ICO: to control uncontrollable

How to protect the investor rights during the cryptocurrency crowd sales

Holland startup Confido investors have lost at least $374 000. The project webpage was shut down, the social media accounts were deleted and the project team stopped any form of communication with their investors. At it turned out, project team photos, CVs and, eventually, names, were fake.

Confido case is one of the hundreds. On the expert forums the stories, when the project team after the ICO and funds collection stops responding to the messages, are growing at a disturbing rate. Also investors often complain about the startup failures to meet deadlines.

For instance, one of the biggest ICOs in 2017, the Tezos project, has postponed the Tezzies token issue for several months. Investors doubt the feasibility of the project launch due to the conflict within the project team and urgently hold together to prepare a class action lawsuit against the ICO founders. But the trial outcomes are foggy: the crowdfunding method and the crypto currency technology used for fund collection is not yet mature enough to have an established regulatory practice.

Lack of guarantees of promises fulfillment, investor rights protection and ICO project audit are the main complains against the new financing method among regulators and traditional financial market players.

According to Merel van Vroonhoven, the executive of the Netherlands Authority for the Financial Markets (AFM), “the high risk of fraud and loss of investment in combination with the current hype surrounding ICOs form a dangerous cocktail”.

Criticism of ICO comes not only from the traditional investors and regulators, but even from the traders, who were accused of fraud. For instance, Jordan Belfort, who published the memoir “The Wolf of Wall Street”, which was adapted into a film starring Leonardo DiCaprio, declared that ICO is “the biggest scam ever”.

“It’s the biggest scam ever, such a huge, gigantic scam that’s going to blow up in so many people’s faces,” Mr Belfort told the Financial Times. “It’s far worse than anything I was ever doing.” He added: “Probably 85% of people out there don’t have bad intentions but the problem is, if 5 or 10% are trying to scam you it’s a … disaster.”

Almost all financial regulators of the most countries agree that the ICO market has to be regulated. The United States, Canada, Singapore have chosen to regulate ICOs as the securities market. But with certain conditions: if the project token does not satisfy the securities criteria, they have a right not to register. Consequently, this regulatory method do not fully cover the market.

China took a hard-line stance on ICO followed by South Korea. They have issued a ban on the crowdfunding through cryptocurrencies crowd sales. But this approach will only lead to the industry entering grey, semi legal area with financial flows going sideways.

From an alternative point of view, ICO market does not need the centralized regulation, because it could seriously slow down the industry development with unnecessary barriers and bureaucracy.

“For blockchain projects not the external regulation but the market mechanisms are able to solve the quality problem in the ICO market”, suggested  blockchain enthusiast Marina Gurieva during the interview to CoinFox.

Another method to fight against scammers and futureless projects is the ICO projects valuation procedure and ratings. Currently many platforms and services offer to audit the ICO project. They publish reports, estimating the investment risks, current market situation in the ICO project sector, founders and team competences. Nevertheless, this method comes with its own risks: services can manipulate ratings, issue fraudulent reports bribed by startup projects.

“All too often they assign marks based on lurking methods and for additional payment agree to add to the mark”, wrote on Telegram German Klimenko, presidential advisor for internet development matters.

One of the ways to protect investors against scam and at the same not to put excessive pressure to the new industry, is to transfer ICO projects to the decentralized platform, where relationship between investors and startup founders are regulated by smart contracts. One of these solutions was developed by the Descrow team.

The offered solution is a decentralized platform, where startups can launch crowd sales. Both startups and investors register in the platform. After that investors choose the project they find interesting and assign the investment sum. Descrow platform using smart contracts will monitor that the deadlines are met and roadmaps are followed.

The key feature that differentiate the solution from the common crowd sales is that collected funds are not directly and fully transferred to the project team. Project team receives only the funds necessary to start the development process, while the rest of funds remain frozen. If the investor for any reason decides not to continue financing, he will receive back the frozen funds.

If developers postpone the current road map stage completion, they will be fined 2% of the funds collected during the ICO.

Investors can have an insurance against risks: token holders can recover the invested funds. The insurance claim will vary with the chosen risk management program. The compensation funds will come from the Descrow reserve fund, which will be fueled from several sources, including the commissions startups pay for ICO listing in the platform.

ICO market is often compared to the 2000s dot com bubble, when even the most prospectless startup could easily raise funds without much effort placed to the project development.

According to the Joichi Ito, director of the MIT Media Lab, it was possible to make money out of nowhere, and even if one wanted to create a good company, the employees could have just asked: why should I work, if I can do nothing and still receive money. If we delegate the regulator role to smart contacts, at least startup founders will not be able to receive millions for doing nothing.

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