What You Need To Know About ICOs: Gary Sheynkman, Managing Partner, Leyden Ventures What offerers and investors need to understand about Initial Coin Offerings (ICOs) to avoid getting burned.
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Entrepreneur Middle East asked a few UAE-based investors and entrepreneurs about their thoughts on the brave new world of Initial Coin Offerings (ICOs). Here's what Gary Sheynkman, Managing Partner, Leyden Ventures had to say.
What are the factors one should take into consideration when launching an ICO?
"It is important to realize that there are different types of tokens. There are core protocol tokens, such as Bitcoin and Ether (Ether are the tokens on the Ethereum Blockchain), and then you have tokens based on Ethereum which are basically a method to create something like loyalty points, or some sort of a mercantile mechanism inside of the application that you are building, or to fundraise for your business through untraditional means. An ICO pre-sale is a promise to get a discount on an economic unit within a new system, once it's built or if it's operating already.
This is where it gets interesting from a securities law perspective, because if it's a "once it's built' situation, then, at least the US government, considers it as a security. But, if it has a use case already on day one, then it is a utility and you are selling something else, a commodity. There are large companies, US$300 million+ organizations, that are now issuing tokens for some useful things and those are honest utility tokens because they are launching a token that can participate in a company that is worth millions/billions of dollars. That is a worthwhile investment.
I would be extremely wary of anyone launching their utility token sale before they have a product. There are two definitions with the same name. There are what I would consider security tokens, which is an organization that issues you a token in accordance with securities laws, you sign a subscription agreement, and have a contractual relationship that is represented by a token. So, you get a contract and you have a tradeable token at the end of that exchange. Then, there are companies that are issuing tokens which the governments would say are security tokens, but they are not following the regulations in terms of contract work.
I think that a large portion of ICOs that are marketed to people on Facebook, Twitter, or Instagram are fraudulent either purposely or by accident, meaning that they are just not sophisticated enough to understand that they are committing securities fraud. It's probably mostly the latter, but when I see a pre-sale for things that are clearly not built yet and are marketed on Facebook to you, that is by definition securities fraud. They are marketing something that does not exist yet and they are just fundraising for their company this way. They can call it whatever they want but that is not what it is in the eyes of the regulators.
So, when it comes to security and utility tokens, my tip is: know the difference. But I'd rather not give investment advice because some people have a high tolerance for risk and then some traders take those weird tokens, just to get in and get out, make a couple of percentages, and do well. Just in the way that you play over-the-counter bulletin board type stocks that are not listed on any proper exchange, you do the same with tokens. That is a very different conversation than a large hedge fund coming in with millions of dollars into a token they plan to hold for several years."
What are your tips on approaching ICOs- for both investors and entrepreneurs?
"In general, I would recommend to investors interested in the ICO space to look at how a token is governed, how it is issued, whether it is mined, pre-mined, and so on. If anyone is looking at purchasing tokens, you have to review the team and you have to understand the company they are working on. A scenario where they explain how the process of changing the protocol will be governed versus a situation in which a company's private interests can change the governance of the tokens that you purchased. You have to be careful and you have to look at vested interests. Teams are important, but also advisors and board members of the company. There is extreme volatility in these alternative coins and you have to watch what you are doing.
In general, an investment into a token should be viewed as an investment into a company, so you have to look at the team, the legal structure of the organization and how they can make changes to the protocol. If the team is not willing to disclose that, you should avoid that token. Mostly, you are entering into a smart contract to distribute the token once the sale is done, and then there is not a whole lot that prevents them from being bad actors. In more established companies, there is a subscription agreement which gives you some sort of economic rights, and this is where security tokens become interesting because that token represents a legal agreement between you and the company, a security in the jurisdiction you are buying it from. In the near future, whether we are talking about security or utility token issuances, you will have specially trained judges or arbitration that will be able to mitigate this stuff. Right now, it's the Wild West.
For entrepreneurs, I'd say that blockchain is not magic, it won't make every business better, but if you have a need to create an economy within your product and have those transactions be secured and have your company be a trusted party, then it is a great way of doing it. As an example, I think you will eventually have a broader freelance market that exists in the Middle East. Blockchain is a great application of that because you can empower people to work for a number of parties without having to worry about getting paid. If somebody wants to create a freelance platform on blockchain where you are remitted in bitcoin or other tokens for your payments, that, I believe, would do well in this part of the world. So, it is always use caseoriented and you have to be intellectually honest about it."