Initial Coin Offering (ICO)

An Initial Public Offering (IPO) equivalent to the cryptocurrency world.

Initial Coin Offering (ICO) is an initial public offering (IPO) equivalent to the cryptocurrency world. For example, a company may want to raise funds this way to create a new app, coin, or service.

Investors may buy the new cryptocurrency token. In exchange, investors might have a utility related to the goods and services or an ownership stake in the firm or the project.

Other names for this technology are "token sale" and "token launch." The token sale allows the company to establish the user base and fund the development of the product.

But keep in mind that tokens and coins are two different things. However, they are used interchangeably in public media.

A coin is a unit of value that is native to the blockchain. In other words, it is simply a means of exchange used to incentivize the blockchain network participants. The native coin examples are BitcoinEthereumRipple, and Litecoin cryptocurrencies. 

The only purpose of the coin is to exchange value. So, its functions are limited by that.

Ether is the currency of the Ethereum protocol, and it functions as a coin for the Ethereum blockchain. But here is the one distinct feature of Ethereum. The protocol allows operating with smart contracts on top of blockchain technology. 

So, logical conditions like "if…then…when…" can be coded, executed, and replicated automatically. On top of that smart contracts, developers may create a token whose functionality is beyond the exchange of value.

Developers may add any functionality, but the most common is the asset's representation. When any token is created in Ethereum, it is first considered an intelligent contract with unique predetermined rules governing them.

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How an Initial Coin Offering (ICO) Works

When the firm wants to raise funds, it must determine how it will be structured. There are three common ways to structure the process:

  • Static supply and static price

The firm may want to finance its specific goal or align the funding based on its limitations. Each token sold will have a determined price, and the total token supply is constant.

  • Static supply and dynamic price

The coin offering might have a static (limited) supply of tokens and dynamic financing goals. In other words, the amount of raised money varies based on the token's price.

  • Dynamic supply and static price

In this case, the price will be constant (will not fluctuate), but the supply will vary. So, the collection of tokens will determine the amount of raised funds.

The other thing that crypto projects must consider is a white paper. It is typically available to potential investors via designated websites about the token. The promoters explain the following factors in the white paper:

  • The goal of the project
  • What need does the project address by fulfilling the project?
  • How much money does the project need?
  • How many tokens will the founders keep?
  • What currencies (fiat or crypto) will the firm accept? In other words, how can investors pay for the project?
  • How long will the campaign run?

So this document is designed to attract investors and enthusiast supporters to invest in the project's tokens. Investors may either use fiat currency or cryptocurrency to purchase new tickets. 

It is common for investors to use cryptocurrencies such as Bitcoin and Ethereum as the means of payment. The newly issued tokens are similar to the stocks sold in an IPO.

If the project can't raise enough funds (minimum amount) for its goals, it will return all the money to its investors. In that case, the ICO is considered unsuccessful. 

On the other hand, if the minimum funding requirements are met, the money will be spent to realize the project's goals.

Types of Initial Coin Offerings

ICOs are held either privately or publicly. Private ICOs involve only accredited investors. In this case, the firm has more control over the minimum investment amount and who can be an investor.

The public one is ultimately the opposite. Anyone can buy the tokens through cryptocurrency exchanges. Beyond these two categories, there are five other types that you may encounter:

  • Security token offering (STO)

The STO is quite similar to an IPO. The coins serve the same function as shares, representing the ownership claim. The Securities and Exchange Commission (SEC) regulates these types of tokens.

  • Interactive initial coin offering (IICO)

It is the same ICO, but it limits how many tokens each investor can buy. Therefore, it helps many people to participate in the event.

  • Initial supply auction

It is a strategy of releasing a coin with the highest initial price. Then, as the auction proceeds, the price decreases until the active market price is achieved.

  • Simple agreement for future tokens (SAFT)

It is a type of protection for initial investors. Investors can use the tokens in the future. These tokens are risky since you are investing in early or seed-stage startups.

  • Airdrop

One of the funniest ways to pick up new coins is a cryptocurrency airdrop. In this case, the firm gives away some cash for free to feed up the new market. So the cryptocurrency is sent to active members' wallets for free or, sometimes, for a minor service.

For example, the required service could be retweeting a post sent by the currency's issuer.

Who Can Launch an ICO? 

Nowadays, any person can launch an ICO. In most countries, including the US, there is no regulation. So, the only thing you need to launch a new cryptocurrency is the appropriate technology.

But the lack of regulation leaves room for potential scams and fraudulent activities. For example, scammers can easily trick people into investing in new projects and escape with a lot of money.

So, before investing in a coin, always do your homework. First, you have to validate that the people conducting the ICO process are honest and accountable for the process. Also, check the product's leads' history.

If the project has no people with relevant and easily verified experience, you are probably investing in a scam.

Many famous actors (like Steven Seagal) and athletes may encourage you to invest in hot ICOs. For example, boxer Floyd Mayweather Jr. and DJ Khaled promoted Centra Tech (a $30 million ICO in 2017). But, eventually, the US court recognized Centra Tech as a scam.

As a result, two celebrities and three founders are pledged to be guilty and must pay all the fines. Any firm that can raise funds through ICO does not necessarily mean that your business must do the same.

