What to ask when looking at an ICO

What to ask when looking at an ICO

What to ask when looking at an ICO

Two days ago in Vancouver, the National Crowdfunding Association of Canada (NCFA) put on its third annual VanFUNDING conference. This was the first event since the rise of the Initial Coin Offering (ICO) and the change was palpable. The speakers were focused either on how to handle ICO’s or describing emerging blockchain technologies. The BC Securities Commission tech team was there sponsoring a hackathon, and in the opinion of long-term attendees, there was a lot more money in the room this year. I noticed this, at least anecdotally, as I manoeuvred in the hallways trying to chat with different entrepreneurs. I became aware of funders lining up to do the same, albeit with more interesting intentions.

A fantastic and extremely practical presentation came from Bernd Petak of Northmark Ventures. His focus was on what an investor should look at when assessing an ICO and the project behind it. His recommendations were designed to cut through the noise and hype that surrounds these opportunities to identify value.  I found that aspects of his assessment criteria would also be important when looking at these offerings from a regulatory perspective. So I ran a number of them by members of the BC Securities Commission‘s tech team during the hackathon and it was clear that many of these same factors play into the weighing of the speculative v.s. the commercial value of an ICO that the commission performs.

The big question that Bernd was trying to equip people to answer was: Is operating on the blockchain appropriate for this company? In other words, do they really need the blockchain to do what they are going to do. His emphasis was meant to assess the advantages and disadvantages of blockchain deployment. To answer the question above Bernd suggests you ask:

1. Does this application benefit from decentralization?
2. Is it taking the middleman out of the process it is being applied to?
3. Does the immutability of the blockchain bring some advantage to the process?
4. Does the project require a store of value or a transfer of value?

Once these initial points have been answered, Bernd suggests you follow up with these more detailed questions:

5. Is there an appreciation of the technical requirements of the users? 

Although they are becoming more straightforward every day, setting up a cryptocurrency wallet, securing your private key and interacting with a blockchain are not things that an average user is going to be comfortable with or even interested in doing. A project that requires mass adoption for success but does not have a plan in place to address these technical barriers is going to run into problems.

6. Is the choice of blockchain protocol a good fit? 

By blockchain protocol, Bernd was referring the different flavours of blockchain out there, including the Ethereum network, Bitcoin, and Hyperledger. There are a number of others and variations of each. They all have certain advantages that they bestow on the different projects that use them. One of the advantages of Ethereum is the ability to support smart contracts and the ease of creating and deploying tokens. Hyperledger gives you a private network where you can control access and expand or shrink it as needed. There are a number of things to look at here, but the question is does it seem like the people behind the project took this into account when making their proposal.

7. Is there an advantage to creating a network of users for this process and is the ICO offering geared toward this end?

This questions is trying to determine if the offering is just to raise capital, or whether this project requires a network of users to be viable.

8. Is the offering of this token primarily a speculative endeavor? 

This is the question that the BC Securities Commission are primarily interested in. All of the above questions play into the assessment of whether an offering is a well thought out, viable, long-term project as opposed to an immediate desire to raise cash.

The final two questions speak directly to this and should be asked of any project you examine.

9. Are the issuers holding back a large number of tokens for their own use?

This should raise alarm bells as it has the hallmarks of a classic pump and dump scheme. Regulators look to this as well. Any issuer doing this would need to justify why they are holding back so many tokens. Testing is sometimes used as a justification, but it should not be. Any offering where the issuer is holding back a large number of tokens should be viewed with caution.

10. Can the tokens be resold immediately or is there a waiting period after the initial sale before they can be resold? 

While none of these questions are determinative they are good tools to measure the long term viability of the host of offerings being presented to investors.  They also get to some of the aspects of the design of the token itself that regulators are going to use when determining whether an offering is a security or not.

Post by Stephen Pedersen.

If you’re interested in learning more about ICO’s, watch this video. Our practice includes advising companies preparing token issues. Get in touch if you’d like to know more.

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