List of contents
What is an ICO?
ICO vs. IEO (Initial Exchange Offering)
ICO vs. STO (Security Token Offering)
How do ICOs work?
Who can launch an ICO?
What are the regulations surrounding ICOs?
What are the risks of ICO?
Closing
What is an ICO?
Initial Coin Offering (abbreviated as ICO) is a method for project teams to raise funds in a cryptocurrency environment. In an ICO, the team produces blockchain-based tokens to sell to early backers. This process functions as a crowdfunding phase – users receive tokens that they can use (either immediately or in the future), and the project receives money to fund development.
This practice was popularized in 2014 when it was used to fund the development of Ethereum. Since then, it has been adopted by hundreds of venture capital firms (especially during the boom in 2017), with varying degrees of success. Although the name sounds similar to Initial Public Offering (IPO), they are essentially very different methods of raising funds.
An IPO generally applies to established businesses that sell a partial ownership stake in their company as a way to raise funds. Instead, ICOs are used as a fundraising mechanism that allows companies to fund their projects at a very early stage. When ICO investors buy tokens, they are not buying any ownership in the company.
ICOs can be a viable alternative to traditional funding for technology startups. However, oftentimes, new entrants struggle to secure capital without having a functional product. In the blockchain environment, established companies rarely invest in projects whose benefits are only written in a white paper. Moreover, the lack of regulations regarding cryptocurrencies deters many investors from considering blockchain startups.
This practice is not only utilized by new startups. Established companies sometimes choose to launch a reverse ICO, which is functionally very similar to a regular ICO. In this case, a business already has a product or service, but then issues a token to decentralize its ecosystem. Or, they launch ICOs to attract a wider range of investors, and raise capital for new blockchain-based products.
ICO vs. IEO (Initial Exchange Offering)
Initial Coin Offerings and Initial Exchange Offerings are similar in many ways. The main difference is that the IEO is not launched by the project team itself, but in conjunction with a cryptocurrency exchange.
The exchange partnered with the team to allow its users to purchase tokens directly from the exchange's platform. This is beneficial for all parties involved. When a reputable exchange supports an IEO, users can rest assured that the project has been rigorously audited. The team behind the IEO benefits from the increased exposure, and the exchange also benefits from the success of the project.
ICO vs. STO (Security Token Offering)
Security Token Offering was once labeled as the “new ICO”. From a technological point of view, they are identical – tokens are created and distributed in the same way. But on the legal side, the two are very different.
Due to some legal ambiguities, there is no consensus on how regulators act in setting the terms of ICOs (discussed in more detail below). As a result, there is no meaningful regulation in this industrial environment.
Some companies decide to take the STO route as a way to offer equity in the form of tokens. Also, it can help them avoid uncertainty. Token issuers register their offerings as securities offerings with the relevant government bodies. This way, they will be treated the same as traditional securities.
How do ICOs work?
ICOs can take many forms. Sometimes, the team launching it already has a functional blockchain that they will continue to develop in the coming months and years. In this case, users can purchase tokens sent to their address on the blockchain.
Alternatively, the blockchain has not yet been launched, in which case the tokens will be issued on an already established blockchain (such as Ethereum). When a new chain is launched, the holders can exchange their tokens for the newly created ones.
However, the most common practice is to issue tokens on a smart-contract-capable chain. Again, much of this is done on Ethereum – many applications use the ERC-20 token standard. While not all of them originate from ICOs, it is estimated that there are over 200,000 different Ethereum tokens today.
Apart from Ethereum, there are other chains that can be used – Waves, NEO, NEM, and Stellar are some popular examples. Given how flexible these protocols are, many organizations do not plan to migrate, instead choosing to develop projects on top of existing foundations. This approach allows them to leverage the network effects of an established ecosystem, so developers can use proven tools.
ICOs are announced before their launch date to establish the rules for running them. The terms can be an operating time frame, the application of a hard cap on the number of tokens to be sold, or a combination of both. There may also be a whitelist where participants must register beforehand.
Users then send funds to the specified address – generally, payments use Bitcoin and Ethereum as these two coins are the most popular. The buyer provides a new address to receive the tokens, or the tokens are automatically sent to the address used to pay.
Who can launch an ICO?
Today, the technology for creating and distributing tokens is widely accessible. But in practice, there are many legal consequences to consider before launching an ICO.
In general, there is still a lack of regulation in the cryptocurrency environment, several important questions remain unanswered. Some countries expressly prohibit the launch of ICOs, but even the most crypto-friendly jurisdictions have not yet established clear laws. Therefore, it is very important to understand the laws of your own country before considering an ICO.
What are the regulations surrounding ICOs?
It is difficult to give one answer for so many different circumstances, as there are many variables to consider. Regulations vary from jurisdiction to jurisdiction, and each project likely has its own nuances that can influence how the government views it.
It should also be noted that the absence of regulations in some places does not mean a free pass to raise funds for projects through ICOs. So, it is highly recommended to seek professional legal advice before choosing this form of crowdfunding.
In some cases, regulators have sanctioned teams that raised funds in what they deemed to be securities offerings. If authorities find a token to be a security, the issuer of the token must comply with the strict measures applicable to this type of traditional asset. In this regard, the US Securities and Exchange Commission (SEC) has provided some good insights.
In general, regulatory development is still relatively slow in the blockchain environment, especially because this technology is moving quickly beyond the capabilities of the existing legal system. However, many government entities are now discussing implementing a more transparent framework for blockchain technology and cryptocurrencies.
While many blockchain enthusiasts are already aware of the possibility of government interference (which may hinder development) with this technology, most of them are also aware of the need for investor protection. Unlike in traditional types of finance, the ability of everyone around the world to participate can pose some major problems.
What are the risks of ICO?
The prospect of a new token providing huge returns is an exciting one. But not all coins are created equal. In any type of crypto investment, there is no guarantee that you will get a positive return on investment or return on investment (ROI).
It is difficult to determine whether a project has merit, as there are many factors involved. Potential investors should conduct due diligence and extensive research on the tokens they are considering. This process should include a thorough fundamental analysis. Below is a list of some questions worth asking:
Does the concept have any weight? What problem does it solve?
How is supply allocated?
Does the project require a blockchain/token, or can it be done without a blockchain/token?
Does the team have a good reputation? Do they have the skills to run the project?
The most important rule is to never invest more than you can afford to lose. The cryptocurrency market is highly volatile, and there is a significant risk that the assets you own will fall in value.
Closing
Initial Coin Offerings have become a very effective means for projects in their early stages to obtain funding. Following the success of the Initial Coin Offering launched by Ethereum in 2014, many organizations managed to raise capital to develop new protocols and ecosystems.
However, buyers must clearly know their investment objectives. There is no guarantee of profit. In the cryptocurrency environment, this kind of investment is very risky, and there is almost no protection if the project fails to deliver a meaningful product.