Ethereum’s Smart Contracts’ Built-in Functionality Offers a Way to Protect ICO Investors

December 2, 2017 12:37 PM UTC

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The latest method of crowdfunding originating in the cryptocurrency world is exploding, with ICOs raising more than 3.5 billion this year. It is also giving a headache to regulators and a growing number of swindled investors. The latest example saw one such cryptocurrency startup, Confido, disappear with $375,000 of investor money. However, the list is long and includes even some older ICOs.

One example is Opair – an ICO promising to decentralize debit cards. While it should have been pretty obvious that a no-name group of individuals could not overhaul the banking system and provide decentralized debit cards that would work anywhere right off the bat, with no banking experience, people were hopeful.

Not long after the Opair token was listed on exchanges, lots of coins were rapidly dumped, the main website was taken offline, and the team went silent.

Some ICO con artists are already falling to the hands of justice. In late September 2017, the SEC has filed charges against New York-based businessman Maksim Zaslavskiy and two related firms, alleging that the businessman has misrepresented the amount he generated from the two ICOs. At the time, the SEC was also successful in securing a court order to freeze the assets of Zaslavskiy and the two companies. The prosecutors in the case have further claimed that the purported assets that support the token sale did not actually exist.

Unlike any technology beforehand, blockchain has an important moral dimension which lays in the way it’s structured. To take part in a decentralized and self-regulated system asks for a great responsibility and full transparency. Unfortunately, due to poorly written crowdfunding rules and negligent investors, it has become common for funds to be mismanaged post-ICO.

ICOs are commonly done on the Ethereum network, second largest blockchain after Bitcoin. So called smart contracts contain the logic that defines the rules of the crowdfunding process. Smart contracts collect ether and issue tokens that are to be used for whatever service the particular ICO is planning to offer. Despite the functionality that Ethereum smart contracts offer, almost all ICOs are structured to allow the founders total control of the funds post-ICO. Meaning, there is very little financial incentive for the development team to build the actual product. Unfortunately, such short-sighted fundraising lead to a negative perception in public and legislative steps taken by various governments including the US and China.

One mechanism that ICOs are commonly employing these days is so called “token vesting”. This mechanism is used by some of the most well known ICOs, including Bancor (ether raised equivalent to 153 million $). The idea is to limit the ability of ICO founders to trade with their share of tokens post-ICO. Commonly, each six months, certain amount of tokens is released to the founders. This prevents the founders from dumping the tokens post ICO. However, it does nothing to prevent them from mismanaging all the collected ether.

While ICOs use voting mechanisms in the actual platform (i.e. Aragon), others like CryptoTask use voting to control the release of funds in stages post-ICO. Another approach is to have multiple sales over some period of time. If people aren’t happy with the efforts so far, not much will be raised in future sales. Monolith and FunFair both took this approach.

As long as investors are informed that such mechanisms exist and can indeed protect them, cases such as this week’s Confido would have been avoided.

It remains to be seen if the community will be able to structure the eco-system in a way to properly govern itself, or we will see governments stepping in more and more to regulate the market.

Last modified: May 20, 2020 9:17 PM UTC

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