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Initial coin offerings and fund raising

Introduction

For many companies, the fund raising stage involves facing a number of daunting decisions. Perhaps the most difficult decision during this period is choosing the method of raising capital. Most fund-seekers have chosen the same routes of raising capital for decades like venture capital, angel investors and bank loans.

Seen by many as the newest phase of fund raising, following the recent craze in crowdfunding websites such as gofundme.com, initial coin offerings (ICO) are becoming attractive in various markets. In fact, a number of companies have released their own cryptocurrencies in order to capitalize on the opportunity, for instance the Canadian instant messaging company Kik, which recently introduced their cryptocurrency “Kin” into the market, with a goal of raising $120 million to fund various projects.

What is ICO?

With the support of government and private entities, companies are seeing benefits in opting for fundraising through ICO. But what is the process of an ICO?

When a company decides to go public in an effort to raise capital, it releases its private shares to sell to the public. The price at which these shares are initially offered to the public is called the initial public offering, or IPO. Similarly, when a company using blockchain decides to raise capital in order to fund a certain project, it choses to offer a number of tokens in exchange for capital. But what exactly are tokens?

Tokens are an electronic asset that, just like the shares, which depreciate or appreciate in value. The speculative nature of such units is what causes such variation. Unlike shares that represent equity in a company, investors in cryptocurrencies receive tokens. These tokens can be sold and traded on cryptocurrency exchanges in exchange for other cryptocurrencies, such as Bitcoin and Ethereum.

Releasing an ICO

The process of releasing an ICO can be summarized in the following steps:

First, informing and incentivizing the public. The objective here is to create interest and draw investors’ attention. The developer announces their intention of undergoing the project and releases what is called a white paper. A white paper is a document that outlines the project, its objectives and requirements, and other important details. The white paper is one of the main tools used in marketing the project along with the T&Cs and Privacy Policy of the developer.

Second, if the developers anticipate sufficient demand from investors, they then create the token which they will offer the public in exchange for capital (the recent trend has seen more exchanges of Bitcoin or Ethereum). The volume of tokens offered is capped, as having a limited amount of tokens creates higher demand. Developers also have to decide on the duration of time that the ICO will run. Typically the white paper and the T&Cs of the ICO will encompass the abovementioned information.

Third, the developer advertises the ICO on various online platforms in order to attract further attention from potential investors. If the capital raised by the developer does not meet the minimum funds required by the firm, usually outlined in the whitepaper, the developer returns the money to the initial investors and the ICO is deemed unsuccessful. However, if this fund requirement is met at the end of the time frame, the capital raised is used to initiate the objectives set out in the whitepaper. Sometimes the issuers go for a pre-ICO ie, the token sale event that the enterprises run before the official crowdsale or ICO campaign goes live, to raise the funds even prior to the ICO.

Fourth, entering into the governing documents like token purchase agreement with the investors and the operating agreements between the issuers and operating company. The governing documents can be made bespoke depending upon the requirements of the company and the investors.

UAE perspective

Countries all over the world have responded positively towards this crypto-craze, including the UAE. In the Middle East, the UAE has been at the forefront of incorporating cryptocurrency and more generally blockchain technology in its government processes. This is in line with the country’s objectives of advancing the UAE’s technological infrastructure, with cryptocurrency being used by both governmental and commercial entities.  In fact, in early October 2017 the UAE government announced its own blockchain based cryptocurrency “emCash”, a digital currency that will enable citizens to pay for both government and non-government services via the Empay smartphone application. In fact, the UAE plans to become the first government to use blockchain technology for all documents by 2020, with the Dubai Land Department being the first government entity to adopt the technology.

The Financial Services Regulatory Authority (FSRA), the regulatory arm of the Abu Dhabi Global Market (ADGM) earlier in October, 2017 described the ICO as a ‘novel’ and ‘cost-effective’ way of raising funds. ADGM then issued a supplementary  guidance on the ICOs and the virtual currencies for those considering the use of ICO. ADGM has held progressive stance of assessing the applicability of the regulations on a case to case basis. FSRA shall on a case to case basis decide, whether or not the tokens exhibit the characteristics of a security. The same classification shall decide as to whether or not the activity will be treated as a regulated activity.

On the business community end, we see that there have been a number cryptocurrencies launching, including Farad Cryptoken, deemed to be the first cryptocurrency backed by real economic activity.

Having said that, both the company initiating the ICO and the investors, need to be diligent and cognizant to ensure that the investment does not result in loss. From the investor’s perspective, it is essential to assess the business model and the credibility of the company and the promotors. At the same time, from a fundraiser’s perspective, it is essential to identify it’s target audience and to ensure that the whitepaper and the governing documents give a fair picture.

 

Authors: Ms. Kokila, Akshata Namjoshi and Adel Khalil Ahmad

 

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