Initial coin offerings are the latest red-hot investment trend, seeking to disrupt the traditional means of raising venture capital for startup businesses and firms. The market itself has witnessed an incredible expansion in the last year.
For example, at the time I wrote this in early March, cryptocurrency market capitalizations topped off at $466 billion across more than 1,500 different coins. A year ago, that number was just $21 billion, according to Coin Market Cap, a website that monitors cryptocurrency and ICO markets.
As the cryptocurrency market explodes and new coins, accompanied by white papers to seduce future investors, flood the market, is the Securities and Exchange Commission looking to cool down its rapid-paced growth?
RISKY BUSINESS
So, how does it work exactly? An ICO usually involves selling a new currency, or token, as a way for a company to raise money. If that cryptocurrency succeeds and its value appreciates, the investor makes a profit, just like stocks on Wall Street. However, an ICO is not like a traditional stock investment. Buying in an ICO does not get you a share of the company, only a piece of coin in exchange for giving a startup some cash. The return on the investment is a coin with an increased value.
Choosing to invest your money in an ICO can be a risky move. The unregulated market doesn’t have to answer to the same regulations and requirements as traditional investments, like venture capital or stocks, do. However, it does react like other markets do, just more violently.
Any number of news stories, market corrections, or regulatory changes in the cryptocurrency landscape can cause the market to react and the value of multiple coins to surge quickly or fall dramatically.
Attorney Mark Rasmussen, a partner with the law firm Jones Day, likens some ICOs to the Wild West, saying the current landscape makes for difficult terrain for investors.
“There were a lot of gains in bitcoin to be had last year and I think there’s a lot of fear of missing out on other cryptocurrencies,” Rasmussen said. “Some are rushing into the cryptocurrency market and contributing their hard-earned money into products that they don’t fully understand.”
What makes it so difficult? Rasmussen explained the concepts behind these coins – blockchain and the cryptography it is created with – are new and need to be understood more thoroughly before leaping into an investment.
“Blockchain technology and the cryptography behind it are new concepts to people and they don’t fully appreciate the impact of it,” he said. “They see the chance at making money and so they’re rushing into things before they fully appreciate it.”
“There are a lot of good actors out there that are developing blockchain applications and issuing a token in ways that the SEC probably would not have any problems with,” Rasmussen explained. “But there are some bad actors out there, too, taking advantage of the frenzy and are not following the securities laws. Even more significantly, they’re making outright false statements in their offerings and promising things that can’t possibly be true and that’s where the real danger is.”
To combat rising threats in cybersecurity, the SEC announced in September the creation of its Cyber Unit taskforce, which focuses on targeting cyber-related misconduct.
The Cyber Unit is designed to focus the Enforcement Division’s cyber-related expertise on targeting cyber-related misconduct, such as cyber-related threats to trading platforms and other critical market infrastructure, market manipulation schemes involving false information spread through electronic and social media, hacking, dark web misconduct, intrusions into retail brokerage accounts and violations involving distributed ledger technology and initial coin offerings.
CRYPTO CRACKDOWN
While not regulated, the digital currency market has certainly not gone unnoticed by regulators, including the SEC.
In December, SEC Chairman Jay Clayton warned investors of the dangers of putting their money into cryptocurrencies, saying trading and public offerings in the emerging asset class may be in violation of federal securities law, according to an article in Reuters.
Clayton’s statement came just hours after the SEC stepped in to stop an ICO for restaurant review app Munchee.
In the enforcement action, the SEC halted the multimillion-dollar ICO for securities violations, but it wasn’t on allegations of fraud. The company simply didn’t register its offering under the securities laws.
In its cease-and-desist order, the SEC argued that Munchee’s MUN tokens constitute securities because the tokens were “investment contracts.” According to the order, the tokens were ultimately deemed a security regardless of their “utility” when the sale took place.
“Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling — such as characterizing an ICO as involving a ‘utility token’ — but instead requires an assessment of ‘the economic realities underlying a transaction,’” the SEC wrote in the order.
The SEC said that “about 40 investors” bought tokens through the sale, but it is unclear how much was raised by the group of investors. The agency also noted that it contacted Munchee on the second day of its sale and that it “did not deliver any tokens to purchasers.”
The SEC picked up the pace after that, most recently serving subpoenas to 80 different ICOs, including one for an ICO from TechCrunch founder Michael Arrington. In an interview with CNBC, Arrington said, “We received a subpoena. Every [crypto]fund I’ve talked to has received one,” but he didn’t seem to be bothered by it, adding: “That’s fine. They just have to figure out what they want. They need to set up rules so we can all follow them, and the market is begging them for that.”
A December 2017 report from professional services firm Ernst and Young showed that more than $400 million raised through ICOs has been lost or stolen – more than 10% of total funds raised.
EY reported that, at the time, the total amount of funds raised through ICOs was approaching $4 billion, twice the volume of venture capital investments in blockchain projects. But since late 2017, the ICO volume has been slowing down, and fewer projects are reaching fundraising goals.
