Definition of Initial Coin Offering (ICO)
For traditional companies, there are a few ways of going about raising funds necessary for development and expansion. A company can start small and grow as its profits allow, remaining beholden only to company owners but having to wait for funds to build up. Alternately, companies can look to outside investors for early support, providing them a quick influx of cash but typically coming with the trade-off of giving away a portion of ownership stake. Another method sees companies go public, earning funds from individual investors by selling shares through an Initial Public Offering (IPO).
An Initial Coin Offering (ICO) is the cryptocurrency space's rough equivalent to an IPO in the mainstream investment world. ICOs act as fundraisers of sorts; a company looking to create a new coin, app, or service launches an ICO. Next, interested investors buy in to the offering, either with fiat currency or with preexisting digital tokens like ether. In exchange for their support, investors receive a new cryptocurrency token specific to the ICO. Investors hope that the token will perform exceptionally well into the future, providing them with a stellar return on investment. The company holding the ICO uses the investor funds as a means of furthering its goals, launching its product, or starting its digital currency. ICOs are used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.
BREAKING DOWN Initial Coin Offering (ICO)
This is the most basic definition of an ICO. However, there is much more to the trendy crowdfunding method than this. Indeed, just as ICOs have rapidly come to dominate attention in the cryptocurrency and blockchain industries, so too have they brought along challenges, risks, and unforeseen opportunities. Investors buy into ICOs in the hope of quick and powerful returns on their investments. The most successful ICOs over the past several years give investors reason to maintain this hope, as they have indeed produced tremendous returns. However, this investor enthusiasm also leads people astray. Because they are largely unregulated, ICOs have become a hub of frauds and scam artists, looking to prey on investors who are overzealous and underinformed.
Below, we'll explore the ins and outs of ICOs, beginning with a thorough overview of the ICO process itself. We'll examine some of the benefits of ICOs as well as some of the most successful ICOs in history and where investors can go to seek out new ICOs in which to take part. Finally, we'll take a look at risks that investors take when they participate, in addition to criticisms of the ICO space.
The Basics of an ICO
When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for. During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an IPO-type transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the funds requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.
ICOs are similar to IPOs and crowdfunding
Like IPOs, a stake of the startup or company is sold to raise money for the entity’s operations during an ICO operation. However, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return in their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are referred to as crowdsales.
ICOs also retain at least three important structural differences from IPOs. First, ICOs are decentralized, with no single authority governing them. Second, ICOs are largely unregulated, meaning that government organizations like the U.S. Securities and Exchange Commission (SEC) do not oversee them. Finally, as a result of decentralization and a lack of regulation, ICOs are much freer in terms of structure than IPOs.
ICOs can be structured in a variety of ways. In some cases, a company sets a specific goal or limit for its funding, which means that each token sold in the ICO has a pre-set price and that the total token supply is static. In other cases, there is a static supply of ICO tokens but a dynamic funding goal, which means that the distribution of tokens to investors will be dependent upon the funds received (and that the more total funds received in the ICO, the higher the overall token price). Still other ICOs have a dynamic token supply which is determined according to the amount of funding received. In these cases, the price of a token is static, but there is no limit to the number of total tokens, save for parameters like ICO length. These different types of ICOs are illustrated below:
ICO Benefits: What's in it for the Investor?
In an IPO, an investor receives shares of stock in a company in exchange for her investment. In the case of an ICO, there are no shares to speak of. Instead, companies raising funds via ICO provide a blockchain equivalent to a share: a cryptocurrency token. In most cases, investors pay in a popular existing token like bitcoin or ether and receive a commensurate number of new tokens in exchange.
It's worth noting just how easy it is for a company launching an ICO to make tokens. There are online services such as Token Factory that allow for the generation of cryptocurrency tokens in a matter of seconds. Investors should keep this in mind when remembering the differences between a share of stock and a token; a token does not have any inherent value. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute them per their plan by transfering them to individual investors.
Early investors in an ICO operation are usually motivated to buy cryptocoins in the hope that the plan becomes successful after it launches. If this comes to pass, the value of the tokens they purchased during the ICO will climb above the price set during the ICO itself, and they will achieve overall gains. This is the primary benefit of an ICO: the potential for amazing returns.
Indeed, ICOs have made many investors into millionaires. Take a look at the figures for 2017: That year, there were 435 successful ICOs, each raising an average of $12.7 million...the total amount raised for 2017 was $5.6 billion, with the 10 largest projects raising 25% of this total. Further, tokens purchased in ICOs returned an average of 12.8x the initial investment in dollar terms.
The ICO space continues to balloon at a tremendous rate. In the first quarter of 2018, ICOs brought in $6.3 billion in funds, already outpacing the entire 2017 total in just 59% as many distinct ICO projects.