Tuesday, September 22, 2020 / 02:00PM /
Aelex Partners / Header Image Credit: Aelex Partners
is the second part to the article on Regulating Cryptocurrency and Initial
Offerings: The Nigerian Perspective, (read part one here).
In part two, we explore Initial Coin Offerings (ICOs), how it is used to raise
funds, the Nigerian legal framework on ICOs, and the pros and cons of ICOs.
A New Way of
rapid increase in the value of cryptocurrency and the possibility of high gains
within a short time frame has seen a number of companies deciding to use the
technology driving cryptocurrency to raise funds.
have started seriously considering ICOs as a viable tool to raise capital as opposed
to Initial Public Offerings (“IPOs”). This is because ICOs are not subject to
as much regulatory oversight as IPOs considering the definition of tokens fall
outside the scope of regulated investment instruments in most jurisdictions,
thus simplifying the offering process. In addition, companies get to protect
their shareholding against dilution as the assets on offer during are ICO are
tokens and not shares in the company.
2017, it was posited by financial experts that there was an ICO Bubble1, (a situation where the price of coins
far exceeded their fundamental value due to their connection to ICOs) This was
supported by the fact that in 2017 alone, USD1,362,588,431 was raised from the
top ten ICOs2 globally.
Though the bubble may have burst in 2019 due to ICOs not being able to meet
their targets and the prevalence of fraudulent ICOs, they are still being used
by companies to raise capital3
and the promise of rapid, large investment returns makes it more appealing to
IPO vs ICO
is still a debate in the financial industry that tokens constitute a share or
security of the company; therefore it is similar to an IPO because ownership is
being sold through the use of the tokens instead of shares. This assertion has
its flaws because fundamental differences exist between an IPO and an ICO which
will be highlighted below.
The company sells part of
The company has a unique
The capital gained is used
The tokens are usually sold
The owners of the shares
The owners of a token gain
IPOs are heavily regulated
ICOs are hardly regulated
An IPO involves a lot of
An ICO does not involve
characteristics of an ICO and the freedom it affords companies looking to raise
capital has aided the increasing popularity of token sales and in recent times,
ICOs have been categorized and broken down for potential investors to
understand the intricacies of the process.
The Token Sale
ICO or a Token Sale is the process of raising capital through the sale of
tokens to the public for a limited period in exchange for cryptocurrency5. Instead of receiving shares like a
typical IPO, investors receive tokens and pay in cryptocurrency (or cash in
some instances). The tokens received represent the participation of the
investors in the project the ICO was created to raise capital for.
So, Investors in a Token Sale are usually
called participants because ICOs are a form of Crowdfunding; however the
company will be receiving cryptocurrency rather than cash.6 This can be compared to equity-based
crowdfunding where the public donates cash in exchange for shares in the
Types of Token Sales
are two major types of ICOs the Private ICO and the Public ICO. In a Private
ICO, a limited number of investors, typically financial institutions and high
net-worth individuals, participate in the process. The company can choose to
set a minimum investment amount8.
Public ICO on the other hand, is open to the general public, with no limits on
who may participate, subject to any regulatory considerations in the relevant
Private ICOs are becoming a more preferred option compared to public offerings as
regulators are now looking at ways to regulate Public ICOs in order to protect
the investing public.
Characteristics of a Token Sale
order to mitigate the risk investors associate with ICOs, companies have had to
be strategic in structuring ICOs and four characteristics have emerged as the
foundation for any Token Sale Model.
- A cap on the amount of
money that will be raised from the ICO;
- An appropriate time frame
for the period the ICO will run in order to gain the attention of buyers.
The time frame must not be too long so investors can see actual results
and for the specified project to move to the next phase;
- Public information on the
number of tokens that are in circulation, the amount that is going to be
sold and the amount currently being held by all stakeholders in the
ecosystem of the token; and
- The value of the token
must be clear and unambiguous10.
structure of an ICO and the benefits a token offers determines the type of
investors it attracts. The utility the token offers is also one of the factors
that will determine whether an investor will use the token he acquired or trade
it off in return for another token with a different utility or cash.
