Generating funds in the form of “initial coin offerings (ICOs)” is not subject to a particular regulation and doesn’t benefit from any guarantee or other form of regulatory insurance.
What is an initial coin offering (ICO)?
An ICO is a way for companies to acquire funding for the growth of services. With an ICO, the provider issues digital tokens through blockchain technology. ICOs have a cross-border nature, in standard, anyone with Internet access and a digital wallet can buy these tokens. The tokens may sometimes be bought in euros or dollars, but more often in cryptos, such as Bitcoin or Ethereum.
How do initial coin offerings (ICOs) work?
When a company determines to have an ICO, it declares the date, rules, and buying procedure in advance. On the date of the ICO, investors can buy the new cryptocurrency.
Most ICOs employ investors to pay using another cryptocurrency, and the purchase process normally involves sending money to a specified crypto wallet address. Investors give their own recipient address to receive the crypto they buy.
The number of tokens sold during an ICO and the token price can be either fixed or variable.
Anyone can initiate an ICO. Because of the low barrier to entry, several new types of cryptocurrency are launched through this process.
The risks associated with ICOs
The CSSF (Commission de Surveillance du Secteur Financier) stresses that ICOs can involve considerable and sometimes unforeseeable risks for professional investors as well as for customers that partake in the initial call for financing or who invest in tokens on or via specialized platforms.
In specific, the CSSF speculates that the major risks linked to ICOs are the following:
Lack of protection
There are presently no particular regulations that apply to ICOs either at the nationwide or European level. Investments in ICOs do not enjoy any form of particular insurance and are highly theoretical.
The success of the financed project
The projects funded by ICOs are usually in the first stage of development and based on business plans that have not been evaluated independently. There is no guarantee that the projects will be improved or will have the expected success.
Loss of capital
The capital invested in the financing itself or in the tokens developed through secondary markets is not ensured. As a consequence, the capital invested can be partly or completely lost depending on market developments.
Risk of token theft
Specialized platforms and token storage systems may cite vulnerabilities as regards their security, which can lead to risks of hacking and theft.
Liquidity shortage
The trading of the tokens on specialized platforms might be conditional on sufficient liquidity. As an effect, holders of tokens may be unable to sell them, or only in unfavorable conditions.
Volatility
Tokens can be subject to severe price instabilities and include a price bubble risk. The capital invested in tokens through participation in an ICO is not guaranteed and can be partially or totally lost.
Fraud and money laundering
The absence of regulation and management is likely to attract criminals that use ICOs to cultivate fraudulent schemes or commit scams.
Operational disruption
The technologies enabling the creation, transfer, and safekeeping of tokens being particularly innovative can be vulnerable and expose investors to lasting or temporary disruptions of systems and as a result, investors are exposed to the risk of tokens being unavailable.
An investment that doesn’t fit all types of investors
The risks attributed to investments through ICOs mean that these investments are not suitable for most of the customers and for long-term projects such as retirement projects.
How to Protect Yourself from ICO Scams
Before investing in an ICO, consider the following:
- Think about why you want to invest in a digital coin or token.
- Study the business plan and stakeholders to see if they have a background working in blockchain-based businesses or associated industries.
- See if offering documents clarify the objectives for the ICO’s proceeds and if those objectives make sense.
- Foreign locations could make it harder to get enough information or get help if a problem occurs.
There is no assurance that an investor won’t be on the losing end of a scam when investing in an ICO. So to help avoid ICO scams, you can put the following into practice:
Make sure that project developers can clearly specify what their goals are.
- Look for transparency.
- Study the ICO’s legal terms and conditions.
- Confirm that ICO funds are stored in an escrow wallet.
Investors are attracted to ICOs for the ambition of buying in early to a successful cryptocurrency. Although this is possible, it takes significant research and time to sort through the large numbers of upcoming ICOs. Considering the risk included, it’s best to address it with caution.
If you plan to launch your investment fund in Luxembourg to start your ICO, contact your Damalion expert now.
