Cover story: What you need to know about initial coin offerings

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 29, 2017 - June 04, 2017.
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The growing use of cryptocurrencies has given birth to a rising phenomenon called initial coin offerings (ICOs). This financial instrument, seen as an investment option and a fundraising channel for start-ups, saw over US$270 million raised from companies in various industries last year, according to Smith+Crown, a cryptofinancial news and research firm.

Like an initial public offering, an ICO is a method for companies to raise funds, but via blockchain technology. The key difference between them is that in an ICO, companies issue cryptocurrencies (known as digital tokens) to investors instead of shares as in an IPO, at a specified price. Investors then stand to profit from the appreciation in value when the tokens are listed on third-party cryptocurrency exchanges.

Matthew Tan, founder and CEO of Etherscan — the only Malaysian-owned blockchain start-up backed by some of the world’s largest blockchain companies, including Coinbase and Digital Currency Group — says it is common to see the prices of ICO tokens increase exponentially within a short period, fuels investor interest in the market.

"You invest in an ICO, which garners more interest, and you get 400% to 500% returns within a few months by selling the tokens on the exchanges," he says.

Rene Bernard, president of the NEM Association of Malaysia, agrees.

"If you have invested in some of the ICOs that have gained a lot of hype in the market, it is not impossible to see their prices shooting up 2,000% in a few weeks’ time," he says.

Venture capital companies are beginning to pay attention to ICOs as more start-ups begin to utilise this new channel. Without the need to fulfil regulatory processes and file costly paperwork, it is seen as a cheaper and faster option to raise funds compared with traditional channels like venture capital companies.

Tan says a few hundred million dollars have been raised in the past three years, with almost half the amount raised in the past six months.

“When these [blockchain] start-ups can bypass intermediaries and reach out to investors directly via ICOs and raise a few million dollars within a few hours, without giving out equity, why should they go to venture capitalists?” he asks.

Smith+Crown’s research shows that successfully funded projects over the past year involve various industries, such as asset management, supercomputing and gaming, that propose to be built on blockchain technology.

Successful ICOs last year include ICONOMI, a blockchain-based investment fund platform that allows investors to purchase its tokens and invest in its cryptocurrency funds. The project raised US$5 million within 10 days.

GOLEM is a decentralised platform that allows participants to earn GOLEM tokens by sharing computing power with others to process graphics and analyse business, stock market and scientific data. The project raised over US$8.5 million in just 29 minutes.

The largest ICO launched last year was the Decentralised Autonomous Organisation (DAO) project, which is an application using Ethereum blockchain technology. The DAO is run by computer codes without humans managing it. It is intended to act as a vehicle to support Ethereum-related projects. The project raised US$150 million within 27 days.

In Malaysia, an ICO project called EcoBit is open to investors till June 8. As at May 19, this first of its kind "green project" raised 797.3427 bitcoins and 507.2474 ethers (equivalent to US$1.8 million), according to its official website.

According to the website, the company behind the project, Climate Protectors Sdn Bhd, has teamed up with the Kelantan government to manage and maintain one million acres of rainforest for 30 years. It will also implement an eco-friendly project at the EcoBit Sanctuary Asia on Carey Island, Selangor.

The company says it will generate revenue from various projects, such as an aquaponics farm, a spirulina farm, hotel, coconut plantation and blockchain bank.


How it works

 Investors can sell their ICO tokens if they are listed on well-known cryptocurrency exchanges such as Poloniex and Bittrex. The value of the tokens they buy in an ICO rises on the exchange due to an increase in demand. Demand rises when more people use tokens to gain access to the functionalities provided by the blockchain technology the tokens are built on. At the same time, the supply of tokens is capped by the software that determines how they are issued and how many.

For instance, the company behind Ethereum blockchain gained a lot of attention globally when it launched its ICO in July 2014. The company raised over US$15 million to develop its new-generation blockchain that enables various functions. These include “smart contracts”, a computer protocol that can automatically facilitate the negotiation of a contract and enforce it using computer codes, without involving human drafting.

While the “smart contract” protocol is still being developed and experimented on for different applications, it is known that each transaction enabled by “smart contracts” will require the use of ether — the digital tokens embedded in the Ethereum blockchain system.

As such, the more parties use Ethereum blockchain in their applications, the more the value will appreciate, and ether holders will be able to enjoy a return by selling it on cryptocurrency exchanges. On May 11, one ether was trading at US$88.48, or 0.0495 bitcoin. The appreciation of its value is due to its future potential coupled, with market speculation.

“It has appreciated by more than 2,000% since the ICO was issued,” says Tan.

