Initial Coin Offering (ICO)
An Initial Public Offering (IPO) equivalent to the cryptocurrency world.
What is an Initial Coin Offering (ICO)?
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. The only purpose of the coin is to exchange value. So, its functions are limited by that.
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 Bitcoin, Ethereum, Ripple, and Litecoin cryptocurrencies.
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 it.
Key Takeaways
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ICOs serve as a means for companies to raise funds in the cryptocurrency world, similar to IPOs in traditional finance. Investors purchase new cryptocurrency tokens and gain utility along with ownership stakes in the project or firm.
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ICOs come with significant risks due to regulatory uncertainties and the prevalence of scams. Investors must conduct thorough research and due diligence before participating in any ICO.
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ICOs are often structured in various ways, such as static or dynamic supply and pricing models, to meet specific financing goals. A clear white paper detailing the project's objectives, funding needs etc. is needed for attracting investors.
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ICO investments are speculative and volatile. Regulatory issues, fraudulent activities, and market fluctuations shows the importance of informed decision-making and risk management strategies for investors.
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:
1. 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.
2. 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.
3. 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.
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:
1. 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.
2. 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.
Note
ICOs are typically used to fund new cryptocurrency ventures, such as the development of a new blockchain platform or a decentralized application.
3. 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.
4. 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.
5. 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.
However, 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.
Note
Through ICO trading platforms, investors receive unique cryptocurrency “tokens” in exchange for their monetary investment in the business.
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.
ICO 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:
- The goal of the developers must be clear. Successful offerings have a clear white paper with understandable goals.
- The project of the company must be transparent 100%. There should be no gray areas.
- Always check the terms and conditions. Since there is no regulation, you must validate the offer's legitimacy.
- 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:
- To store another cryptocurrency (such as Ethereum or Bitcoin)
- To hold the currency or tokens being sold in an offering
Initial Coin Offering (ICO) vs. Initial Public Offering (IPO)
| Comparison Terms | Initial Coin Offering (ICO) | Initial Public Offering (IPO) |
|---|---|---|
| Ownership Stake | Participants in an ICO typically do not acquire ownership in the company or project but rather purchase tokens that may provide access to the project's products or services. | In an IPO, investors purchase shares of the company, which entitles them to an ownership stake and voting rights. |
| Regulation |
ICOs often operate in a less regulated environment, with varying degrees of oversight depending on jurisdiction. |
IPOs are subject to stringent regulatory oversight by agencies such as the SEC in the United States, ensuring compliance with securities laws and investor protection measures. |
| Investor Expectations | ICO participants are often driven by the potential for speculative gains as the value of the token appreciates over time, with fewer expectations of dividends or traditional investment returns. | IPO investors typically expect to realize financial returns through dividends, capital appreciation, or trading shares on public stock exchanges. |
| Accessibility | ICOs may have fewer restrictions on investor participation, allowing retail investors from around the world to contribute funds directly to the project. | IPOs are typically accessible to institutional investors, accredited investors, and the general public through brokerage firms and underwriting syndicates. |
| Funding Mechanism | ICOs raise funds by selling or offering digital tokens or cryptocurrencies, which may represent access to a platform, utility within the ecosystem, or future benefits. | IPOs primarily raise funds by issuing equity shares to investors in exchange for capital, which the company can use for various purposes such as expansion, debt repayment, or research and development. |
| Market Maturity | ICOs are commonly used by startups and early-stage projects to raise capital for development and expansion, with varying degrees of maturity and risk. | IPOs are associated with established companies seeking to transition from private to public ownership, often after achieving a certain level of growth and stability. |
Advantages Of ICO
ICOs provide unique opportunities for funding innovative projects and accessing global capital markets. Let's delve into the key advantages of ICOs:
1. Access to Funding
ICOs provide startups and projects with a direct avenue to raise capital from a wide range of investors without the need for intermediaries such as banks or venture capital firms.
This democratized fundraising model enables entrepreneurs to access funds more quickly and efficiently, potentially accelerating project development.
2. Global Reach
Unlike traditional funding methods that may be limited to specific geographic regions or accredited investors, ICOs have a global reach.
This allows projects to attract investment from individuals and institutions worldwide, expanding the potential investor base and increasing fundraising opportunities.
Note
The success of an ICO often depends on factors such as the project's whitepaper, team expertise, market demand for the product or service, and the overall credibility and transparency of the project.
3. Liquidity
ICO tokens are often tradable on cryptocurrency exchanges shortly after the completion of the token sale.
This liquidity provides investors with the flexibility to buy and sell tokens as needed, enhancing the attractiveness of ICO investments compared to illiquid traditional venture capital or private equity investments.
4. Democratization
ICOs democratize access to investment opportunities by allowing retail investors to participate in early-stage funding rounds.
This level playing field provides individuals with the chance to invest in innovative projects and potentially reap substantial returns, leveling the investment landscape and promoting financial inclusion.
5. Token Utility
ICO tokens can have utility beyond mere investment, offering holders access to specific goods, services, or features within the project's ecosystem. This utility can increase token demand and value, providing additional incentives for investors to participate in the ICO.
Disadvantages Of ICO
As with any investment opportunity, it's essential to consider the downsides of participating in ICOs to make informed decisions. Some of the drawbacks are as follows:
1. Lack of Regulation
The ICO market operates in a largely unregulated environment, exposing investors to various risks such as fraud, scams, and regulatory uncertainties.
Without robust regulatory oversight, investors may fall victim to fraudulent schemes or misleading information, leading to significant financial losses.
2. Volatility
ICO tokens are susceptible to extreme price volatility, with values often experiencing rapid fluctuations driven by market sentiment, speculation, and external factors. This volatility can pose challenges for investors seeking stable returns and may deter institutional participation in the ICO market.
Note
ICOs typically involve the issuance of digital tokens, which may represent a stake in the project, access to a product or service, or simply a speculative investment.
3. Investor Protection
Unlike traditional securities offerings subject to stringent regulatory requirements and investor protections, ICO investments offer limited legal recourse in the event of fraud, mismanagement, or project failure.
Investors may face challenges recovering their funds or holding project teams accountable for unfulfilled promises, increasing the risk of loss.
4. Lack of Transparency
Some ICO projects lack transparency regarding critical aspects such as the team's credentials, technology development progress, or business model viability.
This opacity makes it difficult for investors to conduct thorough due diligence and accurately assess the risks associated with ICO investments, potentially leading to uninformed investment decisions and losses.
Examples of Initial Coin Offerings
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.
Note
One of the challenges with ICOs is the lack of regulatory oversight, which has led to concerns about investor protection and potential fraudulent activities within the ICO space.
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 Test. In 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.
Conclusion
Initial Coin Offerings (ICOs) provide a high-risk, unregulated method for companies to raise funds. While promising potential returns, investors must approach with caution due to regulatory uncertainties and the prevalence of scams.
Thorough due diligence is crucial before participating in any ICO to mitigate risks associated with volatility and fraudulent activities. The lack of oversight leaves room for fraudulent activities, emphasizing the critical importance of thorough due diligence before participating in any ICO.
While some ICOs have seen massive fundraising success, others have faltered, leaving investors empty-handed and highlighting the unpredictable nature of the market.
To reduce risks in ICO investments, they should understand the project's goals, assess the team's credibility, and scrutinize terms and conditions. While ICOs promise potential, they demand careful navigation and informed decisions to protect the investors.
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