Those who invest in ICOs require protection

It seems like a law of contemporary finance that investment instruments will increase in complexity over time. Retail investors should be especially worried. Many who missed the boat on bitcoin are now chasing newly issued cybercurrencies. But if you think bitcoin is complicated and its value highly volatile, so-called initial coin offerings (ICOs) are worse. Concerned about the fledgling trend which has great potential for scams, money laundering and other criminal activities, mainland financial authorities have imposed a temporary ban on them.

Hong Kong investors can buy ICOs already in the market, though the Securities and Futures Commission has warned them to be especially cautious. Some ICOs have murky financial structures which may fall foul of local securities law. It’s often unclear whether the digital “tokens” amount to equities in the firm that is raising capital to fund new ventures or simply function as a cybercurrency for trading purposes. Their underlying technology is mostly the same as that which underpins bitcoin.

The ICO craze exploded on the mainland this year. Bitcoin and ether, another digital currency, are usually used to buy ICO tokens. By the middle of July, tech firms on the mainland had raised US$1.1 billion in 89 digital coin sales, roughly 10 times more than in all of 2016. Their popularity has proved a fertile field for speculators and even criminals. This is because they grow in value if their business looks viable or their networks become popular, which in turn attract more buyers and boost liquidity. An estimated 10 per cent of money intended for ICOs in China was looted by scams using hacking techniques such as phishing this year, according to Chainalysis, a New York-based firm that analyses financial transactions.

A big part of bitcoin’s surge in value this year stemmed from its widespread use in buying ICOs. Its recent dramatic fall has been mostly caused by the ban on ICOs and unconfirmed reports that mainland financial authorities are planning to shut down cryptocurrency exchanges. Regulators are also cracking down on ICOs because of concerns about capital outflows being exploited using cybercurrencies as a conduit. The authorities are right to take action, but it is being seen as temporary. Despite their potential for illicit activities, ICOs and digital currencies have their uses. Bitcoin, for example, has proved its usefulness, and is here to stay.

As a source of crowdfunding, ICOs have a use for new business ventures denied the usual funding channels. Regulators should take this time to regulate ICOs, such as controlling the size of the offerings or requiring full disclosure of their underlying structure. This way, liquidity may be enhanced and investors better protected.