Based on the website ICO Alert — one of the sources people in the cryptocurrency community look out for ICO activities — as at May 16, ICOs looking to raise funds include Aragon, which has built its functionalities based on the Ethereum blockchain, aims to offer companies and other organisational structures the ability to reduce paperwork and operate under a decentralised model. On May 18, Aragon closed its ICO, raising US$25 million in just 15 minutes.

XARCADE is a platform built on the NEM blockchain that allows gamers to exchange in-game tokens by using XEM tokens (the digital token that fuels the NEM blockchain) and other functions.

Storj is a peer-to-peer network comprising users who rent out their hard drive space and bandwidth to others, which functions like a cloud storage solution. It is said that Storj’s service is “10 times faster and 50% less expensive than traditional data centre-based cloud storage solutions”.

According to the same website, there are seven ICOs in the pipeline in June and four more in July.

Tan says the process of purchasing a token for an ICO is straightforward. Investors must possess commonly accepted cryptocurrencies — such as bitcoin and ether — in their digital wallets or via an exchange. When the ICO is offered, investors can purchase the ICO tokens with bitcoins or ether from their digital wallets.

Loh Sern Yi, a cryptocurrency trader who has bought ICOs, says the price per token could be as low as US$1 and there is usually no maximum. “It ultimately depends on the issuers.”

For start-ups to raise funds via an ICO, all they have to do is to set up a website and post the related information online. The most important piece of information is the white paper, which is similar to a business proposal. It explains how the project will use blockchain technology to create and provide new products and services for real-world applications.

“All you need is a solid white paper, sufficient marketing hype, an interesting vision and a good team. You don’t need to come out with an actual product in an ICO,” says Tan.

Some ICO projects provide more details on their website and in their white paper, which include the targeted milestones for each year and the projection of future profit and revenue, says the NEM Association’s Bernard.

For instance, an ICO project called ChronoBank, which aims to use blockchain technology "to connect suppliers of labour hours (including both companies and individuals) to the users of the workforce"  has gone the extra mile in its white paper to give investors more details, such as projected profits and revenue.


A very risky investment

 ICO projects are considered high-risk investments as they are not regulated. Each ICO project can be viewed as its own government as the issuer determines its own rules and regulations. In the US, the Securities and Exchange Commission is still investigating this segment. Therefore, the interests of investors are not protected if the outcomes are not as promised.

Aaron Ting, vice-president of the Malaysian Investors’ Association, says one of the drawbacks, obviously, is that there is no investor protection since ICOs are unregulated. “It is an investment option for those who have a high risk, high reward appetite.”

Tan agrees, saying that the lack of rules and regulations in the world of ICOs and cryptocurrency exchanges should be investors’ main concern. "Although some projects are trying to follow existing rules and regulations by putting in place some best practices, there are still no laws to protect investors."

At the same time, he says while the upsides are huge, the downside could be bigger by now.  “I would say the risk-reward looked better six months ago. It is very risky now.”

Of late, the fundamentals do not match the sky-high valuations, he says. “As far as I know, despite all the potential of the projects portrayed in the white papers, I have not seen any completed since the boom in the ICO market [over the past year].

“Even though the white paper claims that by purchasing ICO tokens, investors own part of the start-ups’ assets and liabilities and have a claim on its profit, there is nothing much you can do if the project does not materialise and the people behind it take your money and run. There are no rules and regulations to govern the space.”

In addition, Tan says the market capitalisation of ICO tokens is small and the size of issuance is limited, making them vulnerable to market mani­pulation. “Pump-and-dump tactics are not uncommon on cryptocurrency exchanges as the market is not regulated.”

Moreover, it is not easy to tell the genuine apart from the scams. Industry experts agree that investors should be extremely aware if they plan to invest in ICOs. While there will be one or two wildly successful projects, it is mostly a blind guess at the moment.

“It is really too hard to tell at this point in time. There may be some with good ideas and projects but they may fail to carry it through. For now, your guess is as good as mine,” says Etherscan’s Tan.

Robin Lee, founder and CEO of Hello Gold Sdn Bhd says, “It’s like during the internet boom. You couldn’t really tell that Google, Amazon and Apple would turn out to be the big winners they are today. The potential of the technology is huge, but it is very hard to tell who will create the great success at the end of the day. It is still in the early stages.”

Hello Gold is a company that uses blockchain technology to enable investors to buy and sell gold via their smartphones. He says investors should be cautious when investing in ICOs as there are no intermediaries to provide sound advice or warn investors about the risks involved, because the ICO market is still in its nascent stage and the infrastructure surrounding it has yet to be built.

“Having no intermediaries is good for investors who have the knowledge and know the risk well. This enables them to reduce fees paid to middlemen.  