The Types of Investors in a Token Sale
are two types of participants in a Token Sale – Stakeholders and Speculators.
Stakeholders are buyers who acquire a token to be able to use it for the true
utility it was created for. In the first article, we talked about the Brave
browser and how it is using its Basic Attention Token (BAT) to create value by
rewarding people who advertise on its browser with the token when a user views
their ad which does not have an ad tracker or is transparent11. If the Brave browser was to have an
ICO, they would most likely sell their BAT and a Stakeholder buyer would
acquire it to use in securing an advert space on the browser because the BAT
can be used in the Brave ecosystem to gain products or services12.
are investors who do not wish to use the utility that a token offers. They
participated in the Token Sale with the hope of making a return on the token
when its value rises, either by selling to Stakeholders or other Speculators.
require an understanding of a combination of finance, technology and the
regulatory requirements that may hinder the process in the jurisdiction the
issuing entity resides in. Therefore, the steps highlighted below in order to
be successful will entail an understanding of the subject matter
Kickstarting a Token Sale
the mechanism for an ICO is fairly simple, it has a low barrier of entry and in
most jurisdictions, it can be started without jumping through regulatory hoops.
There are typically four stages in kickstarting an ICO:
includes the preliminary stage where the company or the token issuing entity
identifies their potential investors and the project they want to fund.
identifying its potential investors and its underlying project, the token
issuing entity will issue a White Paper (similar to a Prospectus for an IPO)
that provides details of the underlying project and details of the tokens that
will be issued in exchange for cryptocurrency13.
White Paper is made publicly available, usually through the issuing entity’s
website. The White Paper will include the mechanism for payment of
cryptocurrency to the issuing entity’s account. t is now common practice for
payments to be made into an escrow account, to foster investor confidence in
the validity of the ICO14.
tokens are created. The tokens will be the representations of an asset or a
utility on the blockchain native to the token and are tradeable for other
tokens or coins15. The
issuing entity does not need to create new tokens, instead they can build on
existing blockchains such as Ethereum which allows the creation of tokens on
issuing entity will usually run a promotion campaign to attract potential
investors. These campaigns are usually executed online to achieve the widest
investor reach. It should be noted that a lot of online platforms such as
Facebook and Google ban the advertising of ICOs16;
therefore, it is recommended that the campaign run on the issuing entities
website or on cryptocurrency exchanges.
the creation of the tokens, the tokens are issued and the token purchasers or
investors will pay for the tokens, usually in cryptocurrency. Issuing entities
can request for fiat currency if they wish, but common practice is the use of
coins to buy tokens.
the purchasers have paid for the token, they can use their tokens in the
project ecosystem as a utility for the product or trade the token on a
Cryptocurrency exchange, subject to any lock-in period prohibiting the exchange
or sale of the token -this will be stated in the White Paper.
is financially risky as we highlighted in our first article, so in order to
assuage the fears of investors, the management team of the issuing entity
usually take tokens themselves to prove to potential investors that the ICO is
is a process flowchart highlighting the stages of a typical ICO:
The Nigerian Legal Framework on ICOs
defined in our first article, a token is an asset built on top of an existing
blockchain, which has the ability to replicate such functionality or assets18. We also explained how securities are
financial assets and provided the definition of securities according to the
Nigerian Regulatory Framework for securities19.
regulatory framework for securities being offered to the public or to private
individuals in exchange for cash comprises of the following rules and
Investment and Securities Act 2007 (“ISA”); and
Rules and Regulations of the Security and Exchange Commission 2013 (“SEC
279(1)(c) of the SEC Rules provide that all securities subject to registration
by the Securities and Exchange Commission (“SEC”) may be offered through the
- offer for subscription;
- offer for sale;
- rights issue;
- bonus issue;
- debt-equity conversion;
- private placement by public companies and other entities; and
- offer by introduction;
- debenture/loan stock;
- State and Local government bonds
SEC Rules also provide that an entity may offer or transfer its securities
electronically: provided that where an investor elects to have a certificate,
such certificate shall be issued by the issuer20.
