One overused metaphor in business is that, when a new product does not go well, the management team changes its name, re-brands it, and re-launches it, as if it were a truly newer product all together. This approach to accepting failure and moving on would not be so laughable, if the new product was diametrically different and addressed the issues that cause the failure in the first place. The crypto Initial Coin Offering (ICO) space is now going through such a rebirth. In order to accommodate regulators, blunt fraud, and re-enchant investors, most promoters will switch to Security Token Offerings (STOs).
According to CoinSchedule.com, a crypto market tracker, the ICO industry, if it is worthy of that name, raised $21 billion in 2018, more than twice the amount the year before. Recent reports have acclaimed that over 1,000 companies that went this route over the past few years have had to close up shop, find new capital backers, or be acquired. One report revealed that:
Fewer than half of all ICOs survive four months after the offering, while almost half of ICOs sold in 2017 failed by February 2018.
Investors ate the losses at a 90% rate, but unfortunately, many entities left their cash in Ether (ETH), their funding cryptocurrency, only to see the value of their reserves decline with the market.
Many entities just disappeared, shutting down their websites and, in several cases, conducted elaborately planned “exit scams” by leaving in the dead of night with whatever funds remained. The most notable incidence of a fraud of this genre was Modern Tech’s Pincoin, an ICO in Vietnam that raised $660 million from 32,000 investors, but soon hit the road stage left, all capital in hand, never to be heard from again. Organized crime was at the heart of the frauds, but something needed to change.
The SEC was the first regulator to make a strident step, calling every token, with the exception of Bitcoin and Ethereum, subject to strict registration and disclosure rules, meant to protect investors from outright fraud. After several highly publicized seizures and arrests, ICO promoters got the message and pulled back. ICO fundings dropped from $5.8 billon in June to roughly 10% of that figure by yearend. In the meantime, investor awareness improved. Most are now reluctant to participate in ICOs going forward, especially those launched from overseas. Gullible investors still take part.
The preferable path out of this mess appears to be what is called an STO. ICOs rarely give investors a share of its profits or a stake in the capital raised. Their token provides access to the service being development, and if all goes well, then the “utility” token, as it is called, will appreciate in the market, as the service goes viral. The SEC argued that substance took place over form. In order to proceed, STO promoters plan to comply with “Section 3(c)(1) of the Investment Company Act of 1940, which allows private funds to avoid SEC rules,” as long as they deal with “accredited investors”, i.e., institutional players and wealthy individuals.
Will the new STO path work? Fundraisers will go after a more discerning pool of capital and fewer participants, but they can also avoid the fear of SEC incarceration and heavy fines down the road. Will STOs still be a risky investment? Of course – investing in any new enterprise is always fraught with performance risk, the parlance of VC circles, but, hopefully, the worrisome fraud component will go away.
Several companies took the STO route in 2018, but analysts believe that 2019 will be the year of the STO. Earlier ones have already experienced a 99% success rate and only 10% have failed. Insiders expect the switch to STOs to be swift and have already discovered that “accredited investors” are more willing to take risk and put their money down, as long as there is a security interest in the firm provided by the token at hand.