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What is painful in ICO collapse, is it inevitable and why this catharsis is needed?

01 August 2017 21:00, UTC
Dmitry MACHIKHIN, partner of GMT Legal, IMMO evangelist

ICO (initial coin offering) or Token sale is a method of primary and sometimes venture capital raising, into a project by issuing a limited number of its own crypto-token and further selling them to a wide range of people. Often such companies work on blockchain technology, but not necessarily, as in the case of the Zirkoin tokens or the expected "Bioсoin"-token of the company "LavkaLavka" offering farm products. In total about $2 billion have been raised since the very first ICO in 2013. And a half of this sum – over the past year. This amount is a multiple of the classical venture financing market. Such figures have appeared, among other things, because of the significant growth of the cryptocurrency exchange rates in the spring-summer of 2017. Of course, there has been a "boom" of ICO, which continues to this day.

The most important goal in ICO for a company issuing its tokens is getting real financing, without giving their customers equity control over their company (as happens in the classic IPO). This model, in fact, is a cryptocurrency crowdfunding, which, in turn, under the onslaught of ICO, is already losing popularity. Tokens buyers, as a rule, receive an analogue of classic dividends, and then, when a token appears on one of the crypto-exchanges, its owner has the opportunity to trade it.

At the first acquaintance with ICO, the question of regulation immediately arises: how legal is this method of attracting funding or investments. The correct answer to this question at the moment simply does not exist. Companies and investors are willing to take advantage of the gap in regulation and get big profits from this. On the other hand, this is a field for fraud and manipulation. That's where the ICO "pain" is and why catharsis should happen inevitably. We will speak about this below.

The positions of states are currently different. But there is a common opinion – the ICO needs to be regulated. Only a few states moved further in this issue and adopted a number of regulatory documents. Among them: South Korea, Singapore, Switzerland, the United States. It's worth mentioning that the US reacts extremely sharply to any bypass schemes, so the main body responsible for securities regulation – SEC officially stated that most deals with cryptocurrency tokens are investment contracts, and that means that tokens are securities, so they need to be handled and managed with complex and expensive procedures, similar to the placement of common shares on an IPO. So, as a result of the recent investigation, the SEC recognized DAO token as a security with all ensuing consequences. An important issue in the ICO procedure is taxation. This question is also practically unsettled. Not long ago the Federal Tax Service when asked about profits received from the ICO responded that it doesn't know the proper answer due to the lack of legal status of the cryptocurrency and ICO. Nevertheless, the FTS employees recommend to declare income and pay income tax (13%).

Of course, in such circumstances, the room for fraud or "scam" is huge. Companies often go to the ICO only for marketing purposes, not expecting the further development of the product and the future price growth of company tokens. After having received financing, often the product itself does not appear what becomes a disappointment for its investors. This is a rather problematic legal field which allows to avoid responsibility. An important factor is always the current security issue in IT. A number of companies which have collected million dollars over the past six months were attacked by hackers that resulted in massive losses for token holders. Many believe that it is the companies launching ICO are behind these attacks. Again, the United States has issued a whole newsletter that is designed to protect the ICO participants from losses and scams.

ICO has become a public fashion, and as Mark Twain said, "whenever you find yourself on the side of the majority, it is time to pause and reflect".
In any case, as the proper regulation and successful enforcement come, ICO will cease to be a way to quickly attract "easy" money into a business or project. We believe that the collapse of the ICO boom has already been launched and will develop over the course of the year.