The majority of cryptocurrency enthusiasts will remember the 2017-2018 period when Initial Coin offerings (ICOs) would pop up every day. It created a very competitive investment ecosystem, as numerous projects wanted to sell their tokens to investors. The majority of those projects never achieved their potential, yet the concept remains somewhat valid.
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Why An ICO?
As the name suggests, an Initial Coin Offering is a great way for teams of developers to bring a platform’s native token to investors globally. An ICO will pertain to cryptocurrency and blockchain projects and helps developers raise money early on. For those who invest during this phase, there is a chance to acquire native platform tokens at a lower price. That is, unless one wants to use the token within the project’s ecosystem at a later date.
One could consider certain similarities between conducting an ICO and opting for crowdfunding. The objective is to collect money in the early stages of product or platform development. With the money raised during an ICO, developers can fund the future development of their projects.
The concept of ICOs became a lot more popular in 2014, when Ethereum came to market. Rather than funding this – at the time, brand new – project through venture capitalists and other investors, the team sold Ether to investors through an Initial Coin Offering. Those who invested back then made a significant profit on their initial contribution. Ever since 2014, the concept of ICOs has gained popularity, and hundreds of projects have explored this method. The vast majority of them are no longer around today, however.
ICO Vs IPO
On paper, the concept of an Initial Coin Offering may sound somewhat akin to an Initial Public Offering or IPO. However, both methods are very different from one another. Although both the ICO and IPO options can lead to achieving funding for a company or project, the core fundamentals differ.
With an IPO, this fundraising method is only accessible to established companies selling ownership shares in their business. Those who invest in an IPO will have a stake in the company and its future success. ICOs, on the other hand, are designed for fundraising early-stage projects that often have no tangible technology or product available as of yet.
For technology startups, opting for an Initial Coin Offering can be favorable over an Initial Public Offering. Securing capital is a big struggle for new companies and teams. Particularly companies in the blockchain space will often struggle to reach out to investors, as most projects aren’t willing to sell a stake in their company early on. Having a whitepaper – but no working technology – is often sufficient to complete an ICO, but will not work when purchasing an IPO.
The Reverse ICO Option
Whereas the concept of an Initial Coin Offering usually pertains to companies seeking funding before building the technology or product, there is a variation on the model. Known as the reverse ICO, it is a way for existing businesses to introduce tokens to more people, decentralizing the system step by step. This latter approach is not as common today, yet it can occur sometimes.
Another reason to conduct a reserve ICO is to bring more investors into the fold. Exploring this option is often done by companies looking to launch a new blockchain-based product or service. Along with getting a broader investor group, the teams will also raise capital, killing two birds with one stone.
The Difference With An Initial Exchange Offering
People who are new to the cryptocurrency industry may wonder if there is a difference between an ICO and an Initial Exchange Offering (IEO). The purpose is the same, as they both aim to let teams raise money and sell their native tokens to investors. However, an ICO is usually conducted on the project’s website, whereas a reputable centralized exchange hosts an IEO.
By partnering with an exchange, the projects seeking funding gain a bit more credibility. It is pertinent for exchanges to properly analyze and vet projects looking to create an ICO, as the exchange’s reputation is on the line. A bonus for the project selling the token is how their asset will be listed on the exchange, facilitating the IEO after the token sale ends. The benefit of extra legitimacy, combined with guaranteed trading opportunities, makes it very appealing to explore an IEO.
What About Security Tokens?
Of the many offering types in the cryptocurrency world, security tokens are perhaps the most intriguing evolution. Initially considered to be the “new ICO model”, a security token offering is not that different from an ICo on the technical front. They both require tokens to be created and distributed similarly. However, there are regulatory differences that everyone needs to be aware of.
Unlike an ICO, every security token offering will need to adhere to strict regulatory guidelines. It is a good way for existing companies to offer equity to investors globally in tokens. To do so, businesses need to register these offerings as a securities offering with the right instances.
However, the business model is not as popular as ICOs once were, as there are only a few dozen STOs on the market today. Until a more transparent regulatory framework is drafted for both ICOs and STOs, it seems unlikely anything significant will change in the coming months and years.
How Does An ICO Work?
