Trough equity crowdfunding evolution and involution: initial coin offering and initial exchange offering

Finally, tokenization has also the potentiality to solve illiquidity problems related to rules of company law of a single country. SMEs and startup indeed usually choose for their companies simplified legal form that are always not allowed to have access to trading venues or that can be transferred only using specific ways such as acts made by a notary.

3.4.3 ICO and IEO cons: technological information asymmetry

Precedent paragraphs showed how ICO and IEO could solve two of the three EBCF drawbacks highlighted in this paper. But ICO and IEO are not immune from drawbacks. One of this is information asymmetry caused by the intense use of technology in those blockchain-based financing instruments.

Information asymmetry occurs when relevant information are not shared in a full and equitable manner among the involved subjects. As consequence, the fully-informed subjects can take advantage of their position, to the detrimental of less-informed ones. Traditionally this problem involved the relation between company shareholders and its directors. ICO and IEO intense use of technology moves the traditional problem of information asymmetry. It regards new subjects such as informatic expert, on the one end, and 'normal' people on the other. So, the token-buying public, who might not deeply know the technological functioning behind that specific ICO, can only believe in founders and their spokespersons honesty, competence and commitment. But, in truth, only founders (and their IT) can totally know the background and the complete functioning of the procedure on which the token it is based. Notwithstanding the fact that the code could be «public», only few people within the crowd will have the necessary competence to «read» it in the proper way. The fact that the code is public can help reducing this risk thank to the help given by the wisdom of the crowd, mentioned in paragraph 3.1.

In addition, a proper regulation establishing the information that must be published or the protocols that must be adopted may help the exercise of a crowd-auditing. But without precise disclosure mechanisms, today information asymmetry risks in ICO and IEO should not be underestimated.

A regulatory intervention to reduce the mentioned risk could help the development of this technology and its adoption by companies and investors. Adoption that today is still limited by lack of trust in its usage. Hearing about «lack of trust» could be weird for a blockchain expert, considering the well know mantra according to which this technology resolves the problem linked with the lack of trust between two parties before the conclusion of a transaction. However, we mean lack of trust «in» blockchain (and so in ICO).

Indeed, the fear for uncertainty that is at the base of all economic actions (especially those related to financial investments) could be enhanced by the obscurity of this new technology for «traditional investors». The fact that the «ordinary» market is considered safer than the cryptocurrency one, since it is guaranteed by authorized authorities and subject to specific and strict laws, maybe be a limit to future ICO and IEO evolution. Nonetheless traditional markets are not ruled by certainty and stability, as the events from 2008 until now still prove. However, in «tokens markets», all risks increase since there is no regulation and no prepared authorities empowered to intervene. Hence, also the lack of assurances by issuers enhances regulatory arbitrage and so uncertainty in the potential conflicts that might arise in ICOs. In this stage, assurances lack should be read in conjunction with disclosure framework and a regulatory lack.

At the end of the day, technological information asymmetry seems to be the most important drawbacks of ICO and IEO. Considering this only great disadvantage and their potentiality to solve most EBCF drawbacks, they could possibly be defined as a real evolution of EBCF. But ICO and IEO are not equal. Therefore, a brief comparison between these instruments may help to discuss the possibility to consider one of them as more dangerous that the other so that, in the future, it could not develop for lack of usage by investors of precise ban by most important financial regulation authorities.

4. ICO vs IEO: evolution or involution?

4.1 Money «creation» and conflict of interest

The ability to «tokenize» everything is a great advantage in a digitalized society. As highlighted in paragraph 5.2, blockchain permits to gives «liquidity» to everything in a secure way.

While there is no problem when the tokenization regards physical assets, specific problems arise in the liquidation process of right versus companies. Indeed, being companies «creature of the law» their creation is very easy as it is easy to provoke their winding up. Therefore, because tokenizing creates something very similar to «money», using «right versus companies» as the underlying asset of the token and use it as a measure of value to buy for services is a risky activity. This is true for the difficulty in recognizing to those tokens a stable value.

