The key reason why crypto startups tend to look for crowdfunding through ICOs is the current lack of regulations that would restrict participation by potential private investors. However, as the cryptocurrency market grows and regulators take notice, several question marks have emerged around legality and potential regulatory roadblocks for investors. For the time being, the U.S. Securities and Exchange Commission (SEC) acts as a precautionary consultant for investors by publishing guidelines they suggest investors follow in order to increase security and transparency. However, the SEC has not yet registered any company related to cryptocurrencies.
“Investors should understand that, to date, no initial coin offerings have been registered with the SEC. The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today tells you otherwise, be especially wary.” – Jay Clayton, SEC Chairman (SEC’s Public Statement 12/2017).
Regulations will Change the ICO Market
As regulations for ICOs begin to be put in place in countries around the world, investors worry about the side effects on their existing investments. No one knows what will happen to the ICOs market after regulations become active, or, in certain cases, whether investors are going to be able to sell their pre-regulation tokens once restrictive regulations are applied.
ICOs have been banned in several countries (China, for example), they are highly regulated in the USA, and more countries are about to apply their own regulations. As a glut of new restrictions are possible, what exactly will happen to investors who continue investing in unregulated ICOs? What changes to investor’s rights will occur if, for instance, an existing company migrates to a non-regulated country, in order to avoid restrictions? The answer to both questions is still unclear. What is abundantly clear is the coming regulations will indeed affect the ICO market. How and to what extent will be a matter of how it shakes down in each country.
Investors and Legal Disputes
A very big concern for ICO investors is whether the legal definition of their relationship to the company in which they invested or their legal right to the tokens they hold will be affected by new laws. Token holders worry what form new contracts will take (between the token issuer and the holder) once regulations have been applied. Since, in some cases, the only available documentation so far comes in the form of white papers from the companies themselves, there is uncertainty about whether courts will accept current contractual agreements. Other questions arise as well, such as, which country’s jurisdiction would a possible lawsuit be subject to? What are the applicable laws such lawsuits would fall under?
Frauds Raise Unpredictable Issues for Investors
Frequently, the creators of a Blockchain startup are unknown. Some, such as the Bitcoin founder, remain anonymous to this day. While the massive profits that some of these companies can produce tend to discourage investors from asking questions, anonymity should be considered a red flag at the very least. Educated investors should be skeptical about anonymous ICO owners and ask how they are protected if an unregulated Blockchain startup suddenly changes course or disappears.
Another detail of importance will be potential consequences for an investor who has provided financial resources to a startup that engages in fraud (e.g. money laundering) without his knowledge. While it is unlikely an investor would face legal issues in such a case, loss or liquidation of assets is certainly possible.
ICOs and Taxation
Taxation has been another grey area thus far for investors in the ICO environment. The growing amount of money being circulated in the industry has attracted the attention of the IRS and other tax authorities (the possibility of using cryptocurrencies for tax evasion is not lost on them). Few countries have applied comprehensive tax legislation yet. When—not if—they do begin taxing digital assets, investors will have to pay attention. There are presently no clear guidelines about how ICO investments will be taxed. How future taxes will be applied to the value of tokens acquired prior to regulations, as well as to which country taxes will be owed to, remains unclear. As daily trading differs from holding tokens in the long-term as assets, there is likely to be separate taxes applied to each (income tax vs. capital gains tax).
Be Cautious of ICOs not Following their Roadmap
Participating in an ICO means offering money for the development of an innovative product that will ideally lead to an appreciation in the value of digital tokens received. Investors often make their investment based on the company’s declared roadmap for future development. However, investors in unregulated businesses sometimes struggle to ensure that their money is actually dedicated to the development laid out in the company’s roadmap. The major concern here is how investors are protected in the event of losses resulting from the company changing their trajectory midstream. In a typical industry, regulations prevent companies deviating from the agreed-upon course of development.
A recent example where the lack of investor protections in the cryptos world was an issue is the Tezos case, where the Breitman couple (founders of Tezos) tried to use the funds collected during the startup’s ICO ($232 million) to pay for the lawsuit against them. They remain in dispute with the Tezos foundation, investors have not yet received their tokens after the Tezos ICO ended last July, and the future of the company is highly uncertain.
All to say, if investing in ICOs is in your investment plan, you will want to pay extra close attention to any and all information that comes out about a) the startup you intend to invest in, and b) the changes to come from governments, regulators, and courts.