In recent months, a new group of Initial Coin Offerings (ICOs) have begun to emerge. Their founders have the clear intent to develop into sustainable institutional businesses, and they are beginning to adopt the best practices in governance and KYC/AML. As the number of jurisdictions issuing regulatory statements for ICOs grows, these “best in class” ICOs will solidify their position as the best option for investors in the blockchain space.¹
The need for regulation
Investors need some protection in the ICO process. Unlike Initial Public Offerings (IPOs), the proposers of ICOs are not selling based on the promise of past profits or current success but rather on the potential of future gains. This is a much riskier proposition. In addition, recent studies have shown that the code produced by many ICO projects fails to match the promises made in the initial white papers that often serve as ICO contracts.² Although investors have raised concerns about gatekeeping and broken contracts, there is still little governance infrastructure to support investors who take direct action against proposers. In short, there needs to be a clearer framework and governance process behind the implementation of token strategy.
MVE: a necessary first step for every ICO
Successful ICOs have a well-defined and problem-based use case, a qualified team, a sustainable and scalable business model, and the intent to develop into a long-term institutional business.³
Diana Adachi, CEO of Pegasus Fintech, elaborates further: “Blockchain based networks or ecosystems are transactional in nature. For these networks to be viable, they require various stakeholders to participate and execute transactions, a platform, a business model, rules and governance at a minimum, hence Minimal Viable Ecosystem.”⁴
The importance of framework and governance
In addition to establishing MVE, an ICO must develop an operational framework and a business strategy:
- Operational framework design encompasses the establishment of clear processes, procedures, and policies.
- Key deliverables include white paper, and a business model.
It is at this point that proposers make initial contact with potential investors. Proposers must be honest. They must offer a solid business strategy that clearly explains both the potential risks and the potential gains to investors. This is especially important in an ICO, since many start-ups do not have prior business success, reputation or existing funds to fall back on.
The ideal business execution includes legal and regulatory issues. It is problematic that many ICOs do not do this. Creation of MVE will ensure that companies establish a clear plan for both operational framework and governance framework. It should include the following:
- Legal documentation that accurately reflects the nature of the token sale. It includes relevant risk and tax language.
- Governance framework design that includes statements about transparency and disclosure, rights of token holders, use of proceeds, policies regarding information security and cyber security, management accountability, conflicts of interest, and media policies.
- Regulatory processes that include KYC and AML, also compliance with jurisdictional requirements.
The volatility and instability of ICOs is inherent in their promise of future success. Investors are contributing to a product or service that may or may not have to adjust its business strategy once the initial launch has occurred. For the protection of both investors and proposers, proposers need to create a solid framework before launch and ensure that adequate governance is in place. The initial framework represents internal initiative; governance must be externally established and enforced by the proper authorities.