Indeed, the valuation and pricing process of a token depends on the stage in which the acquisition took place. In an ICO or in an IEO, tokens can be offered in the primary market, where they are bought directly from the issuer, or in the secondary market, where they could be bought from other investors, usually using the intermediation of an exchange. In the primary market, pricing is made by the company through a comparison with its economic data, i.e. considering the value of the service that the token will help to acquire or the fraction of the company value that the token represents. In the secondary market, the price offered by the investors usually depends on the price the investors bought the token, plus or minus their expectation on the increasing or decreasing of its value in the future. When the mentioned pricing process are «adulterated» the exchange of token could be dangerous because when the bubble will burst, investors will lose their money.

The problem of using token as money with a «false» value is more probable to arise in IEO than in ICO. These are the cases in which the issuer uses the self-issued token to pay for the service received by the cryptocurrency exchange or, immediately after, when those tokens are sold by the cryptocurrency exchange in the market managed by itself. Indeed, in these two particular situations, the rational pricing process can be easy adulterated by situation of conflict of interests.

This can easily happen because, as mentioned, the issuer has the power to create tokens from nothing when they are not related to a «specific» asset of the company. Indeed, tokens underling a right to a service of the company (utility token) or giving some right towards the company without any strong link with its registered capital (general investment token) have no creation limit. The issuer may create as much token as it wants having it the control on the token that can be issued, especially when they are not linked to its own assets (such as equity of debt token). Indeed, when a company could not offer a service anymore, it simply goes bankrupt. While granting more and additional voting rights has the result of diluting the company share capital.

For the exchange, the evaluation process can be also adulterated in the moment in which, being the exchange in control of the order, and so, controlling which order satisfy in a specific moment, gives the exchange the power of deciding the selling price. The exchange will gain a strong guarantee that the token can be sold, be itself in the control of who can sell when someone wants to buy.

The mentioned situations represent a danger that is more probable to be present in IEO than in ICO. Indeed, IEO presents a clear a risk of conflict of interest caused by the position of power acquired by the cryptocurrency exchange. But, while it is clear that this problem need to be addressed by regulator or by the exchange itself (considering the lack of trust that such behavior cold cause in investors), just this major drawbacks seems too weak to induce authorities to ban its usage or to determine investors in not investing in an ICO.

This drawback, indeed, can be easy overcome. From a regulation point of view, it is probable that financial authorities will address this specific problem with regulation aiming at avoiding conflict of interest as the one that today exist in general for intermediaries providing financial services and, specifically, for those managing EBCF platforms. From the investors point of view, a way to gain its trust could be the implementation of smart contract such the one already used by «decentralized cryptocurrency exchange» that will decentralized also the launch of the IEO through the crypto exchange.

4.2 Disintermediation to prevent arbitrary exclusion

In EBCF, platforms try to reduce the risk of fraud through a sort of «screening» operated by the platform who assume the role of the gatekeeper. This entails lots of power on the platform since he becomes the only and necessary intermediary of a crowdfunding operation. Born with the aim to preventing users from wasting their money and contributing to the promotion of blatantly unsuccessful projects, however this screening cannot always be considered a positive aspect of EBCF, being it also a serious drawback as highlighted in paragraph 3.2. In fact, platforms have full power to limit the projects that are shown to the public, not only by the imposition of objective prerequisites but also through arbitrary (and economic) evaluations.

Arbitrary exclusion it is not a drawback at all in ICO. ICO prevents it with its intrinsic disintermediated nature. In fact, ICO, operating on blockchain infrastructure, ensures disintermediation, since no entity can manage the system and so «gatekeeping» it. It is also based on an encrypting algorithmic code, reinforcing the immutability and the immediate verifiability of the transactions. Hence, this technology offers a much more resilient system, realizing a more effective protection against the different types of fraud and entailing greater transparency without any need for intermediation.

