Economic Affairs

The good, the bad and the ugly side of Initial Coin Offerings

More start-ups are using initial coin offerings to raise funds. Investors, beware.

Virtual currency investor Roy Chan almost became a victim of a hack attack.

He had wanted to invest in an initial coin offering (ICO) offered by a financial services developer called Enigma. (An ICO is akin to an initial public offering or IPO where investors use cash to buy shares in a company, except that in an ICO, investors use cash or another widely used virtual currency to buy digital tokens that may represent a security interest in the issuer's assets, or debt owed, or the right to use a promised service in future.)

Mr Chan, who works in a pharmaceutical company here, was about to transfer funds into an account associated with Enigma, but decided to check. A good thing he did, because scammers were targeting investors like him and were luring them to transfer their money to a fake account.

Fraudsters managed to reap nearly US$500,000 (S$681,400) before Enigma shut down the channels and warned investors about the scam.

ICOs 101

Welcome to the world of virtual currencies and ICOs.

According to the website, virtual currencies first emerged about 10 years ago and do not necessarily have a physical form, unlike fiat currency such as coins and notes. Examples of virtual currencies are bitcoin and ethereum's ether. They are not issued by any government, and are not legal tender. This means that they can be used to pay for goods or services only if someone is willing to accept them as a mode of payment.

People can buy digital currencies like bitcoin using cash. Or they can "mine" for bitcoins, by solving complex mathematical problems.

As digital currencies grew in popularity, their use has expanded. Today, bitcoin for example can be used to pay for music downloads or clothing and for meals in a small number of restaurants.

In recent years, some tech companies and start-ups have taken to raising funds for their projects by getting people to buy their digital tokens that may, for example, offer ownership or usage rights to a product or service, or access to a new investment product.

ICOs have exploded in popularity over the past year and even reality TV star Paris Hilton is endorsing a digital company's ICO launch.

ICOs have been used to raise more than US$2 billion so far this year, according to CoinDesk. Some start-ups see this mode as a cheaper and faster alternative to venture capital for raising money. Singapore-based TenX recently raised an estimated US$80 million.

But like any emerging, thinly regulated financial product, they are also highly risky.


Unlike IPOs which are very highly regulated, ICOs are less regulated.

Companies looking to raise funds through an IPO must disclose extensive amounts of information on the company and its governance, and also must have a prior track record of operational success.


In contrast, those who want to issue an ICO often set out their business proposal in a so-called "white paper" published online. This purports to be a kind of offering document, but lacks the rigour of an IPO prospectus.

TSMP Law Corp joint managing partner Stefanie Yuen Thio noted: "The white paper (or business proposal) is often badly drafted, provides very little clarity. The underlying investment, the investors' rights and risks are not well spelt out. ... If the ICO promoter is based outside Singapore, enforcement risks are also higher."

In an IPO, investors have rights as a shareholder. In an ICO, token holders have fewer rights.

The lack of oversight over ICOs has attracted criminals, with some estimates showing about 10 per cent of all ICO funds being stolen by thieves. Phishing scams and hacking are common, and new investors are particularly vulnerable as they may not know the most secure way to store their tokens.

Other dangers include the volatile nature of the investment.

The vast majority of ICOs are undertaken by start-ups and these issuers aren't in a position to issue IPOs because they have no track record and often no working product. Therefore, investors are taking a chance on the underlying technology that may never come to fruition, Withers KhattarWong partner Stephen Banfield warned.

There is much scope for abuse as there is little corporate governance that holds the start-ups responsible for delivering their project, or accountable for how they manage huge budgets obtained from a successful ICO, said Mr Nick Davies, a lawyer with Morrison & Foerster (Singapore).

Further, a digital token's tradable value is also affected by the technical ability of the team behind the project, he added.

"Flaws in the programming can lead to a token's tradable value plummeting within minutes. For instance, a digital token called DAO was hacked last year due to a single absent word in the application's coding. As a result of this oversight, the digital wallets of numerous investors were illegally accessed, and more than US$50 million worth of tokens were stolen," he added.

In Singapore, more than 100 consumers have filed police reports over investment schemes involving digital tokens or currencies.


Regulators worldwide are paying attention to ICOs.

Early last month, the People's Bank of China declared ICOs illegal, banned the practice of creating and selling new digital currencies, and ordered its major cryptocurrency exchanges to be shut down.

