Wednesday, November 15, 2017

ESMA joins chorus of warnings against ICOs

By John Filar Atwood

The European Securities Markets Authority (ESMA) has joined securities regulators from around the globe in issuing a formal warning about the risks of initial coin offerings (ICOs). Guidance on ICOs and cryptocurrencies in recent months has come from, among others, the U.S. SEC, the Canadian Securities Administrators, the Bank of Russia, and the Australian Securities and Investments Commission. China and South Korea have instituted an outright ban on ICOs.

ESMA warned that ICOs are highly speculative and could result in the total loss of investment. In addition, they may fall outside a country’s existing offerings rules, and therefore enjoy none of the protections that accompany regulated investments.

In addition, ICOs may be vulnerable to fraud or illicit activities, owing to their anonymity and their capacity to raise large amounts of money in a short timeframe. ESMA noted that several recent ICOs were identified as frauds, and it is possible that some ICOs are being used for money laundering purposes.

ICO definition. An ICO is a way to raise money from the public using coins or tokens. In an ICO, a business or individual issues coins or tokens and sells them in exchange for virtual currencies such as bitcoin or ethereum. ICOs are conducted online, and the tokens are typically created and disseminated using distributed ledger or blockchain technology.

Some tokens serve to access or purchase a service or product that the issuer develops using the proceeds of the ICO, according to ESMA. Others provide voting rights or a share in the future revenues of the issuing venture. Some tokens are traded and/or may be exchanged for traditional or virtual currencies at coin exchanges.

Few exit options. Among the risks identified by ESMA are that investors may not be able to trade their tokens or to exchange them for traditional currencies. Not all tokens are traded on virtual currency exchanges, EMSA noted, and when they are their price may be very volatile.

ESMA also noted that most ICOs are launched by businesses that are at an early stage of development with an inherently high risk of failure. Tokens generally have no intrinsic value other than the possibility to use them to access or use a service or product that is to be developed by the issuer. ESMA warned that there is no guarantee that the services or products will ever be successfully developed.

The information that is made available to investors is in most cases unaudited, incomplete, unbalanced, or even misleading, according to ESMA. ICO information tends to emphasize the potential benefits but not the risks, ESMA added, and is not easy to understand.

Finally, ESMA advised that the distributed ledger or blockchain technology that underpins the tokens is still mostly untested. The code used to create, transfer or store the tokens may be flawed, ESMA warned, preventing investors from accessing or controlling their tokens. The technology may not function quickly and securely during peak trading periods, and tokens may be susceptible to theft through hacking, ESMA concluded.