The same it is not true for IEO in which, as in EBCF, the platform re-gain the gatekeeping role and power of excluding potentially unsuccessful projects. But asking again the question if this drawback is enough to determine the future unsuccess of this instrument, the answer could be very similar to the one given at the end of paragraph 7.1. This because arbitrary exclusion is a «drawback of an advantage» that IEO has on ICO, that is to say the possibility to gain a previous screening of potentially scum projects. To solve this «residual drawback», instead of having specific regulation addressing this aspect, it is possible that also here, the use of decentralized cryptocurrency exchange may solve this issue, for instance, conditioning the launch of an IEO on the platform to the previous evaluation of a board of expert, having taken technical solution to gain the desired anonymization. The adoption of this solution could be profitable for all the stakeholders involved. Indeed, this selection process may induce more trust in investors, considering the reduction of potential conflict of interest given by the anonymous evaluation. From this, also the issuer could gain a direct advantage, considering the possibility to sell more token to an entrusted crowd of investors. The same is true for the crypto exchange that can gain from the commission on the transaction concluded.

So if it is true that ICO, disintermediation permits the access to finance using a decentralized networks powered by diffuse contributors, that do not suffer from arbitrary exclusion problems, it is also true that too much decentralization would not allow to prevent investors from being victim of scum or fraud. From this point of view, after having taken the right adjustment in order to limit dangers of conflict of interests, IEO could be an instrument that may gain more trust to investors.

Final remarks

The conducted analysis on the three discussed financial instruments let us show how ICO and IEO could both be considered two valid evolution of EBCF. Both solve two important drawbacks of EBCF meaning that both investors and entrepreneur have good reason to collect money using ICO and IEO instead of the now «old» EBCF.

At the end of the day, this paper tries to shed some light in the still cloudy world of blockchain related financing instruments. Further research may focus their analysis on other newcomers of this crypto-family. Some of these are known as: Security Token Offering (STO), which promise to finance a projects offering tokenized version of securities; and Decentralized Autonomous Initial Coin Offering (DAICO), in which the project is conducted by an Decentralized Autonomous Organization as the one created after the now very famous The DAO Case. Indeed, a comparison of their characteristics and the analysis of their risks could help for sure the work of regulators whose time to intervene in a complete and proper way is going to be everyday nearer.

crowdfunding coin offering cryptoasset

References

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4. Bellini M. (2018) Blockchain and Bitcoin: come e nata, come funziona e come cambiera la vita e gli affari la tecnologia che e diventata il simbolo della rivoluzione digitale e valutaria. Class Editori.

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18. FurnariS. L. (2018a) ICO in Italia: applicability della disciplina sull'equity crowdfunding e suoi potenziali benefici // R. Lener (2018) Fintech: Diritto, Tecnologia e Finanza. -- I Quaderni di Minerva Bancaria.

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21. Hewlett S. A., Marshall M., and Sherbin L. (2013) How diversity can drive innovation // Harvard Business Abstract.

22. Howell S. T., Niesser M. and Yermack D. (2018) Initial Coin Offerings: Financing Growth with Cryptocurrency Token Sales. -- Finance Working Paper № 564/2018, European Corporate Governance Institute (ECGI).

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24. Jiafu A., Wenxuan H. andXianda L. (2017) Initial Coin Offerings: Investor Protection and Disclosure. -- University of Edinburgh Business School.

25. Kranz J., Nagel E. and Yoo Y. (2019) Initial Coin Offering: Economic and Technological Foundations of Token Sales on the Blockchain Business & Information Systems Engineering (June/2019).

26. Lucantoni P. (2018) Distributed Ledger Technology e infrastrutture di negoziazione e post-trading // R. Lener (2018) Fintech: Diritio, Tecnologia e Finanza. -- I Quaderni di Minerva Bancaria.

27. Markowitz E. (2013) When Kickstarter Investors Want Their Money Back // URL: http://www.inc.com/ericmarkowitz/when-kickstarter-investors-want-their-money-back.html.

