In April, a little-known Indian start-up called OneCoin was in the middle of selling its own digital currency when the Indian authorities raided the meeting, jailing 18 OneCoin staff and ultimately seizing more than $7 million in investor funds.
The British newspaper the Mirror described OneCoin, which pitched itself as the next Bitcoin, as a “get-rich-quick” scheme, calling it the virtual currency virtually worth nothing.
But then a few black sheep will always try to profit from the hype in the early phases of developing a new technology or product. Occasional bad practices or commercial failures are unlikely to deter innovation and the entrepreneurial spirit when it comes to overhauling existing systems.
For risk takers, investing in initial coin offerings (ICOs), blockchain, or crytocurrency projects that give you coin ownership, is attractive given their explosive growth. Bitcoin, the best-known virtual currency, has risen from $900 at the start of the year to more than $18,000, at the last count, despite numerous warnings to investors from the likes of former Fed chairman Alan Greenspan and JP Morgan chief executive Jamie Dimon
Aside from the potentially attractive returns, the development of ICOs and virtual currency could entirely change the way we make money transactions and how central banks manage their monetary policies.
Digital assets can play an important role in an innovative digital economy. They facilitate the creation, recording and transfer of rights in ways that propel financial technology, commerce, and interaction in new directions.
Digital or cryotographic tokens are a type of digital assets based on blockchain technology, often (but not always) utilising platforms such as Bitcoin and Ethereum.
But as with all early-stage investments, digital token sales involve risk. So how to go about minimising the risks when investing in ICOs and cryptocurrencies generally?
Often, digital tokens serve as pre-paid vouchers for a product that does not yet exist, meaning risk is inherent.
There are several major risks that a potential investor in an ICO or cryptocurrencies should consider.
The first risk is that the ICO is able to create blockbluster virtual tokens, popular enough with both users and investors that there is enough liquidity to achieve critical mass in secondary trading.
Another potential risk is that management are unable to execute the token sale or market products effectively. Of course investors should also be alive to the possibility of a scam, such as the OneCoin scandal in India.
If the platform does not have adequate cybersecurity to prevent a damaging hack it could undermine users’ confidence in the platform. A legal challenge or a regulatory crackdown on token sales could also crush a young ICO.
The final risk, which applies to most start-up projects, would be bad timing of issuance due to unforeseen circumstances i.e. luck.
There is already a significant body of law governing token sales, including financial services regulation and the law of fraud and contract. However, there remains a gap where industry practice can provide significant support until regulatory and legal actions start to shape behaviour more tangibly.
It’s also true that industry practice cannot set guidelines for industry players to a point where they mitigate all risk. But nor should it. All innovation and entrepreneurship by their very nature involve risk, and purchasers should understand this.
However, token sales should only carry risks relating to external factors beyond the reasonable control of the issuers.
Way forward
By following and understanding a set of best-practice guidelines, issuers and purchasers alike can mitigate the risks under their control.
The FinTech Association of Hong Kong in early December published a paper describing Best Practices for Token Sales. This is a “how-to” guide to running a good sale, identifying the key cybersecurity, legal, regulatory, tax, governance, strategy, and execution principles.
Most issuers are doing their best to make their token sales as effective as possible. Nonetheless, ensuring best practice is followed at all times is critical to long-term success.
Amongst its recommendations, the paper advises issuers to make clear a number of key facts, including a fair and open disclosure of the ICO platform and its in-house digital currency, its risk mitigation plan, as well as its credibility.
Digital assets and token sales are likely to remain a part of the digital economy, creating opportunities and efficiencies. They can also provide access to value in new ways and to new people (including the unbanked), which is important for financial inclusion.
The success of this market will be directly linked to the ability of participants to understand and mitigate risk. An ongoing constructive dialogue around the issues between industry and regulators is imperative.
About the authors
Karen Contet Farzam: Founding board member of the FinTech Association of Hong Kong, board sponsor of the Policy & Advisory Committee, Co-Founder - WHub.io
Urszula McCormack: Co-chair, Policy & Advisory Committee, FinTech Association of Hong Kong, Partner - King & Wood Mallesons
