Beijing, China. Sept 4th: “Starting Monday, ICO activities should be halted, and ICO platforms should not engage in exchange services between fiat currencies, virtual coins and tokens…ICOs, in essence, are a kind of unauthorized and illegal public fundraising, which is suspected of being related to criminal activities such as financial fraud and pyramid schemes,” said a statement from the People’s Bank of China.
Chinese authorities on Monday ordered a ban on Initial Coin Offerings (ICOs), a nascent form of fundraising in which technology start-ups issue their own digital coins, or “tokens”, to investors to access funds as the rapidly expanding market spawned concerns over financial risks.
Following the news, the value of virtual currencies include Bitcoin immediately plummeted.
Also called an Initial Public Coin Offering (IPCO), ICOs are an unregulated means by which companies issue “tokens,” or cryptocurrencies, to investors in exchange for currencies of more liquid value such as Bitcoin, without the need to follow rules associated with traditional channels such as IPOs. Unlike IPOs, in which investors buy stocks in companies, investors in ICOs receive digital coins developed by the firms, which could appreciate in value if the companies fare well and demand for their currencies grows.
In an ICO campaign, a percentage of the cryptocurrency is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin.
When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for. During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the funds requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.
Early investors in the operation are usually motivated to buy the cryptocoins in the hope that the plan becomes successful after it launches which could translate to a higher cryptocoin value than what they purchased it for before the project was initiated. An example of a successful ICO project that was profitable to early investors is the smart contracts platform called Ethereum which has Ethers as its coin tokens. In 2014, the Ethereum project was announced and its ICO raised $18 million in Bitcoins or $0.40 per Ether. The project went live in 2015 and in 2016 had an ether value that went up as high as $14 with a market capitalization of over $1 billion.
ICOs are similar to IPOs and crowdfunding. Like IPOs, a stake of the startup or company is sold to raise money for the entity’s operations during an ICO operation. However, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return in their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are referred to as crowdsales.
ICOs, once a game confined to a few, have taken off this year in China, attracting more players both innovators and scammers — and catching the attention of regulators.
The first token sale occurred in 2013, when Mastercoin sold its own digital tokens and raised 5,000 bitcoins, the most popular cryptocurrency.
Photo: Etherum token ICOs
In 2014, blockchain-based platform Ethereum raised more than 30,000 bitcoins. With the value of such virtual currencies surging this year, ICOs have lured more investors eager to make a quick buck. The value of Bitcoin had jumped 59 percent in August alone, while Ethereum had surged 88.2 percent.
This year, 65 ICOs in China raised 2.62 billion yuan from 105,000 investors in the country, according to a report from the National Committee of Experts on the Internet Financial Security Technology.
Though the boom has helped tech companies access much-needed funds for development, it has also created fertile ground for scammers looking to take money from ignorant investors under the guise of ICOs, which could threaten the country’s financial stability if left unchecked.
Governments in other countries have started to take note of risks.
In a notice on Aug. 28, the U.S. Securities and Exchange Commission (SEC) warned investors about potential scams involving stocks of companies claiming a relationship to or engagement with ICOs.
China’s latest regulation came as authorities have repeatedly highlighted the importance of containing financial risk as the country faces a build-up of debt, and booming new financial products challenge regulations.