28. Martin T. A. (2012). The JOBS act of 2012: Balancing fundamental securities law principles with the demands of the crowd.

29. Moslein F. (2018) Legal Boundaries of Blockchain Technologies: Smart Contracts as Self-Help? Universitat Marburg (I nstitut fur Handelsund Wirtschafisrecht); Munich Center on Governance (MCG).

30. NasrabadiA. G. (2015) EBCF: Beyond Financial Innovation // Crowdfunding in Europe. -- Brussels : Springer Internati onal Publishing.

31. Reed E. (2018) Equity Tokens vs. Security Tokens: What's the Difference? // Bitcoin Market Journal.

32. Rohr J. and Wright A. (2017) Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratizati on of Public Capital Markets.

33. Surowiecki J. (2005) The wisdom of crowds. -- New York : Anchor Books.

34. Willfort R. and Weber C. (2016) The Crowdpower 2.0 Concept: An Integrated Approach to Innovati on That Goes Beyond Crowdfunding // Crowdfunding in Europe. -- Springer Internati onal Publishing.

35. World Bank Group (2017) Distributed Ledger Technology (DLT) and Blockchain // FinTech Note, No. 1.

36. Yermack D. (2017) Corporate Governance and Blockchains. Review of Finance. Oxford University Press.

REFERENCES

1. Agrawal AK, Catalini C, Goldfarb A. Some simple economics of crowdfunding. NBER working paper series Working Paper 19133 [Internet]. 2013. Available from: http://www.nber.org/papers/w19133. (In Eng.)

2. Annunziata F. Speak, if you can: what are you? An alternative approach to the qualification of tokens and initial coin offerings. Bocconi Legal Studies Research Paper Series Number 2636561. February 2019. 2019. (In Eng.)

3. Armour J, Enriques L. The Promise and Perils of Crowdfunding: Between Corporate Finance and Consumer Contracts. ECGI -- Law Working Paper No. 366/2017 [Internet]. 2017. Available from: https://ssrn.com/abstract=3035247. (In Eng.)

4. Bellini M.Blockchain and Bitcoin: come e nata, come funziona e come cambiera la vita e gli affari la tecnologia che e diventata il simbolo della rivoluzione digitale e valutaria. Class Editori. 2018. (In It.)

5. Biffi A. EBCF: un modello di analisi del comportamento di imprenditori e investitori. 2013. (In It.)

6. Block J, Colombo M, Cumming D, Vismara S. New players in entrepreneurial finance and why they are there. Small Business Economics. 2018;50(2):239-250. (In Eng.)

7. Conley JP. The Economics of Crypto-tokens and Initial Coin Offerings. Vanderbilt University; 2017. (In Eng.)

8. Cornell CJ, Luzar C. Crowdfunding Fraud: How Big is the Threat? [Internet]. 2014. Available from: http://www. crowdfundinsider.com/2014/03/34255-crowdfunding-fraud-big-threat/. (In Eng.)

9. De Filippi P, Hassan S. Blockchain Technology as a Regulatory Technology: From Code is Law to Law is Code. First Monday. 2016;21(12). (In Eng.)

10. De Luca N. Foundations of European Company Law. Luiss University Press; 2016. (In Eng.)

11. De Luca N. Documentazione critiografica e circolazione della ricchezza.2019. (In It.)

12. De Luca N, Furnari SL, Gentile A. Equity Crowdfunding. Digesto delle discipline privatistiche: Sezione Commercial, UTET Giuridica. 2017. (In It.)

13. Fisch C. Initial coin offerings (ICOs) to finance new ventures. Journal of Business Venturing. 2019. (In Eng.)

14. Fisch C, Masiak C, Vismara S, Block J. Motives to invest in initial coin offerings (ICOs) [Internet]. 2018. Available from: https://ssrn.com/abstract=3287046. (In Eng.)

