Businesses and individuals may use initial coin offerings (ICOs) and initial token offerings (ITOs) to fund the development of a variety of projects, including alternative cryptocurrencies, software or other types of products and services. Those promoting coin/token offerings may promise investors high returns in a new investment space, but the reality is that participating in an ICO/ITO can be risky and you could stand to lose your entire investment.
What is an initial coin/token offering?
ICOs/ITOs are a way that start-up businesses can raise money from people over the internet to fund the development of digital platforms, software products or other types of businesses. An ICO/ITO is typically managed over the internet, allowing people to visit a website and purchase coins/tokens using a fiat currency (such as Canadian dollars) or a cryptocurrency like bitcoin or ether.
The coins/tokens sold as part of an ICO/ITO may have a planned future use, such as allowing buyers to access a digital platform, use an alternative cryptocurrency or access other types of products and services.
Some businesses may also tell buyers that they will receive a return on their investment or that the coins/tokens can be resold to other buyers if they wish to exit the investment, which may not always be the case. There is no guarantee that coins/tokens can provide a return on investment or that there will be a market where buyers can resell coins/tokens if they need to do so.
In some ways, an ICO/ITO may seem similar to an initial public offering (IPO) as the coins/tokens offered can resemble traditional shares of a company, where their value may increase or decrease depending on the company’s success. However, the coins/tokens can also be different from the shares sold as part of an IPO because they usually do not represent an equity interest in the business, meaning that investors do not have part ownership of the business, have voting rights or receive dividendpayments.
3 things to consider before participating in an ICO/ITO
1. Coins/tokens are often securities
An ICO/ITO may involve the sale of securities. If you purchase coins/tokens that tie their value to the future profits or success of a business, it is likely that the coin/token will be considered a security.
Selling securities is a regulated activity and businesses that do so are required to meet certain legal obligations that are in place to protect investors.
Businesses may market coins/tokens in different ways, including software presale tokens, donations or crowdsales. If the coins/tokens are securities, the businesses offering them to the public may need to be registered with the Ontario Securities Commission. Learn how to check if a business is registered.
Businesses may publish “whitepapers” for their ICOs/ITOs that describe things such as the amount of money they are aiming to raise, how the money will be used and how long the coins/tokens being offered will be available for purchase. If the coins/tokens being sold are securities, businesses may be required to provide specific disclosure documents, such as a prospectus or an offering memorandum, which contains information about the business, its management, operations and business risks.
Before you invest, you should ask questions about the investment and any disclosure documents that investors are entitled to receive. Any document that you receive should be in plain language and easy to understand.
2. Businesses located outside of Canada
Many businesses raising money through ICOs/ITOs are located outside of Canada, but are marketing their coins/tokens to Canadian investors. Even if a business is located outside of Canada, it must follow Canadian securities laws if it is selling coins/tokens to Canadian residents.
Registration with the Canadian securities regulatory authorities is often required to sell coins/tokens that are securities to the public. One of the key obligations for registered firms is that they only sell coins/tokens to investors if it is suitable to do so. Learn how registration protects investors.
Beware of any transactions that are conducted anonymously. You should know the identities of the businesses’ management members and how to reach them. Also, be wary of any businesses that only collect limited information about you, such as your IP address or digital wallet address.
Some digital platforms or cryptocurrency exchanges (which are online exchanges that allow people to buy and sell cryptocurrencies such as bitcoin and ether) will allow you to buy coins/tokens that someone else previously purchased through an ICO/ITO. As the subsequent purchaser of these coins/tokens, you would normally be entitled to protections under securities laws. However, many of these platforms operate across the world and often without any oversight or regulation. Your rights may be difficult to enforce.
3. Limited use for coins/tokens
Buying a coin/token through an ICO/ITO is not the same as buying a cryptocurrency that is widely used, such as bitcoin or ether. Coins/tokens may have extremely limited use, and you may only be able to use them on a specific digital platform for certain products or services. If the business does not successfully complete the project that it was hoping to develop using the money it raised from an ICO/ITO, the coins/tokens it issued may have no use at all.
If you purchase a coin/token, you may be buying nothing more than a promise that the business will deliver a service or product in the future. You may need to wait months or even years before the coins/tokens can be used or provide a return on investment, if any. There is also no guarantee that they will increase in value the same way as bitcoin and ether.