Digital token basics

Digital token offerings – commonly called “initial coin offerings” or “ICOs,” “initial token offerings” or “ITOs,” and “token generation events” – are increasingly popular ways for businesses to raise money. Investors may be eager to get in on a new trend, but should be wary of the considerable risks that often accompany these products.

Businesses and individuals may offer digital tokens—a type of “cryptoasset” (often called “cryptocurrencies”)—to raise funds for a variety of projects, including alternative cryptoassets, software or other types of products and services. Those promoting digital tokens may promise investors high returns in a new investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition space, but the reality is that buying digital tokens can be risky and you could stand to lose all your money.

What is a digital token offering?

Digital token offerings are typically managed over the internet, allowing people to visit a website and purchase digital tokens using a fiat currency (such as Canadian dollars) or another cryptoasset like bitcoin or ether.

The digital tokens sold may have a planned future use, such as allowing buyers to access a digital platform, use an alternative cryptoasset or access other types of products and services.

Some businesses may also tell buyers that they will receive a return on their investment or that the digital tokens can be resold to other buyers if they wish to exit the investment, which may not always be the case. There is no guarantee that digital tokens can provide a return on investment or that there will be a market where buyers can resell digital tokens if they need to do so.

As noted above, digital token offerings are often called “initial coin offerings” or “ICOs,” and in some ways, these offerings may seem similar to an initial public offering (IPO)Initial public offering (IPO) The first sale of shares that a company offers to the general public. Also called a Primary Distribution.+ read full definition. Many businesses market digital tokens as investments that, like traditional shares of a company, may increase or decrease in value depending on the company’s success. However, in reality, digital tokens are typically different from the shares sold as part of an IPO because they usually do not represent an equityEquity Two meanings: 1. The part of investment you have paid for in cash. Example: you may have equity in a home or a business. 2. Investments in the stock market. Example: equity mutual funds.+ read full definition interest in the business, meaning that investors do not have part ownership of the business, have voting rights, or receive dividendDividend Part of a company’s profits that it pays to shareholders in proportion to the total number of shares held. The Board of Directors sets the amount. For common shares, the amount varies. It may skip dividends if business is poor or the directors invest money in things like new equipment or buildings.+ read full definition payments.

3 things to consider before participating in a digital token offering

1. Digital tokens are often securities

Most sales of digital tokens are subject to rules involving the sale of securities. If you purchase digital tokens that tie their value to the future profitsProfits A financial gain for a person or company. Equals the money left over after you subtract your costs from the money you made.+ read full definition or success of a business, it is likely that the digital tokens will be considered a security.

Selling securities is a regulated activity and businesses that do so are required to meet certain legal obligations that are in place to protect investors.

Businesses may market digital tokens in different ways, including software presale tokens, donations or crowdsales. If the digital tokens are securities, the businesses offering them to the public may need to be registered with the Ontario Securities CommissionOntario Securities Commission An independent Crown corporation that is responsible for regulating the capital markets in Ontario. Its mandate is to provide protection to investors from unfair, improper or fraudulent practices and to foster confidence in fair and efficient capital markets.+ read full definition. Learn how to check if a business is registered.

Businesses may publish “whitepapers” for their digital tokens that describe things such as the amount of money they are aiming to raise, how the money will be used and how long the digital tokens being offered will be available for purchase. If the digital tokens being sold are securities, businesses may be required to provide specific disclosure documents, such as a prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition or an offering memorandumOffering memorandum A document describing the business of an issuer. This document is designed to help potential buyers make an investment decision when they are considering exempt-market securities.+ read full definition, which contains information about the business, its management, operations and business risks.

Before you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition, you should ask questions about the investment and any disclosure documents that investors are entitled to receive. Any document that you receive should be in plain language and easy to understand.

2. Businesses located outside of Canada

Many businesses raising money through the sale of digital tokens are located outside of Canada, but are marketing their digital tokens to Canadian investors. Even if a business is located outside of Canada, it must follow Canadian securities laws if it is selling digital tokens to Canadian residents.

RegistrationRegistration A requirement for any person or company trading investments or providing advice in Canada. Securities industry professionals are required to register with the securities regulator in each province or territory where they do business.+ read full definition with the Canadian securities regulatory authorities is often required to sell digital tokens that are securities to the public. One of the key obligations for registered firms is that they only sell digital tokens to investors if it is suitable to do so. Learn how registration protects investors.

Beware of any transactions that are conducted anonymously. You should know the identities of the businesses’ management members and how to reach them. Also, be wary of any businesses that only collect limited information about you, such as your IP address or digital wallet address.

Some cryptoasset trading platforms or (which allow people to buy and sell cryptoassets such as bitcoin and ether online) will allow you to buy digital tokens that someone else previously purchased. As the subsequent purchaser of these digital tokens, you would normally be entitled to protections under securities laws. However, many of these platforms operate across the world and may not comply with applicable laws or regulations. Your rights may be difficult to enforce.

3. Limited use for digital tokens

Digital tokens may have extremely limited use, and you may only be able to use them on a specific digital platform for certain products or services. If the business does not successfully complete the project that it was hoping to develop using the money it raised from the selling of digital tokens, the digital tokens it issued may have no use at all.

If you purchase a digital token, you may be buying nothing more than a promise that the business will deliver a service or product in the future. You may need to wait months or even years before the digital tokens can be used or provide a return on investment, if any.

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