The professional services firm looked at more than 372 ICOs and found that in addition to the stolen funds increasing the project risk, the personal data of investors was also at risk of being exposed.
EY explained in its report that phishing was the most widely used hacking technique for ICOs, with hackers stealing up to $1.5 million in ICO proceeds per month.
The professional services firm research also noted that the volume of ICOs has been slowing since late 2017, with less than 25% of ICOs reaching their target in November 2017, compared to 90% achieving their target goal in June.
ERRING ON THE SIDE OF CAUTION
Investing in cryptocurrency or tokens can be a speculative endeavor and those considering putting any amount of money in it should be, as with any other investment, prepared to lose it all.
“Take your time to understand new cryptocurrencies,” Rasmussen said. “Don’t get swept up in the hype of cryptocurrencies and don’t let your fear of missing out cause you to put money into an ICO that you can’t afford to lose.”
Notably, Vitalik Buterin, the founder of the popular cryptocurrency and blockchain technology Ethereum, urged those looking to invest their savings to seek out traditional methods instead of putting their hard-earned money into volatile cryptocurrency.
In mid-February this year, Buterin tweeted out a warning: “Reminder: cryptocurrencies are still a new and hyper-volatile asset class, and could drop to near-zero at any time. Don’t put in more money than you can afford to lose. If you’re trying to figure out where to store your life savings, traditional assets are still your safest bet.”
If you’re seeking to invest in a company and a digital currency it is raising funds with, Rasmussen cautioned potential investors to take a close look at the white paper or other offering document that a company may have released leading up to the launch of an ICO.
“Some are very professional and do a good job explaining the purpose of the token being offered and the ecosystem in which it can be used. Some do not. Some are riddled with errors and typos,” he pointed out.
“Many of the companies launching ICOs are startups and they don’t have an operating history and they don’t have financial information that they can report, let alone audited financial statements,” Rasmussen continued. “They’re not providing really robust risk disclosures, which if you compare that to any securities offering that’s been registered with the SEC, there’s a long document that contains risks that the investor should be aware of.”
Some ICOs have a version of that but again, many do not.
So, how can potential investors proceed cautiously in a hyper-volatile environment?
“Every potential investor in the ICO market should really study the white papers carefully, and look for hallmarks of fraud,” he said. “If people are promising specific amounts of returns that’s usually a sign that something is wrong there. If people are promising that they are compliant with all securities laws. That merits further investigation because to date there has been no ICO that’s been registered with the SEC and offerings done pursuant to a recognized exemption typically place restrictions on who can invest.”
Using cryptocurrencies for real estate transactions
While bitcoin and other cryptocurrencies are not widely accepted at major retailers or most websites yet, they can be used for larger purchases, like real estate, if the seller and buyer are willing to agree to the terms.
The Keyes Company’s Elizabeth Perez Team completed the sale of a Miami townhouse on Feb. 7. This is believed to be the third such transaction to close in Florida as both real estate buyers and sellers are starting to embrace cryptocurrency, the company said.
Manuel Perez of the Coral Gables, Fla.-based team closed the sale of the 1,321-square-foot townhouse for 41.35 bitcoin, or $338,878, at the time of sale. The transaction’s seller and buyer were not disclosed.
The price of bitcoin can swing dramatically, so how was this transaction safe from those wild swings?
Perez told HousingWire that to protect both sides of the transaction, there was a fluctuation limit in place during the transfer period for the money.
“The value was set in dollars, and the number of bitcoins was determined at the moment of the closing,” Perez explained. “We negotiated with the buyer to have a fluctuation limit during the period of transfer, as a safeguard for both sides against a sudden crash or spike. Luckily, while there was some fluctuation, it was minimal by the time of receipt and everyone walked away happy.”
Perez said this transaction shows that cryptocurrencies are becoming “mainstream” in the real estate industry and business world. Perez is also handling a Miami Beach condominium in which the owner is willing to accept both bitcoin and ethereum currencies.
“Real estate sales using bitcoin or ethereum are adding legitimacy to the use of cryptocurrencies in the real world,” he said. “Our team is seeing interest from other buyers and sellers in these kinds of transactions.”
Perez said he sees bitcoin and ethereum transactions – for general goods and services, as well as real estate – becoming more frequent. Perez believes the volatility of the market comes from those who don’t quite know or understand the technology behind the coins. “The more people that read about it, and understand it, the more comfort you get with it, and the greater adoption you’ll have of it,” he said.
With the sale of the townhouse, Perez told HousingWire he gathered articles, videos, forum posts and other information about cryptocurrency and studied it with his client, who was somewhat familiar with the technology and the coin but not the specifics of it.
“It was really about the education to get them interested in it, as well as comfortable with what the technology and the ecosystem that’s built around it,” he said. “Looking back at PayPal, people had to continually use it to grow comfortable with it and the idea of putting their payment information online. This is a very similar process.”