15. Fleming L. Perfecting cross-pollination. Harvard Business Review [Internet]. 2004. Available from: https:// hbr.org/2004/09/perfecti ng-cross-pollination. (In Eng.)

16. Furnari SL. Market analysis, economics and success drivers of equity crowdfunding. In: Colombo MG. Giudici G. Proceedings of the 3rd Entrepreneurial Finance Conference. 2018. (In Eng.)

17. Furnari SL. Validita e caratteristiche degli smart contract e possibili usi nel settore bancario finanziario. In: E. Corapi, R. Lener. I diversi settori del fintech. CEDAM, Milano; 2019. (In It.)

18. Furnari SL. ICO in Italia: applicabilita della disciplina sull'equity crowdfunding e suoi potenziali benefici. In: R. Lener. Fintech: Diritto, Tecnologia e Finanza. I Quaderni di Minerva Bancaria. 2018. (In It.)

19. Hacker P, Thomale C. Crypto-Securiti es Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law. Oxford Business Law Blog. 2017. (In Eng.)

20. Helm There is a chance to make big money. Harms. 2007;3. (In Eng.)

21. Hewlett S A, Marshall M, Sherbin L. How diversity can drive innovati on. Harvard Business Abstract. 2013. (In Eng.)

22. Howell ST, Niesser M, Yermack D. Initial Coin Offerings: Financing Growth with Cryptocurrency Token Sales. Finance Working Paper № 564/2018, European Corporate Governance Institute (ECGI). 2018. (In Eng.)

23. Iovieno Il portale nell'EBCF: un nuovo gatekeeper? Un'analisi alla luce della regolamentazione italiana e statunitense. DII. 2016;1. (In It.)

24. Jiafu A, Wenxuan H, Xianda L. Initial Coin Offerings: Investor Protection and Disclosure. University of Edinburgh Business School. 2017. (In Eng.)

25. Kranz J, Nagel E, Yoo Y. Initial Coin Offering: Economic and Technological Foundations of Token Sales on the Blockchain Business & Information Systems Engineering. 2019. (In Eng.)

26. Lucantoni P. Distributed Ledger Technology e infrastrutture di negoziazione e post-trading. In: R. Lener. Fintech: Diritto, Tecnologia e Finanza. I Quaderni di Minerva Bancaria. 2018. (In It.)

27. Markowitz E. When Kickstarter Investors Want Their Money Back. [Internet]. 2013. Available from: http:// www.inc.com/eric-markowitz/when-kickstarter-investors-want-their-money-back.html. (In Eng.)

28. Martin TA. The JOBS act of 2012: Balancing fundamental securities law principles with the demands of the crowd. 2012. (In Eng.)

29. Moslein F. Legal Boundaries of Blockchain Technologies: Smart Contracts as Self-Help? Universitat Marburg (Institut fur Handelsund Wirtschaftsrecht); Munich Center on Governance (MCG). 2018. (In Eng.)

30. Nasrabadi A. G.EBCF: Beyond Financial Innovation. Crowdfunding in Europe. Brussels: Springer Internati onal Publishing; 2015. (In Eng.)

31. Reed E.Equity Tokens vs. Security Tokens: What's the Difference? Bitcoin Market Journal. 2018. (In Eng.)

32. Rohr J, Wright A. Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets. 2017. (In Eng.)

33. Surowiecki J.The wisdom of crowds. New York : Anchor Books; 2005. (In Eng.)

34. Willfort R, Weber C. The Crowdpower 2.0 Concept: An Integrated Approach to Innovation That Goes Beyond Crowdfunding. Crowdfunding in Europe. Springer International Publishing. 2016. (In Eng.)

35. World Bank Group. Distributed Ledger Technology (DLT) and Blockchain. FinTech Note, No. 1. 2017. (In Eng.)

36. Yermack D. Corporate Governance and Blockchains. Review of Finance. Oxford University Press. 2017. (In Eng.)

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