What is an ICO?
An initial token offering (or ICO) is a method allowing teams to raise funds for projects in the crypto sphere. In an ICO, teams generate blockchain-based tokens to sell to their early supporters. This is a crowdfunding phase: users receive tokens that can be used (immediately or in the future) and the project raises money for its development.
The practice was popularized in 2014 with funding for the development of Ethereum. Since then, this format has been used by hundreds of companies (especially during the 2017 boom) with varying degrees of success. Although the name sounds similar to Initial Public Offering (IPO), the two are radically different in how the funds are obtained.
IPOs generally involve established companies selling shares of their company to raise capital. ICOs are used as a mechanism to allow companies to raise funds very early to launch their project. When investors in an ICO buy tokens, they are not buying a share of the company.
ICOs can be a viable alternative to traditional financing for tech startups. New entrants often have difficulty obtaining capital without having an already working product. In the blockchain sphere, established companies rarely invest in projects based on the white paper. In addition, the lack of regulation in the sector often deters them from considering blockchain startups as worthy of interest.
This practice is not only used by new businesses. Established companies sometimes choose to launch a reverse ICO, a form of ICO similar to traditional ICOs. In this case, the company already has a product or service and launches a token to decentralize its ecosystem. It can also organize an ICO to target a larger number of investors and raise funds for a new blockchain-based product.
Comparison of ICOs and IEOs (Initial Exchange Offerings)
Initial Exchange Offerings and Initial Exchange Offerings are very similar. The main difference is that IEOs are not only organized by the project team, but in partnership with a cryptocurrency exchange.
The exchange partners with the team to allow its users to directly purchase tokens on its platform. This can be beneficial for all parties involved. When a reputable exchange launches an IEO, its users expect that the project has been carefully reviewed. The team behind the IEO benefits from great visibility. The exchange, for its part, has everything to gain from the success of the project.
Comparison of ICOs and STOs (Security Token Offerings)
Security Token Offerings were once referred to as “new ICOs”. From a technological point of view, these are identical: the tokens are in fact created and distributed in the same way. From the legal side, however, these are very different.
Due to some legal ambiguity, there is no consensus on how regulators should qualify ICOs (more details below). As a result, the sector has still not been subject to significant regulation.
Some companies have decided to carry out STOs in order to offer shares in the form of tokens. Plus, it could help them avoid some legal issues. The issuer registers its offering as a “safety” offering with the appropriate government agency, subjecting it to the same treatment as traditional securities.
How do ICOs work?
An ICO can take various forms. Sometimes the team organizing the ICO already has a working blockchain that they will continue to develop in the months and years to come. In this case, users can purchase tokens which will be sent to their address.
Conversely, others do not yet have a blockchain, in which case the tokens will be issued on an already functioning blockchain (like Ethereum). Once the new chain is launched, holders will be able to exchange their old tokens for tokens issued on it.
The most common practice is to issue tokens on a chain compatible with smart contracts. Again, this is mainly done on Ethereum – many applications use the ERC-20 token standard. Although not all of them come from an ICO, it is estimated that Ethereum hosts nearly 200,000 tokens today.
In addition to Ethereum, other chains can also be used: Waves, NEO, NEM or Stellar are some popular examples. Given the flexibility of these protocols, many organizations do not plan to migrate, but instead choose to build on existing foundations. This approach allows them to leverage the network effects of an established ecosystem and gives developers access to tools that have already been tested.
An ICO is announced in advance and specifies the rules for its operation. This can define an operating period, set a ceiling for the number of tokens to sell, or combine the two. There may also be a whitelist that participants must register for in advance.
Users must then send funds to a specified address – bitcoin and ethereum are generally accepted due to their popularity. Buyers provide a new address to receive the tokens, or the tokens are automatically sent to the address from which the payment was made.
How to launch an ICO?
The technology to create and distribute tokens is widely accessible, but in practice there are many legal considerations to take into account before organizing an ICO.
Overall, the cryptosphere lacks regulatory guidance, and some crucial questions have yet to be answered. Some countries ban the launch of ICOs outright, and even the most cryptocurrency-friendly jurisdictions have yet to pass clear legislation. It is therefore imperative that you understand the laws of your own country before considering an ICO.
What are the regulations surrounding ICOs?
It is difficult to give a single answer as there are so many variables to take into account. Regulations vary from jurisdiction to jurisdiction, and each project likely has its own nuances that may affect how government entities perceive it.
It should be noted that the absence of regulation in some places does not constitute freedom to finance a project through an ICO. It is therefore important to obtain legal advice from a professional before choosing this form of crowdfunding.
On numerous occasions, regulators have sanctioned teams for raising money in what they then deemed to be “security” type deals. If the authorities deem a token to be a security token, the issuer must comply with the rigorous measures that apply to traditional assets in this category. The United States Securities and Exchange Commission (SEC) has also provided information on this qualification and its consequences.
In general, regulatory development is rather slow in the blockchain ecosystem, with technology evolving faster than the cumbersome legal system. Still, many government entities have discussed establishing a more transparent framework for blockchain technology and cryptocurrencies.
Although many blockchain enthusiasts are wary of possible government overbidding (which could hamper its development), most recognize the need to protect investors. Unlike traditional financial courses, the ability for anyone around the world to participate in these financings presents significant challenges.
What are the risks of ICOs?
The prospect of a new token offering huge returns is attractive. But not all currencies are equal. As with any crypto investment, there is no guarantee that you will achieve a positive return on investment (ROI).
It is difficult to determine whether a project is viable as there are many factors to take into account. Potential investors should exercise due diligence and conduct thorough research on the tokens they are considering purchasing. This process must include a fundamental analysis of the project. Below you will find a non-exhaustive list of questions to ask yourself:
Is the concept viable? What problems is the project trying to solve?
How is the supply distributed?
Does the project really need a blockchain or a token?
Is the team reputable? Do they have the necessary skills to bring the project to life and ensure its sustainability?
Obviously, never invest more than you can afford to lose. The cryptocurrency market is a very volatile market, which can cause you to gain or lose a lot of money.
To conclude
Initial Token Offerings have proven to be extremely effective in enabling early-stage projects to obtain funding. Following the success of the Ethereum ICO in 2014, many organizations were able to obtain capital to develop new protocols and ecosystems.
However, buyers need to be aware of what they are investing in. There is no guaranteed return. Since the cryptocurrency industry is in its infancy, these investments are very risky, and there is little protection if the project fails to deliver a viable product.