“However, for investors who don't have the knowledge, they have to proceed with caution as they are fully responsible for their own investments,” says Lee.

In addition, it may not be so easy for investors to do their own research. Lee says while there are various sources (such as and Reddit) for investors to get updated on key events in the cryptocurrency world, the discussion and comments tend to be too technical. “Comments made online can be unclear unless you understand both the terminology and technology. You have to check the details, research the sources and verify the identity of those who post comments.”

One of the websites for investors to obtain information on ICOs is

An industry player who declined to be named says other risks include the dissemination of false news by market players to bring down the prices of certain tokens so they can accumulate more at the low, or simply short them to reap a return.

There is also the possibility of cyberattacks on projects or exchanges to cause token prices to plunge and benefit from it.

“There are all kinds of possibilities. When an event like this happens, these people can use options or leveraging facilities, such as margin trading, to amplify their returns at the expense of others. It’s a Wild Wild West [in this industry], ” says the industry player.

For example, last June, a hacker made off with US$50 million in ether when it exploited the weaknesses in the DAO’s smart contracts.



Stick to bitcoin and ether, say industry players

The best way for beginners who believe in the potential of blockchain technology to invest is to use the dollar cost averaging (DCA) approach to buy into the cryptocurrencies that have the largest market capitalisation, say industry players. These include bitcoin and ether, which are ranked the top two in the cryptocurrency world in terms of market capitalisation.

Matthew Tan, founder and CEO of Etherscan, says these two cryptocurrencies are most widely used and accepted and their functionalities are the best known.

"Bitcoin is known for the transfer and storage of value. It is the safest and most widely adopted cryptocurrency in the world. Ether, which is the digital token of the Ethereum blockchain, is a financial protocol that has huge potential moving forward," he says.

While the functionalities of bitcoin are already well known, Tan is a supporter of the Ethereum blockchain. He says Ethereum is akin to the Hypertext Transfer Protocol (HTTP) in the early 2000s. While the possibilities of HTTP were unknown at that point in time, today, it is widely used to create websites and for social media.  

One of the most widely reported uses of the Ethereum blockchain is the United Nations World Food Programme (WFP) distributing funds in the form of cryptographic coupons to dozens of shops in five Jordanian refugee camps.

The WFP will also use an eye-scanning hardware, made by a London-based company called IrisGuard, to verify the identities of the 500,000 recipients currently receiving traditional aid.

Robin Lee, founder and CEO of Hello Gold Sdn Bhd, agrees with Tan, saying that investors who are positive about the potential of blockchain technology could set aside a sum they can afford to lose to buy the cryptocurrencies with the largest market capitalisation.

Cryptocurrencies, he says, such as bitcoin and ether, are built on a blockchain with "utility uses".

"Utility means that other projects [that raise funds via ICOs] tend to be built on the bitcoin and Ethereum blockchain. Bitcoin is the safest and most secure blockchain with a longer block. Ether has a 'smart contract' functionality that allows a lot of new projects to be built on it.

“There is no doubt that these blockchain technologies are going to be huge in the long term,” he says.

If investors want to take on more risk for a greater variety of investments, Rene Bernard, president of the NEM Association of Malaysia, says they can look at the top 10 cryptocurrencies in terms of market capitalisation. They include the digital tokens of Ripple, Litecoin, NEM, Dash, Ethereum Classic, Stellar Lumens, Moneoro and Steem.

Another way of investing, says Tan, is via venture capitalist funds that help investors buy into blockchain technology start-ups and companies. Blockchain Capital, a venture capital fund that invests in blockchain technology and bitcoin companies, is an example.

"If you're not so comfortable about managing your portfolio and investing directly in cryptocurrencies, this could be the way to go," he says.



ICOs should be regulated

Aaron Ting, vice-president of the Malaysia Investors’ Association, suggests that the authorities look at regulating ICOs. Malaysia could carve a niche out of the blockchain industry if the government becomes one of the first few in the world to do so.

“Since there are very few jurisdictions where ICOs can be done legally, Malaysia has a good opportunity to regulate and take the lead as the ICO capital of the world.

“By doing this, the country could benefit from being a blockchain financial and technology hub, which could generate jobs and revenue for the government by collecting taxes from ICO enterprises registered in Malaysia.”

Ting says ICOs should be governed by rules and regulations to prevent scams and protect investors.

“We recommend the implementation of ICO regulation and licensing requirements so that we can mitigate some of the risks associated with  ICOs. We should look to apply capital market standards, if possible. It is hard as care must be taken not to stifle the growth of the ICO market.

“And once ICOs are regulated, investors and the public will be able to differentiate between genuine projects and the many fraudulent ICOs set up by Ponzi scheme operators, who are currently active in the market.”