution to the soar/slump valuations Bitcoin and other cryptocurrencies undergo, according to Jesse Lund, global vice-president of IBM blockchain. A stable coin is a digital currency that is pegged to another stable asset such as gold, or to major fiat currencies such as euros, pounds, yen, or the US dollar. IBM is currently experimenting with Stronghold USD, a new stable coin that is backed by US dollar deposits.
“It operates like Bitcoin but technically it is a digital US dollar that gives a claim on a federally insured bank, and is a step toward more scalable and reliable digital payments,” says Mr Lund. “It’s much more versatile than cash.”
Initially, Stronghold USD will be available only as a business-to-business solution for financial institutions, multinational corporations and asset managers.
However, Mr Lund does not believe Stronghold will eliminate cryptocurrencies such as Bitcoin. “They will continue to have value because they have legitimate attributes to address users that want privacy and anonymity,” he says.
Still, before cryptocurrencies and ICOs gain widespread acceptance, there will have to be clarity about how they are regulated globally. Cryptocurrencies can be viewed as money, securities, commodities or swaps, each of which, in the US, is regulated by a different agency with the Internal Revenue Service. In addition to this there are 50 state governments getting a look in as well.
Not only are individual countries trying to work out regulatory structures, but as the Financial Services Board, a multinational agency, recently reported, there are ongoing international efforts to monitor the financial stability implications of cryptoasset markets, distributed ledger technology, crossborder issues regarding ICOs, and banks’ exposure to cryptoassets.
Until a resolution is found, the risks and challenges will remain.