One in five ICOs may be frauds — but investors are bullish on them anyway

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One in five ICOs may be frauds — but investors are bullish on them anyway

The number of initial coin offerings, or ICOs, has skyrocketed in the past two years as more companies flock to the new and controversial way to raise capital.

In an ICO, companies create a digital token or coin, then sell it to investors in exchange for cash or more commonly, cryptocurrency, usually bitcoin or ether.

Despite increasing scrutiny from regulators around the world, blockchain research firm Smith + Crown told CNBC that funds raised through ICOs are increasing quickly.

About $6.6 billion was raised through 217 ICO sales for the first quarter of this year, a 65 percent increase from the $3.9 billion raised in the last quarter of 2017.

Cryptocurrencies are underpinned by the blockchain technology, which is why at one time, ICOs were carried out mostly by blockchain start-ups.

But many other types of companies are flocking to ICOs today, even if those firms do not have or require the use of the blockchain.

A significant proportion of ICOs show signs of fraud. In a review of 1,450 digital coin offerings, the Wall Street Journal found that about 19 per cent of these ICOs, which had raised about $1 billion in total, raised red flags that included "plagiarized investor documents, promises of guaranteed returns and missing or fake executive teams."

The SEC last week launched a bogus ICO called HoweyCoins as part of an effort to educate investors about warning signs to watch for.
The SEC last week launched a bogus ICO called HoweyCoins as part of an effort to educate investors about warning signs to watch for.

Despite the high risks involved in launching and buying into ICOs, there can be significant payoffs for both founders that want to raise capital, and investors who want to make money.

One of the most successful ICOs launched was that of the Ethereum project, which has become the world's second largest cryptocurrency. It sold 60 million ether coins in 2014 to raise capital in the form of 31,000 bitcoin.

Mangrove Capital, an early investor in Skype, performed analysis claiming that if an investor had blindly invested in every visible ICO, including a significant number which failed, the return would have been 13.2 times that of your initial investment.

Mangrove did not disclose the number of ICOs it used in its research.

The United States Securities and Exchange Commission has been investigating and shutting down ICOs. Last week, the agency launched a bogus ICO called HoweyCoins as part of an effort to educate investors about warning signs to watch for.

Watch: What is blockchain?