The organization for economic co-operation and development (OECD) has explained some of the difficulties of ICOs in business financing especially for start-ups.
February 04, 2019 | AtoZ Markets - Since 2017, the use of ICOs to finance start-up businesses has been on the rise. Despite the advantages ICOs offer to start-ups, there are some side effects that have proven to be costly along the way. The OECD, in its January report, looked at some of the difficulties of ICOs in modern finance. The chief among them is non-regulation. ICOs and the cryptocurrency industry are still largely unregulated. According to OECD, until there are internationally accepted regulations, ICOs are unlikely to replace the orthodox venture capital means of seed financing.
OECD: ICOs are Risky
OECD, in its reports, believes that ICOs are currently risky. Other regulatory bodies have displayed similar discontents over the years. Just looking at them on papers, ICO seems to be an excellent way of raising funds for businesses but the OECD fears the risks far outweigh the potentials. The reports says:
ICOs in their current shape and form carry important risks for SME (small and medium enterprise) issuers and investors subscribing to token offerings
Many of these companies have stunted after their ICOs – losing an average 66.7% of their token values. Issuers accountability, token economics and security have been the major deteriorating factors on these ICO projects. Some ICOs also hide vital information which include their real location, identity and financial statements. The security and exchange commissions have compelled some ICO companies to return investors' funds and declare bankrupt. Though the industry is very young, but the problems it has faced are enormous. These problems are still largely unsolved. However, the OECD has provided some answers with a lot of exemptions and footnotes.
OECD Offers Insights on Pre-Mines and Tiered ICOs
The organization has raised alarm on private sales of tokens ahead of ICOs. This according to them could cause conflicts. Firms use pre-ICOs (done by offering tokens on discount) to raise funds that can be used to pay for marketing, advisory costs etc, before the main ICO is launched. Those who buy into these are termed as 'Insiders' by the report. This means that ICO firms involve themselves in inside trading, by issuing pre-ICOs, which later cause conflicts.
In the report, the organization advised against the method of Pre-ICOs. The organization also observed that Pre-ICOs often lead to pump and dump schemes. It adds that, founders who manage to cover these costs often ''carry no personal financial risk in the transaction besides reputation risk''.
ICOs Vs IPOs
Initial coin offering (ICO) is to cryptocurrency what Initial public offering (IPO) is to traditional stocks. They are both fund raising methods for start-up companies or even established huge companies who want to enlarge their business activities. However IPOs and ICOs only share very few similarities. According to the OECD, investors of IPOs are betting on the solid track records of a company while ICO investors bank on turning a crude idea to reality. A company offering IPO, already has a solid business base, a strong team of professionals and business people, assets, financial statements and other tangible information available to investors. Intending stockholders can process these information to decide whether the company is worthy of their investments or not.
An ICO is all about a project, an idea, that if successful, would yield huge returns in a short space of time. So, ICOs focus more on seed funding according to the report. IPOs processes also last three times longer than ICO. With all these features in view, ICOs are more akin to venture capital-style fund raising that IPOs.
ICOs Vs Venture Capitals
Despite relating more to venture capital than IPO, the difference between the two is huge. The report believes that ICOs might not be able to replace venture capital soon. ICOs are very quick in their processes. As soon as the founders get the token listed (which is quite easy as well), it makes a secondary market available that makes 'cashing out' easy. This ease has encouraged many crypto founders. Unlike ICOs, venture capitals can meet with start-ups form a strong position. They can get acquainted with the founding team, learn about their work history and then make their decisions – an informed decision.
Why ICOs Can't Replace Venture Capitals
Token holders and founders relationship is one of the major challenges of ICOs. Unless ICOs are given international regulatory consensus, the report believes this problem won't be solved. Over the years, some regulatory bodies have had their say on ICOs which largely rely on investors' safety. Since the boom in ICOs, investors have lost about 2/3rd of their investment. At the end of the report, the organization compiled the responses of high profile regulatory bodies around the world.
Regulatory bodies in Austria and Indonesia for example feared about the huge risk involved and concerns on investors' fund safety. China and Korea have placed an outright ban on ICOs citing that the current market funds are pushed into a non-productive speculative direction. OECD concluded that unless these problems are solved and there is general acceptance and regulation, ICOs can't pose major threats to the existence of venture capitals.
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