2017 was the year that Initial Coin Offerings boomed. Founders who want to raise money to grow their product or simply to get rich have sold coins to the general public. Because an important function of government is to stop John Doe getting ripped off by con merchants there are lots of laws about who is allowed to sell what, to the general public.
Example of allowed activities include licenced lotteries and shares listed on regulated stock exchanges. It is almost always illegal to just ask the public to send you money and promise they will get more back without government permission. Now, lots of founders and con-merchants find this very inconvenient and want bypass these regulations.
Funding new ventures
The traditional and legal way to raise money is to get it from friends and family and then after you something reasonably convincing to raise money from venture capitalists (VC). This causes many problems for fund raisers because,
VCs conduct due-diligence
VCs conduct rigorous due-diligence,
- They challenge your business plan
- They expect you to have experience in the industry you are working in
- The won’t invest until you have a working product
- VCs, Friends and Family want a clear idea about how they are going to get their investment back
- VCs will not let founders take out money before they do
- It can take a long time to complete the legal work
- It is expensive
The benefits from raising money from the public are clear
- They have insufficient skill to challenge your business plan
- They don’t have the resources to check up on your skills and team
- It is a small amount of money per person so they probably won’t chase you if you don’t pay them anything
- You can sell coins and get rich BEFORE you have done any work
- You get a ready pool of customers for your product
- A successful crowd sale generates lots of good publicity
What is the Howey test?
In the USA it is illegal to sell unregulated securities to the general public. ICO promoters claim that the coins and tokens that they want to sell are “utility” tokens not securities and therefore they can raise money from the public. The USA applies the Howey Test to determine if an offer is a security;
“[a security is] a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
Why being a utility token is a bad thing
The whole point of giving someone else your hard-earned cash is that you profit from their efforts. If a coin or token is marketed as something where this does not happen then that is bad thing. If their only offer is “buy this because others will buy it and it will go up” then the token is a Ponzi scheme. An example of a pure play utility coin is Dash; it is a brilliant payment mechanism but in the long term will be a poor investment because if you own it you don’t make any money unless others buy it and the price goes up.
So you need to buy illegal tokens!
There is a very ironic outcome to my analysis – you should only consider investing in ICOs that are illegal. I am looking for ICOs where the coin pays a dividend like a share – they should fail the Howey test. A good example of this is restartenergy.io. Restart Energy will operate a marketplace for energy and token holders will benefit from transaction fees. Their whitepaper talks about “contributions” not “investments” and “donations” not “transaction fees” but they have a conventional business plan.
ICOs offer a unique opportunity for retail investors to get a stake in start-ups. This is an opportunity that previously was only available to the rich and increasing opportunity in this way is a good thing. However most start-ups lose money and the rich can more easily afford this than the man in the street.
I will invest in ICOs but I will follow the advice of Warren Buffet.
“Never invest in a business you cannot understand.”
If it not clear to me how the business will generate value and how the coin will capture that value I will not invest.