Initial Coin Offering (ICO)

An initial coin offering (ICO), sometimes referred to as crowd sale, is a form of attracting investments in a new crypto token. The name is formed by analogy with IPO (initial public offering), which growing companies use to raise money. However, unlike IPOs, ICOs lack government regulation.

What Is ICO?

Simply put, it is a blockchain based financial instrument that helps kickstart young cryptocurrencies. Developers of such new cryptocurrencies sell the so-called tokens or crypto coins to raise money for the funding of their project before the cryptocurrency is released. Tokens are different from cryptocurrencies in a way that the latter just helps to transfer value in an acceptable way (as physical money), whereas tokens participate in various use cases in the blockchain.

ICO tokens are similar to shares of a company, though usually without equity exchange. Instead, the investors purchase tokens either for existing cryptocurrency, such as bitcoins or for physical (fiat) currency, such as US dollars. Later, in case of success, they can sell these tokens on cryptocurrency markets. An initial coin offering is also similar to crowdfunding: funds are raised to implement a concept at the stage when the company has no product. Investors hope for the future growth of the new crypto coin value as compared to the initial value.

There are different ways to structure an initial coin offering. Some companies may have a static pool of coins that contains a limited number of tokens that are sold at a preset price. Other companies release a dynamic pool that also contains a limited number of tokens, but at the dynamic price, or, vice versa, a dynamic number of tokens at a preset price.

The first ICOs were for Mastercoin and Ripple back in 2013. But the most successful and investor-friendly ICO project is the smart contracts platform called Ethereum, with Ethers as coin tokens. In 2014, when the Ethereum project was announced, its offering raised $18 million in Bitcoins or $0.4 per Ether. The project went live in 2015, and in 2016 the Ether value reached $14 with a market cap of over $1 billion.

Ethereum’s smart contracts fueled the further development of new generation ICOs, allowing the creation of coins that can be transacted on the Ethereum blockchain instead of Ether. Currently, Telegram is planning to launch its own ICO with Gram tokens that can be exchanged directly within the messenger, and it seems to be one of the most promising offerings as of 2019.

ICO vs IPO

ICOs are popular because they are simpler than the traditional means of fundraising, such as IPO or venture investments. However, unlike stock exchanges, ICOs are not regulated by the U.S. Securities and Exchange Commission (SEC). Therefore, due to the lack of regulation and legislation, the simplicity of ICOs can be abused by dishonest startups, which only raise money and then just disappear.

Another difference between is that the buyers of tokens and cryptocurrencies may have rights that are different from those of buyers/owners of shares. In particular, tokens can be both dividends (giving the right to participate in the company's future profits) and utilitarian (giving the right to exchange tokens for services or goods of the company). The choice in favor of utilitarian tokens is often motivated by the desire not to fall under the definition of a “security”, according to the SEC.

How to Create an ICO

If you're thinking of creating your own initial coin offering, consider the following steps:

1. Choose a platform. There is a wide variety of platforms and services where you can base, among which is the above mentioned Ethereum.

2. Decide if you want your transaction costs to depend on a public blockchain. If not, then you will have to implement your own blockchain.

3. Define the price of your tokens based on the planned number of tokens and the amount that you want to raise.

How to Invest

To become an investor, you should first sign up for a cryptocurrency exchange. Then you need to buy the currency to invest in the ICO. After that, send the funds to a digital wallet that supports them and is compatible with it.

Now you can register. To do this, you will need to provide your public wallet address and other information, depending on what is required on the website.

On the launch day, follow the instructions on the website. In most cases, this will involve transferring the funds from your wallet to the ICO's public address. In return, you will receive some of the ICO's cryptocurrency at a rate specified by the terms of the offering.

The ICO will transfer the new token to your cryptocurrency wallet. Now you should either hold onto the new token or exchange it for fiat or cryptocurrencies. In some cases, you may need to hold the token until it becomes listed on an exchange that you can access based on your region.

Regulation

In mid-2017, the SEC published explanations about the ICOs and their risks and comparison with traditional investment methods. The Commission emphasized that this technology can be used to provide fair and legitimate investment opportunities, and proposed to regulate it under the US Securities Exchange Act of 1934. Specifically, it was proposed to register the offer and sale of tokens with the SEC.

On September 4, 2017, seven Chinese financial regulators formally banned all ICOs in China, demanding that the proceeds from all past ICOs be reimbursed to investors. This action has led to large sales and depreciation of most cryptocurrencies in China. Before this ban, ICOs attracted the equivalent of nearly $400 million from approximately 100,000 investors. However, a week later, it was announced that the ban on ICOs is only temporary until the rules and standards governing ICOs appear.

ICOs are also legally banned in South Korea. At the same time, on March 8, 2018, the Korea Times reported that the authorities were planning to legalize the ICOs, explaining that it was necessary to promote blockchain based technologies.

In September 2017, the Australian Securities and Investments Commission (ASIC) published a guide on legal responsibilities for companies that organize ICOs.

On December 4, 2017, the SEC intervened for the first time and stopped the ICO of the PlexCorps project. On December 8, the Canadian court sentenced the organizer Dominique Lacroix to 2 months in prison. Munchee, a Californian startup with a food review app, also suffered the same in December 2017 for an attempt to raise money to create a cryptocurrency that would work within the app to order food. During the same month, the SEC classified ICOs as securities.

Advantages

It is quite easy for a company launching an initial coin offering to make tokens. There are online services that allow generating the cryptocurrency tokens in seconds. Unlike a share, a token does not have any inherent value. Tokens are generated according to the terms. Then they are received and sent to investors.

Early investors in an ICO are usually motivated to buy crypto coins hoping that the plan becomes successful after it launches. In this case, the value of the tokens purchased during the ICO will exceed the price that was set during the offering itself, so the investors will profit from this growth. This is the primary benefit of an ICO.

Risks

Unfortunately, due to the lack of regulation, some of the ICO or crowd sale campaigns are fraudulent. Here are some features that will show you that an initial coin offering you invest in is not a scam:

• Project developers can clearly define their goals. Successful ICOs typically have straightforward, understandable whitepapers with clear, concise goals.

• The project is transparent. Investors should expect 100% transparency from a company launching an initial coin offering, such as the names of people involved, their location, project time frame, etc.

• The project has legal terms and conditions.

• Funds are stored in an escrow wallet - a wallet that requires several access keys.

Summary

An initial coin offering is a crowdfunding activity that helps new cryptocurrencies enter the market. The very first ICO was Mastercoin in 2013, but the most successful one is currently Ethereum. ICOs typically have high growth potential, so investors can greatly benefit from skyrocketing prices after an ICO is launched. However, unlike IPOs, ICOs are not regulated by the government and therefore can be fraudulent. Governments of some countries, such as China and South Korea, completely banned ICOs.