At its core, the purpose of an ICO is to sell tokens of new projects to investors worldwide. That may sound simple on paper, but the reality is often very different. Different iterations of ICOs exist, as some projects will have working technology before raising funds, whereas others might not. In the end, all investors will see tokens sent to their addresses on the blockchain either during the sale or shortly after the ICO concludes.
Assuming the project selling tokens does not have a native blockchain yet, they will usually often tokens on an existing chain. During the 2017 ICO craze, the popularity of ERC-20 tokens on Ethereum shot through the roof. Eventually, some projects migrated those tokens to their native blockchain. With the help of smart contracts, issuing and swapping coins is often a relatively straightforward process.
Outside of Ethereum, there are numerous other blockchains capable of facilitating token sales. During the ICO craze, some teams looked at Stellar, NEO, NEM, or even Waves as a viable ecosystem. Competition in this space allows developers to experiment with different ideas and features. Moreover, it is often more beneficial to build on an established blockchain than create a new one.
It is pertinent to announce the ICO launch ahead of time. Additionally, teams need to lay out the rules and requirements for participation. Factors to mention include the duration of the ICO, a soft or hard cap, and a whitelisting process. Without this information, there is no reason for anyone to invest in an initial coin offering. Whitelisting can involve having to verify one’s real-world identity before receiving access to the token sale.
Can Anyone Launch An ICO?
On paper, the idea of organizing an ICO is open to anyone. Additionally, the technology to create and issue tokens is available to anyone who knows how to put together a smart contract. Nothing prevents anyone from organizing an initial coin offering and selling tokens to investors globally. Nothing except for legal considerations and regulatory requirements that is.
To this day, there is a lot of uncertainty regarding initial coin offering regulation.
Very few countries have any official guidelines yet may clamp down on ICO activity after the facts. That is what happened in the U.S. to numerous projects since 2017. A fair few of them sold unregistered securities instead of tokens with utility, putting them in the crosshairs of the SEC.
However, there is a global lack of regulatory clarity regarding cryptocurrencies in general. Until an answer is found to those questions and doubts, it is often advisable not to explore the ICO option. Opting for the other methods can prove worthwhile – an IEO, STO, or IDO – but even those may not be without legal risk. Rules can differ from one country to the next, making it very difficult to make sense of it all.
It would prove beneficial for all jurisdictions to come up with a unified approach to cryptocurrencies and initial coin offerings. Unfortunately, that is unlikely to happen, as different jurisdictions hardly ever see eye-to-eye regarding these matters. Moreover, individual projects using this fundraising method have their individual nuances, forcing governments to classify them differently.
Just because there is no precise regulation on ICOs doesn’t mean people get a free pass. If a project needs crowdfunding, there are other legally recognized options to explore. An initial coin offering is the last choice on the list, and only after seeking professional help and advice. For now, it is a waiting game to see if governments will decide to create a legal framework for such token sales. As is to be expected, progress on this front is plodding.
Don’t Overlook The Risks
When it comes to investing, there are always risks. Initial Coin Offerings are no different, as there are many things to be mindful of before exploring an ICO. While most investors only see the potential for significant returns, there is never a guarantee every project will perform well. It is equally possible the return on investment will be negative.
Figuring out whether a project is viable is essential, yet also nigh impossible. Investors have a lot of research to perform before committing money. Unfortunately, ICOs are often “time is money” concepts, making speculators and investors forego the basic research. Performing a fundamental analysis remains crucial for every ICO; however, as it will often help uncover the long-term viability of projects.
- Figure out of the core concept is viable or even necessary
- Is there working technology or is the team selling a dream?
- What about the token supply and its allocation?
- Does the idea NEED a blockchain or can it be done without this technology?
- Who are the team members, and what skills do they have?
If any of the questions above are difficult or impossible to answer, it is often best to move on to a different investment option. There have been far too many ICOs with big promises and nothing to show for it after they collected millions in funding.
Even though the concept of an ICO remains valid today, the majority of fundraising has taken a different shape. Following the 2017 craze and subsequent failure to deliver on promises by so many teams, the term “Initial Coin Offering” leaves a bad taste in most people’s mouths. Combined with the lack of regulatory clarity regarding ICOs, it seems this token issuance model may not be around for much longer.
For buyers who still want to explore the ICO option, performing fundamental analysis is an absolute requirement. Failure to do so will cost people money, as there are numerous risks to contend with. No one will protect you from making the wrong investment, and there is no resource in this industry.