The growing prominence of Bitcoin and other blockchain-based cryptocurrencies has created a new world of capital funding opportunities for early-stage fintech startups. In the bourgeoning Initial Coin Offering market, investors with varying net worth and expertise can sign on to fund the birth of new blockchain ventures, trading traditional funds or cryptocurrencies for tokens to be exchanged for a newly developed cryptocurrency. Driven in part by its innovative nature and accessibility, this new capital market is surging. As of June 2017, fintech startups had successfully raised $1.3 billion in ICOs since the beginning of the year, and firms have raised approximately $2.3 billion since the inception of the capital funding strategy.
Despite the growth of the ICO market, its continuing popularity hinges on increasing the trustworthiness and stability of ICO processes. Running counter to the vast possibilities presented by ICOs is the significant risk of fraudulent and criminal activity associated with this funding mechanism. While ICOs bear a strong theoretical resemblance to Initial Public Offerings (IPOs), they lack many of the regulatory safeguards that protect shareholders and provide additional oversight throughout the fundraising process. While the minimal barriers to entry for startups, which typically include the creation of a website and informational white paper, have contributed to the accessibility of the ICO market, they also open the door to ventures that might not otherwise be acceptable to investors on a more regulated economic platform.
In addition to a lack of thorough vetting of ICO startups and their leadership teams, a number of other common industry practices have contributed to the sector’s wavering security. The standard practice of transferring cryptocurrencies and tokens directly to private wallets, as well as arranging ICO transactions via unsecured chat platforms, has further increased the risk of fraudulent token sales and ICO hacks. A number of ICO organizations have also experienced the detrimental effects of the sector’s dearth of regulations. According to Chainanalysis, ICOs have lost an estimated $225 million to cyberattacks and fraudulent activity in 2017. When ICOs are compromised, the result is not only a loss of investor capital, but also a potential monetary gain for criminal organizations. In some instances, public watchdog groups have linked ICO organizers themselves to international crime.
Concerns about the risks associated with ICOs have led national governments to view them with a higher level of scrutiny. For instance, China recently instituted a complete ban on the capital funding practice. Without adequate regulatory oversight, countries around the world will be incentivized to take a similarly stifling approach to ICOs. This represents a significant potential loss for the bourgeoning sector. The loss of both physical capital and trust, which is of the utmost importance in the cryptocurrency sector, could lead to the formation of a liquidity bubble that would hasten the collapse of the ICO market. Without the confidence of investors, legislators, and economies as a whole to back it up, this newly formed sector would likely struggle to return to its former prominence.
For this reason, organizations such as the ICO Governance Foundation (IGF) have set out to establish a sustainable system of governance for the ICO market. For the IGF, this solution is a form of decentralized self-regulation that aligns with the decentralized nature of blockchain as a whole. The IGF has developed a protocol known as IGF-1 that will serve as a supplement to ICO white papers, providing transparent assurance that each ICO has adhered to the best practices and ethical standards agreed upon by the industry at large. To learn more, visit: https://icogovernance.org.