The joy and danger of initial coin offerings
Examples of SA ICOs are few and far between, even though the broader market is exploding
Initial coin offerings (ICOs) could go a long way towards plugging the funding gap that hinders innovative small and medium-sized enterprises, experts say.
But while ICOs have become a relatively popular way to raise funds in developed cryptocurrency markets, only a handful of SA companies have gone this route.
Among those that have is The Sun Exchange, a Cape Town-based blockchain start-up that lets people buy into solar projects. The company is running an ICO out of Malta until the end of July, and in March and April received commitments of US$1.3m in a private presale.
The Sun Exchange pools the money it gets from investors for solar installation projects "that would never be able to get funding through conventional channels", says Abraham Cambridge, founder and CEO of the company.
Another company, Johannesburg-based software development business SovTech, plans to launch an ICO in the second half of 2018 to fund an office development in Sandton, says CEO Gerald Neves.
According to a PwC report, $4.6bn was raised through ICOs globally in 2017, up from just $200m in 2016.
Of the smattering of successful ICOs in Africa, most have been done by blockchain-based remittances firms, though activity and interest is picking up in other areas, says Paul Mitchell, fintech and blockchain lead at PwC SA.
ICOs offer a third funding option for start-ups, over and above traditional debt and equity options. "Start-ups often struggle to raise debt, and may be unwilling to dilute by selling equity early, before their value is established," Mitchell says.
Through an ICO, a start-up also creates "a group of future customers who are prebuying the ability to use the blockchain company’s service, and have a vested interest in the start-up’s success", he says.
Mitchell says ICO funding tends to come from "the crypto-rich — the people who made a fortune off bitcoin and ethereum and are now looking to invest in these businesses partly because they want to diversify and partly because they believe in this space and want to seed the next generation of companies that are changing the world".
Some local companies have already set up ICO investment arms. SovTech, for instance, operates Caesium Capital, a blockchain-based digital asset manager that invests in ICOs. It is also in the process of launching a "fully tokenised" investment bank called Quadratico, says Neves.
ICOs "absolutely can take off" in SA, according to Mitchell. A growing number of blockchain-based businesses in the country are creating "ecosystems that require those tokens".
The Sun Exchange is one of those. Like its peers, it uses its tokens to create incentives for certain behaviours. Cambridge says the company’s SunEx tokens — which are being sold during the ICO — provide incentives for investments in "priority projects".
"As people buy solar cells on our platform, they will earn SunEx [tokens]. And it’s a bit like [Discovery’s] Vitality, where if you complete certain tasks you get bonus [tokens]. So if you buy a solar cell for a school, you will get a bonus allocation of [tokens], and if you put a solar cell in the northern hemisphere, you will attain the ‘endless summer achievement’ and get a bonus.
"The point of the ICO is that we’re preselling these [tokens] at a significant discount. It usually costs $10 to buy as and when we do solar projects, but in the ICO people can buy as many as they want for $1 each."
Cambridge says The Sun Exchange’s ICO "has been a huge project — we want to get it done correctly because it’s a one-off chance of doing this kind of thing".
In essence, investors either bet on cryptocurrency tokens becoming valuable, or they plan to use [them]. While other types of tokens exist, these "utility tokens" are the most popular at the moment, as they are not subject to securities regulations, says Jalal Ghiassi-Razavi, blockchain and ICO lead at PwC SA.
However, Mitchell says launching an ICO is becoming a complex process, and is attracting greater regulatory scrutiny. Regulators in the US, for instance, have decided that most tokens sold during ICOs are securities. "And to sell securities to the public, you need to follow the rules governing the offering of shares, which vary by jurisdiction, but are, necessarily, stringent," he says.
The US securities & exchange commission (SEC) recently issued about 80 subpoenas to companies that had launched ICOs. "It doesn’t mean that they’re going to sue 80 start-ups, but that they’re keeping a very close eye on what’s going on. So, many, if not most, ICOs will now block US investors because they don’t want to be exposed to the danger of the SEC coming after them," says Mitchell.
One SA start-up, Ekasi Bucks, learnt that lesson the hard way. A pioneer in SA’s ICO arena, the company raised R600,000 via an ICO before returning R500,000 of that to US investors to avoid a conflict with the SEC.