aforementioned principles of the SEC Rules seem to give a legal foundation for
potential ICOs in Nigeria but sadly, coins and tokens do not fall under the
scope of securities set out in the ISA and therefore, cannot be registered as
securities that can be offered to the public or to private entities in exchange
for capital in Nigeria. Also, the SEC is yet to classify what coins or tokens
are in Nigeria, hence, ICOs are unregulated in Nigeria.
position may soon change as the Proposed Rules on Crowdfunding by SEC21 seem to permit equity crowdfunding
and ICOs are an offshoot of it. The proposed rules provide that an entity may
issue other investment instruments approved by the Commission (including simple
contracts) without registering the securities or investment instruments with
the SEC. Tokens being offered in ICOs are investment contracts that are built
on blockchains and are easily programmable to provide any type of utility the
issuing entity programmes the smart contract to perform. This position has not
been affirmed by the SEC but it is hoped that ICOs can take advantage of the
proposed provisions of the Proposed Rules.
the National Blockchain Strategy released by the Federal Ministry of
Communications and Digital Economy, while admitting that there is no regulatory
or legal framework for cryptocurrency in Nigeria, believes that there is a
promising future for blockchain in Nigeria due to the adoption of blockchain by
various Nigerian start-ups for numerous purposes. The Blockchain Strategy lists
out the various regulations that the Federal Government has released to create
an enabling environment for cryptocurrency in Nigeria22. It goes further to explain how the Federal
Government wants to use cryptocurrency and blockchain technology as one of the
paths towards a digital economy and one of the strategic objectives is the
creation of investment opportunities through blockchain.
to the Blockchain Strategy, “Blockchain
has the potential to completely transform traditional models in several sectors
both private and public. By promoting blockchain adoption and providing an
enabling environment, new business models will spring up to open opportunities
for businesses that will drive investments in a market such as Nigeria.”
seems to be a nod to ICOs and the government’s consideration of it to diversify
the Nigerian Economy and the methods of investment in Nigeria.
the Final Report of the Fintech Roadmap Committee of the Nigerian Capital
Market by the SEC, lists out recommendations that the Capital Market Community
will take into consideration regarding ICOs:
- SEC should be responsible for the regulation of Virtual Financial
Assets (VFAs) Exchanges and develop a framework around it.
- For the regulation of crowdfunding, interest-based crowdfunding
should be regulated by the Central Bank of Nigeria (CBN) while equity-based
crowdfunding should be regulated by the SEC (ICO, STO or IPOs).
- SEC should issue guidelines and standards for White Papers and
- Advertising and issuance procedures should be defined without
- SEC should create appropriate licensing regimes for new entrants
into the crowdfunding ecosystem.
- SEC should develop a detailed framework for VFA based economy.
- SEC should develop a stringent framework for KYC and due diligence
which will apply regardless of the legal status of an ICO or token.
- SEC should have clear taxonomies of tokens based on their nature,
characteristics and economic realities as their determining factors.
- The taxonomy of traditional securities should remain intact, and
serve as useful, instructive and illustrative guide for the taxonomization of
the new cryptocurrency capital market investment products and services.
- The global best practices in order to give a taxonomy to
cryptocurrency assets especially jurisdictions like Malta should be followed by
SEC. The Malta Guide broadly taxonomises tokens as;
- Payment token
- Asset token
- Utility token
ICOs – Risky Business or Not?
the advantages of an ICO were mentioned earlier in this article, they need to
be highlighted again to understand why ICOs are being strongly considered by
companies as a way to raise capital.
Lack of Regulatory Oversight: Most ICOs lack regulatory
oversight, hence it is an interesting opportunity for founders or entities to
adopt it as a method to raise capital. Bypassing the regulatory oversight that
comes with IPOs is a major boost to the appeal of ICOs to issuing entities and
Substantial Gain Quickly: Since ICOs have a target and
an estimated time to achieve the target which is usually short23, investors usually gather their funds
to invest heavily in ICOs due to the potential returns that are projected. Most
times the returns projected is higher than returns on fixed or floating assets
such as bonds or shares respectively. The recent furore for and discussion
around the novelty and profitability of ICOs has whetted the risk appetite of
certain investors hoping to make a huge return on their investments, which
means that the issuing entity also sees a quick inflow of capital.
