Published in El Pais, 2 January 2021.
Many of you are probably familiar with the term “Initial Public Offering” or IPO. Essentially it is when private companies go public by offering shares of their business to raise funds. It is always big news when a private company makes the transition to public (see Facebook and Google) as business analysts around the world discuss the various pros and cons of buying shares from these companies. Unfortunately, this option to raise funds are not available to most companies as it is a very timely and expensive process, with the introduction of blockchain and cryptocurrency these small companies have found and alternative to raise funds.
Initial Coin offerings or ICOs are the cryptocurrency equivalent of an IPO where companies create a coin and then offer it available to the public for purchase. This requires almost no hurdles as creating your own cryptocurrency is not a difficult achievement and many blockchain developers offer their services to create a coin on the Ethereum network for as little as $200. This could be a viable option for start ups to raise enough capital to achieve their goals without having to go through the many hurdles in an IPO.
There is however a catch to this method. Essentially an ICO allows companies to create money out of thin air as their cryptocurrencies are worth only what they say they are and unlike with IPOs the lack of regulations make it difficult to hold companies accountable for what they do with the money. In fact, in 2017 when they became most popular, many ICOs were in fact scams where they took the money and ran, while certainly unethical, what they did may in fact have been perfectly legal. Even the companies that are legitimate are not offering an ownership stake in the company as they would if they were doing an IPO.
So how do you tell the good from the bad? Well, here are some key factors to look into should you ever invest in an ICO:
What can you do with the coin? Cryptocurrency essentially allows you to use the blockchain, a comparable would be an arcade game where you need to use a token to use the machine. Many participate in ICOs not for investments but to use the blockchain when the project goes live. If the project sounds promising then maybe you think it is worthwhile.
What sort of returns are promised? Be careful with any projects promising ridiculous returns. It is true the return on some cryptocurrencies have been astronomical but that does not mean that this ICO will result in similar returns. The promise of an increase in value could also lead it to be classified as an illegal security in the United States which could see your investment completely wiped out even if the company has good intentions.
Who is running the project? By now the blockchain environment is filled with many prominent people who have worked on many projects, it is also filled with many bad people who have been involved in scams. Simply doing a background check on the key players can help you decide to whether or not stay away.
It is true the ICO landscape is like the Wild West of fundraising but that does not mean it cannot be a good avenue for small companies to raise money. Governments around the world should upgrade their laws to accommodate this avenue of fundraising in order to separate the good from the bad. With the world in economic chaos, we should be open to new ways for companies to get started, to create jobs and reduce unemployment.