Considered as a fundraising method for investment, initial coin offerings (ICOs) are increasing investment opportunities and also generating capital for businesses. Initial coin offerings with blockchain are making financial transactions easier. This is not to say that there are no risks involved, especially considering that ICO is not regulated, unlike the traditional capital markets. Also, cryptocurrency drop in price may affect investors.
ICOs present opportunities for startups to raise capital as attainable in an initial public offering (IPOs) only that ICOs rely on cryptocurrency. However, ICO and IPO are not directly opposite because of some specific significant differences.
The significant advantage of ICO is the elimination of intermediaries in the fundraising processes. So, if you plan to invest in ICOs, you will directly communicate with the startup.
Initial coin offerings (ICOs) involve using cryptocurrency and blockchain technology to generate capital for businesses and startups. With ICOs, investors exchange their monetary investments in companies with some tokens. Thus, ICO is a crowdfunding scheme through a digital coin to fund startups and other businesses.
In return, you as an investor get ICO tokens for your money; the tokens allow you to enjoy certain features or benefits of a project being developed by the company. Thus, ICOs are becoming increasingly important because companies are crowdfunded for software projects that may have many difficulties if the funding relies on traditional structures.
Creating a whitepaper that enumerates the details of a project is the first step before companies invite investors to participate in an ICO. A whitepaper encompasses the business idea behind the project to be funded, the problem the project will solve after execution, the capital needed for the transaction, the number of tokens the founder will hold, the number of shares or the investors required, and for how long the project will last.
Afterward, you, as a supporter of an ICO project, receive the ICO tokens in exchange for the fiat currency or other cryptocurrency. Thus, these ICO tokens are similar to shares you buy during an IPO.
The digital tokens listed on the cryptocurrency exchanges then serve some benefits to you. The tokens make you entitle to the company’s dividends or grant you access to some of the company’s services. Thus, the ICO tokens can be security or utility tokens, depending on the functions.
When an investor has utility tokens, he has future access to the products or services of the startups. This utility token, also called ‘app coins’ or the ‘user tokens,’ are used by startups to fund their blockchain projects while you gain access to the service upon completion. Thus, utility tokens aren’t investments for a share of the company as obtained in the IPO. Additionally, a good structure utility token is not governed by federal laws securities.
Utility tokens are in similitude to preorder for a digital product like eBooks or video games that may not be available for several months; thus, startups create utility tokens for service in the pipeline. Filecoin, for instance, raised $275 million by selling tokens that enable investors or users to gain access to the Filecoin decentralized cloud storage program.
Unlike utility tokens that are not bounded by federal laws, security tokens are under government regulations for specific reasons. First, security tokens represent values for an external and tradable asset. Secondly, the value of the tokens can change due to others’ efforts. Thus, when security tokens transgress the federal security laws, the project may suffer setbacks and accrue penalties. For security tokens, the tokens can represent shares of a startup. Experts in ICO and cryptocurrency predicted that companies would soon be selling shares through ICOs, which will complement or be an alternative to traditional public offerings.
Before companies use ICO for crowdfunding, profound knowledge in technology, law, and finance is essential. Initial coin offering raises capital for startups by leveraging on a decentralized system of blockchain technology. So, before one performs an ICO, the investors and businesses should have an aligned goal. Hence, here are the steps before participating in an ICO.
The intention of every ICO is the generation of investment capital. Thus, software companies first identify and create the targets for the crowdfunding campaign and develop the necessary material like whitepaper to get investors.
The next step for the business is to create a token – utility or security token. The fungible and tradable tokens will represent your asset in the blockchain. You need to understand that these tokens are mere modifications of the existing cryptocurrencies. Also, these tokens are different from stocks as tokens grant you to access some products or services of the company or deliver some stake of the company to you. Thus, tokens do not provide an equity stake of the businesses to you.
Since tokens are modifications of existing crypto coins, companies do not need to write a code from scratch to create a token. Instead, they modify the existing code of coins to create one, which are specified on a blockchain.
While creating the tokens, companies also run online promotion campaigns to attract investors for the projects. However, Facebook and Google, and some other online platforms have banned the promotion of ICO campaigns.
Once startups get investors (you) through the campaign, they offer you the ICO tokens, which are structured in many steps. The company uses the funds raised from the investors to launch a new service or product. You will use the tokens gotten in exchange for your money to have access to the products or hold the tokens till they appreciate.
