European Securities and Markets Authority Warns Investors on ICO Risks

The European Securities and Markets Authority (ESMA) has published two statements that spelled out what it thinks are the risks initial coin offerings (ICOs) offer for investors and startups, respectively.

An ICO is an innovative way of raising money from the public, using so-called coins or tokens and can also be called an initial token offering or token sale. In an ICO, a business or individual issues coins or tokens and puts them for sale in exchange for fiat currencies, such as the Euro, or more often virtual currencies, e.g. Bitcoin or Ether.

Expressing concern for the emerging market, ESMA cautioned investors that the usage of custom cryptocurrencies for raising resources comes with a huge risk of capital loss. In addition, the financial regulator raised the fact that the ICO may be outside of the regulation of European Union laws, which does not benefit investors.

“ESMA has observed a rapid growth in ICOs globally and in Europe and is concerned that investors may be unaware of the high risks that they are taking when investing in ICOs. Additionally, ESMA is concerned that firms involved in ICOs may conduct their activities without complying with relevant applicable EU legislation,” the ESMA statement read.

“ESMA is alerting investors of the high risk of losing all of their invested capital as ICOs are very risky and highly speculative investments. The price of the coin or token is typically extremely volatile and investors may not be able to redeem them for a prolonged period.

“Another key risk stems from the fact that, depending on how they are structured, ICOs may fall outside of the scope of EU laws and regulations, in which case investors cannot benefit from the protection that these laws and regulations provide. ICOs are also vulnerable to the risk of fraud or money laundering,” the ESMA statement explained.

ESMA’s second statement emphasized that startups or open-source projects involved in ICOs are in jeopardy of managing regulated investment endeavors without complying with applicable EU legislation. Firms that are involved in ICOs should give "careful consideration" to these activities, it cautioned, as failure would be considered a breach.

“Where ICOs qualify as financial instruments, it is likely that firms involved in ICOs conduct regulated investment activities, in which case they need to comply with the relevant legislation, including for example: the Prospectus Directive, the Markets in Financial Instruments Directive (MiFID), the Alternative Investment Fund Managers Directive (AIFMD); and the Fourth Anti-Money Laundering Directive.

“ESMA stresses that firms involved in ICOs should give careful consideration as to whether their activities constitute regulated activities. Any failure to comply with the applicable rules will constitute a breach,” the statement said.

The development comes on the heels of other recent ICO counsels including the Japanese FSA's statement to investors on ICO risks, and another from Germany's Federal Financial Supervisory Authority, which remarked: "Investors should be wary of the 'numerous risks' involved in token sales."
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