Why Massive Discounts & Short-Term Liquidity Are Bad For Most ICO Investors

In the early days of Initial Coin Offerings (ICOs), basically for much of this year, one of the keys of a successful ICO raise was ability to snag a crypto-influencer onto one’s advisory board – or to get them to be an early investor in the pre-sale phase of an ICO.

Nowadays, with the explosion of ICOs, crypto-influencers are so bombarded with ICO requests that the practice has become quite difficult. Although the practice persists, the mere presence of a crypto-influencer as an advisor or investor seems to have lost some of its weight. There’s good reason for this.

To the extent a crypto-influencer agrees to join an advisory board, they often ask for compensation in the form of a high percentage of tokens, cash, or both. (In some cases, they even ask for a percentage of capital raised, which is actually a violation of broker-dealer laws, but that’s a topic for another article).

Public ICO Sale = Raw Deal

To the extent the crypto-influencer is an early investor, they often ask for massive discounts (as compared to the public token sale) and near-instant liquidity. Indeed, the purported “liquid” aspect of ICOs is what attracts a lot of investors in the first please. But while this fantastic for the early investor, it is a raw deal for all the other public sale investors.

Let me break down for you why: the purpose of getting an influencer or whale interested in an ICO in the first place is to signal to the public that a project is of a particular quality – one worth the crowd’s attention and investment dollars.

This has been true in the normal startup world, where certain super angels or VCs can attract a company attract follow-on money. The crowd sees the signal of confidence and invests, thinking that they’re investing alongside the early investor. It’s easier (and faster) to do that than dig through a white paper and token economic model and due diligence founders, after all.

In reality though, the early investor is not incentivized to be a real investor, but a speculator. They don’t have to believe in the project at all because they’re not financially aligned with the project. In these situations, the early investor gets a massive discount (I’ve heard as high as 90% sometimes), can quickly dump tokens–either at the public sale price or on the market at what whatever price the crowd is willing to pay for it, gets all their money back, and can even keep a bit to get a free investment. The crowd–often unaware of the terms of the early investor’s investment–invests thinking the early investor has confidence in the project (though it may just be that they got a ridiculously good deal)–pays full or nearly full price for the tokens, and is left holding the bag when early investors dump tokens back onto the market.

In some #ICOs the early investor is not incentivized to be a real investor, but a speculatorClick To Tweet

The entire scheme is great for the whale (free investment); for the ICO team (they’ve collected their pay day); but its a raw deal for the regular ICO investor–who is often least equipped to sustain the investment loss. And, I would argue, short-sighted and unethical.

Don’t get me wrong – I’m not saying early investors should be obligated to hold on to tokens for five or ten years. But seeing these early investors painfully wince at the thought of holding on to tokens for even twelve months, or even until a platform is fully functional – well, that demographic of investor strikes me as a speculator or flipper, not an investor who actually believes in a certain project.

Granted, things are slowly and surely changing (somewhat). A few recent ICOs have required holding periods for their early investors–a good practice. And ICOs that boast massive discounts are starting to look scammy in the eyes of certain investors. (In my book, any ICO issuer who truly believes in the long term nature of their project won’t sell for less than its worth, and for those who do, it’s an indication that they don’t truly believe the valuation or market cap they’re asking for.) Still, massive discounts paired with quick liquidity is common arrangement that crowd investors need to pay more attention to.

A few recent #ICOs have required holding periods for their early investors--a good practice.Click To Tweet

One last note on liquidity–firstly, the liquid nature of most tokens is a fallacy. Tokens that are securities are just as liquid as stock. One one needs to follow certain rules for secondary trading. Companies traditionally have not wanted secondary trading of their shares for a variety of reasons.

Secondly, a lot of ICOs nowadays make statements that they will be soon trading on an exchange. I wouldn’t trust these statements unless the ICO issuer already has a letter from an exchange committing to list them. The truth is that most ICOs will never make it to an exchange. Exchanges are quickly become more selective. Many are regulated, and will not list tokens that are not securities or do not have an opinion letter. And, at least with regard to sales in the U.S., its looking like the vast majority of ICOs looks like securities.

While it’s a lot harder for regulators to enforce rules on the hordes of ICOs, it is much easier for them to regulate the exchanges – and those who run exchanges will not risk the loss of their license to list an unregulated ICO.

it’s a lot harder for regulators to enforce rules on the #ICOs, it is much easier for them to regulate the exchangesClick To Tweet

 

Amy Wan, Esq.CIPP/US, is a Senior Contributor to Crowdfund Insider.  Amy is founder and Chief Legal Hacker at Sagecoin, a Bootstrap Legal Legaltech blockchain project, and is a consultant with ICOinvestor.tv. She has authored many legal publications, including the upcoming Bloomberg Law ICO offering practice guide. Amy was previously Partner at a law firm that specialized in crowdfunding and syndication law, and was the General Counsel of a real estate crowdfunding platform. She has been named one of ten women to watch in legal technology by the American Bar Association Journal in 2014 and was Finalist for the Corporate Counsel of the Year Award 2015 by LA Business Journal. She is the founder and co-organizer of Legal Hackers LA.

Sponsored Links by DQ Promote