By Gordon Harrison, ICO Specialist& Business Development Manager, EMEA, Jumio

The cryptocurrency sphere has recently been transformed by the rise of the Initial Coin Offering (ICO), or “token sale”. Across the globe, they are becoming increasingly commonplace as an alternative way of raising funds for everything from development projects to company launches.

Gordon Harrison

In an ICO, investors are invited to buy digital utility tokens from the project or business’s website, making the purchase using Bitcoin, credit cards or fiat currency. Utility tokens are not currency, and possessing one does not imply ownership of a share in the project or business. Rather, they enable an investor to access features of the project at a later date. Token holders can trade them on the open market, allowing them to make money on their original investment.

In the main, ICOs are not regulated, which has contributed to their popularity among start-ups as a way of by-passing the regulations surrounding the traditional capital-raising process required by venture capitalists and banks. So far this year, more than $1.8bn has been raised by start-ups using ICOs[1] – a figure that has already overtaken the value of early-stage venture capital funding for internet companies[2].

Regulation on the approach

There are signs that this light-touch regulatory approach is about to change, however. Following accusations of serious disruption to the economic and financial order in the Asia-Pacific region[3], ICOs have been banned in China and South Korea. Media headlines denouncing token sales as havens for fraud have increased pressure in many other jurisdictions to follow the two East Asian countries’ lead.

All of this has increased concern among both issuers and investors about the possibility of a clampdown on the horizon[4]. Many of the individuals that choose to invest in ICOs value the full transaction anonymity they offer, and are worried that any additional regulatory oversight will jeopardize this.

For governments, transparency in the ICO process is desirable, as an important means of tackling money laundering and similar fraud. Anti-money laundering (AML) legislation as it stands was created with this transparency in mind, designed to police traditional centralized financial services systems. However, this does make them unsuited to a finance system like the ICO that has been built on the idea of intrinsic anonymity.

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Establishing credibility

Despite the concerns of token sale participants about anonymity, the growing calls for regulation mean it is time for prospective ICO issuers to ensure that their sales meet the rigorous standards of national and international anti-money laundering (AML) and Know Your Customer (KYC) legislation. Beyond simply appeasing regulatory bodies and assuaging their concerns, there are a number of benefits of ensuring that their ICOs comply with the latest regulations.

For example, strong KYC during an ICO can help the listing company establish credibility with banks, making it easier to work with them in the future. Choosing to comply with regulations can lend all-important legitimacy to a project. More, many regulatory bodies seem to be amenable to the idea of token sales, provided they meet existing AML standards. Incorporating KYC protocols into a sale can also make post-funding tracking easier, allowing companies to identify their investors and confirm their accredited status, providing an added layer of transparency that any would-be investor can appreciate.

In addition, by being open and transparent about its plans, a listing company can go a long way towards improving public perceptions of its offering. The current lack of explicit regulations means that ICOs are a potential haven for fraudsters, making it all the more important for legitimate companies to demonstrate that they are providing necessary safeguards for the public.

Doing all of this can help companies burnish perceptions of the long-term legitimacy of their brand. By demonstrating that their initial crypto-assets are well designed and secure, and that they have good governance protocols in place, including comprehensive oversight, yields predictability, security and effectiveness, companies can reassure ICO participants that their tokens are well worth the investment.

Broadening horizons

More than lending legitimacy to a project or business, voluntary legal compliance can expand the market reach of a new ICO, enabling them to participate in a larger number of jurisdictions than they would otherwise be able to. For example, such compliant ICOs can be offered to a subset of “accredited investors” in the US, UK and Canada. Issuing token sales in countries with a less stringent regulatory framework, on the other hand, may give you access to a more limited pool of potential investors.

Operating in larger, more established markets can also help attract big investment to an ICO. As Nick Aytonrecently remarked in Cointelegraph, “Institutional money is itching to get involved in crypto, in Blockchain, in this emerging market that offers returns traditional opportunities don’t offer. But they need to see certain things done properly so that they are allowed to invest: VCs, Investment Banks, Hedge Funds will invest in the right ICO…as they do IPOs.” And a big part of doing things properly is adhering to AML and KYC compliance.

The regulatory guidance on ICOs in many countries remains unclear. Nevertheless, many regulators in large markets, such as the US and the UK, are moving to classify ICOs as securities, heralding a new age of greater oversight. By being more proactive and getting ahead of the compliance curve, ICO listing companies can minimize the risk of fines and other penalties, and ensure they can continue operating in these markets.

Meeting requirements

Compliance with local AML regulations can seem intimidating for an ICO listing company when they are doing so for the first time. However, there are simple steps they can take to meet legislation.

First and foremost, they need to ensure the accurate verification of the people investing in their business or project. To meet this goal, a growing number of issuing organizations are implementing advanced online verification solutions in their token distribution processes.

Capable of verifying an ICO participant’s identity when they make a transaction, these solutions help listing companies to understand the profile, business and account activity of the people investing in their projects. They can also identify any adverse information relating to a potential investor and evaluate the risk before the transaction takes place – ensuring compliance with the most stringent KYC and AML legislation.

Verification systems normally need protocols to be put in place in the ICO transaction process to validate a passport, driver’s license or other ID document. They also usually require biometric facial recognition and liveness detection to verify that the person in question is present at the transaction. Investors’ bank statements and similar supporting documentation can also be studied and verified to add an all-important third layer of security, ensuring optimum due diligence.

Building trust

ICOs are still new to the financial arena, but they have already demonstrated their incredible potential as a way to help start-ups launch their businesses. To fulfil this promise, though, listing companies need to take measures now to firmly establish the legitimacy of ICOs by ensuring optimum due diligence and voluntarily complying with local and global AML regulations.

Companies may be unenthusiastic about taking this route right now, but doing so will significantly boost both their own reputation and that of ICOs in general with regulators and investors alike. This will ensure that token sales continue to pay dividends for listing companies and token holders well into the future.

[1]https://www.ft.com/content/68c795ca-a680-11e7-ab55-27219df83c97

[2]https://www.cnbc.com/2017/08/09/initial-coin-offerings-surpass-early-stage-venture-capital-funding.html

[3]https://techcrunch.com/2017/09/04/chinas-central-bank-has-banned-icos/

[4]http://www.cityam.com/275615/latest-warning-initial-coin-offerings-icos-comes-european

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