The whitepaper and the ICO/IEO controversy: Part 1

Since the advent of cryptocurrencies and the blockchain technology, a whitepaper has had some kind of rebirth. Instead of serving as scholarly document, it has now become synonymous with a prospectus, a document that often precedes an initial public offering (IPO).

An IPO prospectus is a step that a privately owned company takes before inviting members of the public to subscribe or acquire its stock. The issuance or the release of a prospectus to the public is a legal step that must be fulfilled and the while document itself must adhere standards set for such IPOs.

A whitepaper has somehow morphed into a prospectus of some sorts for tech companies that plan to offer tokens for sale to the general public. This routine was probably inspired by the first ever cryptocurrency, the Bitcoin.

When Bitcoin launched, it was preceded by Satoshi Nakamoto’s now famous whitepaper document entitled ‘Bitcoin: A peer to peer electronic cash system.’ Since then it has seemingly become the norm that a whitepaper must precede the start of a token offering.

Complex whitepapers

Prospective investors are expected to read and understand the complex verbiage contained in such documents. However, the apparent abuse of the whitepaper document –whose issuance was/is largely unregulated—by bad actors, has raised concern of many with some regulatory authorities using this as a pretext to curtail this industry.

The Financial Conduct Authority (FCA), a UK based financial regulator, for instance noted the following about the abuse of this document in a consultation paper released in early 2019:

“Whitepaper documents that typically accompany ICOs are not standardised and often feature information (that is) considered to be exaggerated or misleading. Given the lack of clear information, consumers may not understand that many of these projects are high-risk and at an early stage, and therefore may not suit their risk tolerance, financial sophistication or financial resources. These documents are not prospectuses, (they) are not approved by a regulatory authority and do not, generally, provide the level of detail contained in a prospectus in relation to the company, the business and the product.”

Indeed, an ICO whitepaper can overstate the viability of a poorly thought out idea or withhold critical information about a project and nothing will happen to those behind it. This could well have been the case in 2017 when the ICO market exploded. Some whitepapers accompanying many ICOs reportedly went overboard as scammers sought to exploit the apparent laxity of token issuing.

Indeed, early adopters of Bitcoin and other pioneering cryptocurrencies became overnight multi-millionaires. Fraudsters and con artists are quite aware of this fact when wooing their victims.

In 2017, quite naturally, it was this fear of missing out (FOMO) that criminals used to get people to buy tokens. There was no time for rationality, inexperienced and ignorant investors simply plunged in without putting much thought. As expected, the crypto market bubble eventually burst and a lot of tokens that got listed in that period now trade at a fraction of their ICO prices.

Some are actually now worthless while their promoters have simply vanished.  It is such losses and the disappearance of directors that compel the likes of FCA to intervene.

It starts with the whitepaper

Evidently, it is the whitepaper that plays a critical role in drawing investors to a crypto project and authorities around the world are now grappling with the question of just how to regulate this. So whilst there is no consensus on this –the regulation of whitepaper issuance— just yet, prudent investors must in the meantime do everything to avoid falling prey to even more sophisticated Ponzi schemes.

As regulators study and consult on the best way of solving this whitepaper debacle, is attempting to help its readers to avoid falling for scams. We asked some experts and enthusiasts to help readers discern what should be contained in legitimate document and what should not.

Jonathan Fennell is the Founding Partner of Africa Blockchain Advisory and has been immersed in the crypto and blockchain space for 4 years We asked him for his thoughts on whether increased regulation is the answer to the scourge of dubious whitepapers.

While Fennell agreed with the idea in principle he was quick to point out the potential challenges of focusing too much on regulation.

“It is (an issue of regulation) to an extent but at the same time you neither want over regulation nor regulation that does not understand the tech fully.

For its part, the FCA says it is a technology neutral regulator. This stance suggests that the use of new technologies does not alter its regulatory posture. Indeed, the UK is one of the few countries in the West that has not taken a hard line approach towards cryptocurrencies like Bitcoin.

While that maybe the case, our expert warns that for a technology that is still at early stages of development, the FCA (or any regulator for that matter) might not be the best placed for this role, at least for now anyway.

“The FCA wants a say in everything crypto because the technology is destabilizing their power. (However) if it was up to them, all projects would fall under the standard investment procedures and only high net worth individuals would be able to invest in cryptocurrencies,” cautions Fennell.

Fennell suggests that internal regulation (as do many other crypto advocates on the Africa continent) is a more efficient and practical solution than external regulation, at least for now. To the GBA chief, the focus for now should be on innovation, improving current innovations and less on policing innovators.

This approach has seemingly worked in Asia where players in the crypto space have been influential in drafting regulations for that region. 

In the second part on this series, we ask individuals from the African continent to share their thoughts on the same topic and how individuals should avoid getting scammed.