There are increasingly often reports in the media about consumers investing in ICOs with money intended for later, or even with large amounts of borrowed money. They are afraid to miss the boat and hope that the price of the tokens will rise as explosively as the price of Bitcoin. The promise of high returns can, however, make investors blind to the serious risks associated with ICOs. In combination with the recent explosive growth of ICOs, which displays all the hallmarks of a hype, these risks form a dangerous cocktail for investors. Investors run the risk of losing their entire investment. For this reason, the AFM currently considers ICOs to be unsuitable for retail investors. In addition to the AFM’s previous warning regarding investment in cryptocurrencies, the AFM notes the following specific risks with respect to ICOs:
ICOs are currently an ideal means for fraudsters
The cross-border nature of blockchain technology means that private investors around the world are able to participate in an ICO. At the same time, the anonymous and cross-border nature of blockchain technology enables advanced forms of a traditional pyramid scheme that are difficult to recognise. The current hype of ICOs thus forms an ideal opportunity for fraudsters to take advantage of investors who are afraid to miss the boat. There have been several examples of fraudulent ICOs outside the Netherlands, and the AFM has serious concerns regarding the risk that investors in the Netherlands could be misled.
The US supervisor, the Securities & Exchange Commission, has recently brought charges against the issuers of two ICOs (REcoin Group Foundation and DRC World), among other things because they have provided false and misleading information to investors. They promised high returns from activities in relation to real estate and diamonds while in fact the providers were not involved in any of the promised activities.
Exaggeration of expected returns
Many investors let themselves be tempted by the promise of tremendous returns, but they are not sufficiently aware that this is a development that is still very much in its infancy. As with the Internet bubble at the beginning of the century, the promise of new business models enabled by new technology – in this case blockchain technology – generates the risk of overoptimistic expectations. It is very likely that these expectations will not be realised. The reality is that the projects in an ICO are in a very early stage of development, meaning that it is highly uncertain whether the promised plans can be realised. And even if they are realised, there is a high risk that the ultimate value of the product or service will be far too low in comparison to the amount invested. Furthermore, the underlying blockchain technology is itself still in the development phase, meaning that there are real risks of errors in the code or theft of the tokens. This could lead to permanent loss of the tokens, or access to the tokens.
The knowledge and expertise required is underestimated
Until recently, investing in start-ups was restricted mostly to professional parties with specialist knowledge and experience. Blockchain technology, however, enables start-ups to obtain financing through an ICO from anyone with an Internet connection and a digital wallet. Most retail investors underestimate the specialist knowledge and expertise needed to be able to make a well-informed decision regarding this kind of investment. Without this expertise and in-depth knowledge of blockchain technology, it is virtually impossible to distinguish viable business models from projects with little or no added value.
Lack of transparency
The providers of ICOs are often not transparent when it comes to the information they provide to investors. Essential and basic information such as the risks of the project, the rights of the holder of the tokens, or how the financing will be used is described in very summary terms or even not at all. Without this kind of information, it is almost impossible for investors to assess the true value of an ICO and to distinguish bona fide ICOs from fraudulent projects. This lack of transparency is also an obstacle to efficient pricing of the tokens.
Market driven by speculation and even manipulation
In the current environment, many people invest in ICO’s with speculative goals in mind. They are investing in the hope of being able to sell their tokens quickly at a higher price. This highly speculative feature of ICOs is contributing to very high volatility in the prices of tokens traded on specialist trading platforms. These platforms are not subject to financial supervision. Daily price fluctuations of tens or even hundreds of percentage points are not unusual. The tradability of many tokens is moreover limited, meaning that it is relatively simple for malicious parties to manipulate prices.