The Financial Conduct Authority (FCA) warned consumers that they must be conscious of risks involved in ICOs and should research each specific project before investing in it.
"ICOs are very high-risk, speculative investments," the FCA said in a written warning that fell short of last week's outright ban on such fundraising by China. "There is a good chance of losing your whole stake."
ICOs are a digital form of raising funds from the public using a virtual currency, with issuers accepting bitcoin or ether in exchange for a proprietary coin or token that is related to a specific company or project and can then - in theory - be traded like other cryptocurrencies.
They have provided the fuel for a rapid ascent in the value of cryptocurrencies this year that has driven worries that a crypto-bubble could be set to burst.
By creating and issuing digital tokens, entrepreneurs can raise large sums quickly - sometimes hundreds of millions of dollars in minutes - with little or no regulatory oversight. But unlike conventional fundraising, token holders are generally not given any share in the particular project, nor any security.
Moneymailme, a social payments app, told Reuters on Tuesday that it was going to issue an ICO in October, with an initial goal of $20 million. Until now, the company has managed to raise just $3 million, through conventional fundraising methods.
Part of the reason for raising funds via an ICO - rather than via other means - is that it is an easier, faster way to raise money, said Mihai Ivascu, Moneymailme's founder. But he welcomed the FCA's warning.
"I think it’s very good that warnings like this are in the market," he said. "We should all be willing to help authorities in creating a regulatory framework (for ICOs)."
"EXPERIMENTAL" BUSINESS MODELS
Last week China banned ICOs, saying it was necessary to stop illegal fundraising and pyramid schemes, news that briefly sent the value of most cryptocurrencies tumbling.
There appeared to be no negative impact on cryptocurrencies from the FCA warning on Tuesday, with both bitcoin and ether trading slightly higher on the day.
The U.S. Securities and Exchange Commission also issued an "investor alert" in July to make investors aware of potential risks from ICOs. And in August, regulators in Singapore and Canada also cautioned investors about the sector.
For the buyer, the main reason for buying these highly risky tokens is often simply a speculative bet that their value will rise - a bet that has often paid off handsomely in recent months.
The FCA said the digital token issued may represent a share in a firm, a prepayment voucher for future services or in some cases offer no discernible value at all.
"Typically ICO projects are in a very early stage of development and their business models are experimental," it said.
Most ICOs are not regulated by the FCA and many are based overseas and might not intend to use the funds raised in the way set out in marketing brochures, the watchdog said
Jakob Drzazga, co-founder of Berlin-based firm Brickblock, which is building a blockchain-based marketplace, said such warnings were important in protecting consumers. Brickblock is aiming to raise $50 million in an ICO in October.
"(This warning) gives guidance to really research the team that's behind these ICOs and do your due diligence, which I think is really important," he said.
(Reporting by Huw Jones and Jemima Kelly; Additional reporting by Helen Reid; Editing by Mark Potter and Gareth Jones)
By Huw Jones and Jemima Kelly