What is an ICO?
An initial coin offering, or ICO, is a means by which many teams raise funds for projects in the cryptocurrency space. In an ICO, the team generates tokens based on the blockchain and sells them to early backers. During this crowdfunding phase, users receive spendable tokens (either immediately or in the future), while the project receives development funds.
The practice was first used to fund the development of Ethereum in 2014 and has since become highly sought after. Hundreds of companies have adopted this approach (especially at its peak in 2017), with varying degrees of success. An initial coin offering (ICO) sounds a bit like an initial public offering (IPO), but they are actually two very different ways to raise capital.
IPO is often suitable for mature companies, who achieve the purpose of raising funds by selling part of the company's equity shares. In contrast, ICO is more like a fundraising mechanism that allows major companies to raise funds for early-stage projects. When an ICO investor purchases tokens, they do not purchase ownership of the business.
For technology startups, ICOs can be a viable alternative to traditional fundraising methods. Typically, new entrants face considerable funding hurdles if they have not yet launched any functional product. In the field of blockchain, mature companies rarely invest in projects based on the advantages of white papers. Additionally, the lack of regulation of blockchain results in many investors barely considering blockchain startups.
But startups aren’t the only ones using this approach. Certain established companies occasionally choose to issue reverse ICOs, which function very similarly to regular ICOs. In this case, the business has launched a product or service and will issue tokens to decentralize its ecosystem. They may also hold an ICO to attract more investors and raise funds for new blockchain projects.
ICO and IEO (Initial Exchange Offering)
Initial coin offerings share many similarities with initial trading platform offerings. The key difference is that the IEO is not hosted directly by the project team, but is conducted on a cryptocurrency trading platform.
The trading platform has established cooperation with the team so that users of the platform can purchase tokens directly on the platform. All parties involved can benefit. If a reputable trading platform supports IEO, it means that the project has been strictly audited and can often meet user expectations. The team behind the IEO can increase exposure, while the trading platform can achieve project success, which is the best of both worlds.
ICO and STO (Security Token Offering)
Security token offerings were once dubbed the “new ICO.” Since both create and distribute tokens in the same way, there is no difference from a technical perspective. But from a legal perspective, the status of the two is completely different.
Due to the ambiguity of some laws, there is no consensus on how regulators should define the qualifications of an ICO (discussed in detail below). As a result, there are still no strong regulations in place for the industry.
Therefore, some businesses decide to adopt an STO and offer shares in the form of tokens. In addition, this helps them avoid uncertainty. The issuer registers the securities it offers with the relevant government agencies, giving them the same treatment as traditional securities.
How does an ICO work?
ICOs come in many forms. Sometimes, the team responsible for hosting the ICO creates a functional blockchain that they continue to develop over the coming months or even years. In this case, users can buy tokens, which will be sent to the user’s on-chain address.
However, if the blockchain has not yet been officially launched, the tokens will be issued on a mature blockchain such as Ethereum. Once the new chain comes online, holders can exchange their original tokens for newly issued tokens on the chain.
However, the most common approach is to issue tokens on a smart contract type chain. Again, these operations are mainly done on Ethereum. Today, many applications are following the ERC-20 token standard. Although not all tokens originate from ICOs, it is estimated that there are more than 200,000 Ethereum token types to date.
In addition to Ethereum, Waves, NEO, NEM, Stellar, etc. are all popular blockchains. Given the high degree of flexibility of these protocols, many organizations are not prepared to migrate directly and instead choose to build on their existing foundations. In this way, they benefit from the network effects of a mature ecosystem while providing their developers with a rich set of proven tools.
ICOs are often announced in advance and have relevant operating rules. These may include an upcoming timeframe, implementation of a hard cap on the number of tokens to be sold, or both. At the same time, a whitelist may be launched and participants must register in advance.
The user then simply sends the funds to the specified address. Generally speaking, Bitcoin and Ethereum are popular coins, and buyers are extremely receptive to them. Buyers can receive tokens in two ways: by providing a new receiving address, or by having tokens automatically sent to the payment address.
Who has the authority to launch an ICO?
Although the technology for creating and distributing tokens is already widely used by the public. But in practice, there are many legal factors to consider before holding an ICO.
After all, the cryptocurrency space currently lacks regulatory guidelines, and some key questions remain to be answered. In particular, some countries/regions explicitly prohibit the launch of ICOs, and even the most cryptocurrency-friendly jurisdictions have yet to establish clear regulations. Therefore, you must understand the laws of your country before considering launching an ICO.
What regulations apply to ICOs?
In fact, it’s difficult to give a one-size-fits-all answer because there are so many variables to consider. Furthermore, regulations vary from jurisdiction to jurisdiction and each project may have nuances, so any number of factors may influence how a government entity views an ICO.
It should be noted that although there is a lack of regulation in some areas, this is not a free pass for crowdfunding projects through ICOs. Therefore, if you need to choose this form of crowdfunding, be sure to seek professional legal advice.
It is not uncommon for some teams to raise funds through improper means, and even though this method was later classified as a securities offering, they were still sanctioned by regulatory agencies. If authorities rule that a token is a security, the issuer must comply with strict measures applicable to that type of traditional asset. Here, the U.S. Securities and Exchange Commission (SEC) offers great insight.
In general, regulatory development in the blockchain field is indeed quite slow, and the development of related technologies in particular seems to be racing ahead at a rapid pace, far outpacing the slow-turning wheels of the legal system. Despite this, most government entities have never stopped discussing the issues and are committed to implementing a more transparent framework for blockchain technology and cryptocurrencies.
While many blockchain enthusiasts worry that governments may overly intervene in the space (potentially hindering development), most agree on the need to provide investors with protections. After all, blockchain is different from traditional financial categories because anyone from around the world can participate, which inevitably brings some significant challenges.
What are the risks of ICO?
Going forward, new tokens may offer high returns, which is extremely attractive. However, the value of various tokens is not equal. There is no guarantee of a positive return on investment (ROI) regardless of cryptocurrency investment.
The process of determining a project's feasibility is often difficult and lengthy due to the large number of factors that need to be evaluated. Potential investors should conduct due diligence and conduct thorough research on the tokens they are considering purchasing. The process should include conducting a thorough fundamental analysis. The following list includes some of the questions but is not exhaustive:
Is the concept feasible? What problems can be solved?
How is supply allocated?
Are blockchain/tokens a necessary prerequisite to start a project? Or is it optional?
Is the team in good standing? Do they have the skills to bring the project to life?
The most important rule is that investment intensity should be consistent with the level of risk that can be tolerated. Because the cryptocurrency market is highly volatile, there is a significant risk that the value of your tokens may plummet.
Summarize
Initial coin offerings are a good way for investors to raise funds for early-stage projects, and their fundraising efficiency is extremely high. Following the success of Ethereum’s ICO in 2014, many organizations used this method to raise significant amounts of capital to develop new protocols and ecosystems.
However, buyers should be aware of what they are investing in. Investments may not necessarily pay off. Given the late start to the cryptocurrency space, this type of investment is extremely risky. If the investment project cannot provide a viable product, there is almost no way to protect the rights and interests of investors.