South Korea banned ICOs last week, prompting a legislator in Taiwan to push for regulations to be put in place to control cryptocurrency flows.

Last Thursday, Australia's securities watchdog warned consumers that they must understand potential ICO risks and be wary of scams. The British financial watchdog sounded a similar warning on Sept 12.

Regulators in the US, Singapore, Canada, Malaysia and Hong Kong have also fired warning shots that if tokens look like securities, they will be treated as such.

The Monetary Authority of Singapore (MAS) said in early August that any tokens that have the characteristics of securities will fall under its purview.

This came after the US Securities and Exchange Commission (SEC) said that virtual coins or tokens may be securities - subject to federal securities laws. On Sept 29, the SEC made good on that warning. It charged a businessman and two companies with defrauding investors in ICOs purportedly backed by investments in real estate and diamonds.

But industry observers note that blockchain technology is here to stay, and over-regulation may not be the best response.

Mr Davies noted that an outright ban is an easy way for regulators to take control, but such actions "are not necessarily conducive to creating a new healthy cryptocurrency ecosystem".

He added: "The technology behind ICOs is not going to be uninvented, but smart regulation could make Singapore a global hub for what the market has already priced as one of the most important technologies for the digital age - that is blockchain-based companies using distributed ledger technology on a truly global scale."

Blockchain - the technology that publicly records transaction details including the unique alpha-numeric strings that identify buyers and sellers - is here to stay, many industry observers say.


China's ban creates an opportunity for Singapore to become a hub for such digital currency trade and development of blockchain technology, say some experts.

Finance professor David Lee noted that MAS and the Infocomm Media Development Authority have worked hard to attract deep technology. Like Hong Kong, Singapore has the ability and processes in place to fight money laundering and tax evasion that are considered risks in virtual currencies. Such strengths "are great attractions for genuine ICOs and a draw for technically competent developers", he said.

Mr Davies said Singapore's progressive approach makes it more attractive to founders of blockchain-based companies than Switzerland, the US, Gibraltar, and the Cayman Islands.

Rather than impose an outright ban, or come up with new rules targeted at the new digital token offerings, MAS prefers to apply existing regulations to new fintech models. So if a digital token has the characteristics of securities, it will be regulated as such.

An MAS spokesman added: "A recent example of how the existing securities regulatory regime applies to technology-based business models is MAS' regulation of securities-based crowdfunding activities. MAS is of the view that regulation must not front-run innovation, as introducing regulation prematurely may stifle innovation and potentially derail the adoption of useful technology. We must also remain technology-neutral, allowing for innovation to choose the best path to success.

"At the same time, MAS is closely monitoring the development and implications of digital token offerings in Singapore and other parts of the world, as well as taking note of the evolving regulatory approaches taken towards such offers across different jurisdictions."

Despite the risks, demand for such investments is proliferating. even amid tighter regulation and criticism from business leaders such as JPMorgan Chase chief executive Jamie Dimon, who recently called bitcoin a "fraud".

One reason is their speculative value. Bitcoin fell from around US$4,340 to as low as US$2,981.05 in the days after Mr Dimon's comments. But it has since recovered to around $4,433.61 as of Oct 2, according to CoinDesk data. Despite this volatility, bitcoin's value has risen more than 344 per cent so far this year. Ether, the token underpinning the ethereum blockchain, has surged more than 2,200 per cent since last year.

Low interest rates have forced investors to look for alternative asset classes, Mr David Moskowitz, co-founder and chief executive of Indorse, an ethereum-based social network in Singapore, said.

"We have seen the rise of cryptoassets from $0 in market value in 2008 to over US$100 billion currently. This is a trend that cannot be ignored," he said.

As ICOs proliferate, there is a lot at stake for both the start-ups that rely on them for funding as well as for the investors, who stand to lose millions of dollars through scammers and hackers.

The jury is still out on cryptocurrencies. These are high-risk investments that should not be punted by retail investors just because of meteoric gains in the value of certain digital tokens.

Beyond the hype, the question is whether regulators can play a role in positioning Singapore's economy to capitalise on the development of the underlying technology that powers these virtual currencies.

Regulators will have to strike a balance between keeping out the ugly side of cryptocurrencies and warning investors of the risks involved, while maintaining a financial ecosystem that is hospitable to the good that this new fintech trend can bring.

A version of this article appeared in the print edition of The Straits Times on October 04, 2017, with the headline 'The good, the bad and the ugly side of ICOs'. Print Edition | Subscribe