It is the way to go if your business substantially benefits from it.

Special Considerations

Since 2019, ICO activity has declined because of regulatory issues. Sure, you can research, find and participate in the ICOs through such websites as TopICOlist.com. However, although you can compare different ICOs, you cannot stay up-to-date with all the latest offerings.

The offerings can generate great hype, and investors can discuss the opportunities through many online sites. However, investors should be familiar with the cryptocurrency before participating in the offering. 

Investors also should significantly investigate the offerings since it is an unregulated field. There is no guarantee that the project will not be a scam. But, you can avoid the scams using the following guidelines:

  1. The goal of the developers must be clear. Successful offerings have a clear white paper with understandable goals.
  2. The project of the company must be transparent 100%. There should be no gray areas.
  3. Always check the terms and conditions. Since there is no regulation, you must validate the offer's legitimacy.
  4. You should store the funds in an escrow wallet. This wallet demands several access keys to protect you against scams.

Besides the escrow wallet, you need another wallet to store your cryptocurrencies. 

"Why do you need the second wallet?"

Because you can purchase the tokens only by established cryptocurrency (like Bitcoin or Ethereum). So, overall you need two wallets:

  1. To store another cryptocurrency (such as Ethereum or Bitcoin)
  2. To hold the currency or tokens being sold in an offering

Initial Coin Offering vs. Initial Public Offering

Companies go through the IPO to become public. Then, they distribute shares to their investors. In an ICO, firms raise funds through selling or offering cryptocurrencies and tokens. 

In both cases, investors are optimistic about the firm's future or cryptocurrency. As a result, they believe that the asset's value will increase over time.

There are also several differences. First, through IPO, you secure an ownership claim over the firm. But, in ICO, you have no ownership stake in the project and the firm. You are gambling that the future price of the token will rise dramatically.

Also, IPOs are regulated by the SEC, while ICOs are not regulated. This regulation of IPOs led to a similar structure to most stock offerings.

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The lack of regulation + decentralized nature of projects = varying structure of ICOs.

In IPOs, investors expect to realize financial returns. At the same time, in ICOs, the supporters are usually risk-tolerant about investing in new projects. 

Although ICO and crowdfunding are pretty similar, they differ a lot. In most cases, the latter is more about donation, while the prior one is about financial gain. Because of that, ICO is also called "crowd sales."

Advantages and Disadvantages

The coin offering helps companies quickly raise funds. According to the terms of the ICO, the managers generate tokens, receive them, and distribute them by transferring tickets to every individual investor. 

But, since it is not regulated by financial authorities (like the SEC), most of the funds are lost by fraud or incompetence. As a result, they might never be recovered.

The early investors are motivated that the tokens will substantially increase after the cryptocurrency launch. That's the main benefit of the process: colossal return potential.

But the unknown regulation of digital assets gives no guarantee. In some countries, it is even illegal. 

For example, the People's Bank of China banned this type of offering, calling them unproductive for the overall economy and financial stability. Also, in 2021, China banned cryptocurrency mining and named all crypto-transactions illegal.

So, always check the regulation in your jurisdiction (city, state, country) and the soundness of the offering. That way, the benefits might outweigh the costs, and you might enjoy investing in ICOs.

Another issue with coin offerings is volatility. Cryptocurrencies are usually susceptible to bubbles. For example, in 2017, a Wired article accurately predicted the cryptocurrency bubble's burst. 

At that time, numerous investors sought the potential gain from participating in projects similar to Bitcoin and Ethereum. But unfortunately, their expectations were not met by the reality of the market.

So, keep in mind that crypto offerings are always volatile, and you might lose all your investments no matter how promising the project is. So always do your due diligence.

Examples

In 2014, Ethereum ICO was launched and raised $18 million within 42 days. In 2015, Antshares (now "Neo") launched a two-phase ICO. The first stage ended in October 2015, while the second one finished in September 2016. Overall, Neo generated $4.5 million in investments.

In March 2018, Dragon Coin collected $320 million within one month. Also, in the same year, the firm backed by the EOS platform shocked this offering with a massive $4 billion sum raised within the year.

Sometimes, the return on investment (ROI) is not correlated with the money raised. For example, you would generate greater returns with ICOs that raise little money. However, in 2017 and 2018, the ICOs raised the maximum amount of money.

Always consider both the amount raised and the ROI. 

SEC Introduces the HoweyCoin

In 2018, the SEC introduced HoweyCoin, a fake coin to show the danger for individuals. The currency was named after the Howey TestIn addition, the SEC charged Kik for illegal sales of securities. Kik is a messaging platform that raised $100 million in an unregistered offering. 

On December 11th, 2017, the SEC cracked the ICO by Munchee, the food review app firm based in California. The firm wanted to launch a cryptocurrency compatible with the food ordering platform. As a result, the agency issued a cease-and-desist letter.

Investing in ICO is risky and speculative. Neither Wall Street Oasis nor the author recommends investing in cryptocurrencies and coin offerings in this article. Each individual must assess their unique financial position and get advice from a qualified professional before investing.

The author and Wall Street Oasis do not provide any warranties and representations of the information's timeliness.

Researched and authored by Almat Orakbay | LinkedIn

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