The evolution of cryptocurrency and blockchain technology is backing ICOs as a significant fundraising scheme. In 2017, companies generated over $7 billion through ICOs, and the amount almost doubled in 2018. Hence, ICO has two types, which are the private and public ICO
Private ICO has a limited number of investors to participate in the fundraising process. Thus, the investors must be accredited investors like influential individuals and institutions. Also, in a private ICO, a company sometimes sets a limit on the amount to invest.
The public initial coin offerings are open to the entire populace for crowdfunding. Public ICOs are similar to democratized investment schemes as everyone can invest in the project. However, many companies developing a project prefer private ICOs because of regulatory concerns in public ICOs.
Traditional companies generate funds for business growth and expansion through their profits; this means companies rely only on their efforts, which may take a while. Also, companies may look for inflow of cash through investors to start a project, but they will set a portion for the investors as stake. Another way is to raise funds through crowdfunding, where individual investors can buy shares from the company through IPO.
However, ICOs work in an entirely different format; instead of getting shares in the company, ICOs work with supporters because the supporters donate their money for the company in exchange for some returns on their investment. Thus, ICOs are ‘crowd sales.’
Unlike the primarily regulated IPOs, ICO is unregulated and has no direct bearing with government organizations. Also, since it is also decentralized, ICOs are more accessible in structure than IPOS.
Unlike in IPOs, where investors receive shares of stock in a company, there is, however, no share in ICO. Thus, ICO investors receive tokens equivalent to their money. In ICO, you give out funds in terms of bitcoin, ethereum, or other common cryptocurrencies to exchange new tokens under development.
Before you invest in an ICO, you should know that there are no legal guarantees or baseline value of the tokens you will receive. Thus, startups generate, receive and distribute to investors according to the terms of the ICO.
Also, ICO is very easy to create, and tokens are easy to launch because numerous platforms exist to generate tokens in a brief period.
ICOs have the potential for high returns on investment, and it is the primary reason some investors key into ICO. Early ICO investors are motivated to buy the tokens because if the company plans to succeed after their purchase, the price of the tokens will skyrocket, and they will accrue enough gains.
As sweet as ICO could be in generating investment funds for companies and the promise of high returns for investors, ICOs come with some risks and challenges. Many people now invest in ICOs because of the enormous returns gained by the early investors; however, this zeal and enthusiasm among the new investors could spell doom if not correctly plan for.
ICOs could be risky because of associated frauds and scam by some fraudsters since ICOs is chiefly unregulated. And because it is unregulated, overzealous investors’ loss may not be recovered from fraudsters or cryptocurrency drop.
ICOs also risk banning from government and financial institutions. The people’s bank of China backlashed ICOS because it was counterproductive to the country’s financial stability; thus, it was banned, and prices of cryptocurrency drops. Facebook, Twitter, Google, and other social media platforms already prohibited the advertisement of ICO. The Chinese central bank too banned banks offering ICOS-related services.
Ethereum’s ICO was one of the most successful ICOs and among the earliest pioneers. In 42 days of creating the tokens in 2014, it raised almost $18 million. Each ICO token was also worth $1,417 in 2018; thus, it is one of the most successful ICOs.
IOTA’s ICOs in 2015 offered an ROI of 332,500% for early investors. The developer sold about a billion of the tokens, and they raised above $400,000; each coin was also worth $5.69 then. Although the price isn’t as high as other ICOs, the ROI for the investors makes it one of the most successful ICOs.
One may wonder if governments of various countries will not key into ICO to regulate it because of the associated scams. However, different countries have approached ICOs regulations differently. For instance, China and South Korean governments already outlawed ICOs as they are counterproductive to its economic stability leading to cryptocurrency drop.
Australia, United Arab Emirates (UAE), Hong Kong, and New Zealand have published guidelines to govern ICOs. On the other hand, United States, Canada, and some European countries are developing some policies to govern ICOS.
ICOs offer swift and exciting access to funds for startups and businesses to develop a new project in exchange for tokens or access to some aspect of the service under development. However, ICOs are different from IPOs as the latter does not guarantee shares for investors. IPOs, meanwhile, ensure shares of stocks for the investors.
Ethereum and IOTA’s ICOs are some of the most successful ICOS in recent years. This is not to say that ICOs are always rosy, as many fraudsters now use the decentralized nature of blockchain technology and ICOs to scam overzealous investors.