Anyone can Invest: Due to the nature and
accessibility of ICOs which are typically offered online, issuing entities are
not limited to investors within their geographical area, and do not incur costs
that are typically seen with the traditional methods of raising capital. Anyone
can invest in an ICO and the pool of potential investors is essentially every
user of the World Wide Web. The use of cryptocurrency also means that the
issuing entity does not need to worry with the currency in which to dominate
the offer and thus, bypasses any foreign exchange concerns.
with all the advantages mentioned above, why are ICOs still considered risky
business? Well in 2017 alone, 80% of ICOs were identified as scams by Statis
group, an ICO advisory firm24.
To put in context, US$11.9 billion of investor money fell to scams in 2017 and
three fake ICOs alone consumed US$1.31 billion25.
the lack of regulatory oversight means most ICOs end up “going dead”26and investors cannot recoup their money
due to the lack of a mechanism or a reporting procedure to reclaim their funds.
addition, investors and issuing entities are faced with the risk of digital
currency theft as cryptocurrency wallets – where the coins or tokens stored -
are hackable. A study27 from
CipherTrace, a cryptocurrency intelligence firm based in Silicon Valley
provided an overview of the major cryptocurrency thefts, scams, and fraud
worldwide in 2019. The study showed that criminals and fraudsters netted
approximately US$4.26 billion for the first six months of 2019 and US$1.7
billion for the entire 2018 according to the study.
exchanges, wallets, and other cryptocurrency custody services are strengthening
their defenses, hackers continue to innovate and outpace even the current state
of the art in cybersecurity, the CipherTrace study notes28.
are not popular in Nigeria and are hardly used to raise capital by entities in
this part of the world. Also, given the fact that coins and tokens are not
classified in Nigeria, the absence of classification makes Nigeria a very harsh
terrain for an ICO to be conducted, but that may soon change.
January 2018, SureRemit a Nigerian non-cash remittance start-up raised $7
million through an ICO29.
ICOs may become the rave for Nigerian tech companies who do not want to jump
through the regulatory loopholes of the SEC for raising capital and registering
drive of the Federal Government and SEC is also duly noted as the government
and its apex capital market regulatory body looks into the future to tap the
benefits of cryptocurrency and all the technology that comes with its use.
This article is part
of the series titled THE CHANGING OF FINANCE IN NIGERIA highlighting the
various modern financial developments in Nigeria. Other articles in the series
may be accessed here.
4. Deloitte, “Initial Coin Offering a new Paradigm” https://www2.deloitte.com/ru/en/pages/financial-services/articles/initial-coin-offering-a-new-paradigm.html.
accessed 6 August 2020
6. ACCA, “ICOs: real deal or token gesture? Exploring Initial Coin Offerings” https://www.accaglobal.com/content/dam/ACCA_Global/professional-insights/Initial-coin-offerings/pi-initial-coin-offerings.pdf accessed 6 August 2020.
Diya, “The Changing Face of Finance in Nigeria : Crowdfunding” https://www.aelex.com/wp-content/uploads/2020/03/THE-CHANGING-FACE-OF-FINANCE-IN-NIGERIA-CROWDFUNDING1.pdf accessed 6 August 2020.
Finance Institute, “Initial Coin Offering (ICO) An initial public offering that
12.Deloitte, “Initial Coin Offering a new Paradigm” https://www2.deloitte.com/ru/en/pages/financial-services/articles/initial-coin-offering-a-new-paradigm.html
accessed 6 August 2020
Finance Institute, “Initial Coin Offering (ICO) An initial public offering that
uses cryptocurrencies” https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/initial-coin-offering-ico/ accessed 17 August 2020.
Previous Posts from Aelex
Cryptocurrency and Initial Coin Offerings: The Nigerian Perspective – Part 1 – September 15, 2020
Forming Part of the State of the Art are Ineligible for Protection – A Case
Study – September 15, 2020
Covered Under the Value Added Services (VAS) Licence Framework In Nigeria – September 13, 2020
8. Finance Act,
2019: Tax Implications for the Private Equity Industry – July 13, 2020