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Initial Coin Offering (ICO)
What Is an Initial Coin Offering (ICO)?
An Initial Coin Offering (ICO) is the cryptocurrency industry’s equivalent to an Initial Public Offering (IPO). ICOs act as a way to raise funds, where a company looking to raise money to create a new coin, app, or service launches an ICO. Interested investors can buy into the offering and receive a new cryptocurrency token issued by the company. This token may have some utility in using the product or service the company is offering, or it may just represent a stake in the company or project.
- Initial Coin Offerings (ICOs) are a popular fundraising method used primarily by startups wishing to offer products and services, usually related to the cryptocurrency and blockchain space.
- ICOs are similar to stocks, but they sometimes have utility for a software service or product offered.
- Some ICOs have yielded massive returns for investors. Numerous others have turned out to be fraud or have failed or performed poorly.
- To participate in an ICO, you will usually need to purchase a digital currency first and have a basic understanding of how to use cryptocurrency wallets and exchanges.
- ICOs are, for the most part, completely unregulated, so investors must exercise a high degree of caution and diligence when researching and investing in ICOs.
How an Initial Coin Offering (ICO) Works
When a cryptocurrency startup wants to raise money through ICO, it usually creates a whitepaper which outlines what the project is about, the need the project will fulfill upon completion, how much money is needed, how many of the virtual tokens the founders will keep, what type of money will be accepted, and how long the ICO campaign will run for.
During the ICO campaign, enthusiasts and supporters of the project buy some of the project’s tokens with fiat or digital currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an IPO. If the money raised does not meet the minimum funds required by the firm, the money may be returned to the backers and the ICO is deemed unsuccessful. If the funding requirements are met within the specified timeframe, the money raised is used to pursue the goals of the project.
Although ICOs aren’t regulated, the Securities and Exchange Commission (SEC) can intervene. For example, the maker of Telegram raised $1.7 billion in an ICO last year, but the SEC is now attempting to halt the project due to alleged illegal activity on the part of the development team.
Investors looking to buy into ICOs should first familiarize themselves with the cryptocurrency space more broadly. In the case of most ICOs, investors must purchase tokens with pre-existing cryptocurrencies. This means that an ICO investor will need to already have a cryptocurrency wallet set up for a currency like Bitcoin or Ethereum, as well as having a wallet capable of holding whichever token or currency they want to purchase.
How does one go about finding ICOs in which to participate? There is no recipe for staying abreast of the latest ICOs. The best thing that an interested investor can do is read up about new projects online. ICOs generate a substantial amount of hype, and there are numerous places online in which investors gather to discuss new opportunities. There are dedicated sites that aggregate ICOs, allowing investors to discover new ICOs and compare different offerings against one another.
Initial Coin Offering (ICO) vs. Initial Public Offering (IPO)
For traditional companies, there are a few ways of going about raising the funds necessary for development and expansion. A company can start small and grow as its profits allow, remaining beholden only to company owners but having to wait for funds to build up. Alternately, companies can look to outside investors for early support, providing them a quick influx of cash but typically coming with the trade-off of giving away a portion of ownership stake. Another method is to go public, earning funds from individual investors by selling shares through an IPO.
While IPOs deal purely with investors, ICOs may deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of ICOs are motivated by a prospective return on their investments, while the funds raised in crowdfunding campaigns are basically donations. For these reasons, ICOs are referred to as “crowdsales.”
ICOs also retain at least two important structural differences from IPOs. First, ICOs are largely unregulated, meaning that government organizations like the Securities and Exchange Commission (SEC) do not oversee them. Secondly, due to their decentralization and lack of regulation, ICOs are much freer in terms of structure than IPOs.
ICOs can be structured in a variety of ways. In some cases, a company sets a specific goal or limit for its funding, which means that each token sold in the ICO has a pre-set price and that the total token supply is static. In other cases, there is a static supply of ICO tokens but a dynamic funding goal, which means that the distribution of tokens to investors will be dependent upon the funds received (i.e. the more total funds received in the ICO, the higher the overall token price).
Still, others have a dynamic token supply which is determined according to the amount of funding received. In these cases, the price of a token is static, but there is no limit to the number of total tokens, save for parameters like ICO length. These different types of ICOs are illustrated below.
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Advantages and Disadvantages of Initial Coin Offerings (ICO)
In an IPO, an investor receives shares of stock in a company in exchange for her investment. In the case of an ICO, there are no shares per se. Instead, companies raising funds via ICO provide a blockchain equivalent to a share—a cryptocurrency token. In most cases, investors pay in a popular existing token like bitcoin or ether and receive a commensurate number of new tokens in exchange.
It’s worth noting just how easy it is for a company launching an ICO to create these tokens. There are online services that allow for the generation of cryptocurrency tokens in a matter of seconds. Investors should keep this in mind when considering the differences between shares and tokens—a token does not have any intrinsic value or legal guarantees. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute them according to their plan by transferring them to individual investors.
Early investors in an ICO operation are usually motivated to buy tokens in the hope that the plan will succeed after it launches. If this actually happens, the value of the tokens they purchased during the ICO will climb above the price set during the ICO itself, and they will achieve overall gains. This is the primary benefit of an ICO: the potential for very high returns.
ICOs have indeed made many investors into millionaires. Take a look at the figures for 2020: That year, there were 435 successful ICOs, each raising an average of $12.7 million. the total amount raised for 2020 was $5.6 billion, with the 10 largest projects raising 25% of this total. Furthermore, tokens purchased in ICOs returned an average of 12.8x on the initial investment in dollar terms.
As ICOs have come to the forefront in the cryptocurrency and blockchain industries, they’ve also brought along challenges, risks, and unforeseen opportunities. Many investors buy into ICOs in the hopes of quick and powerful returns on their investments. The most successful ICOs over the past several years is the source of this hope, as they have indeed produced tremendous returns. This investor enthusiasm can also lead people astray, however.
Because they are largely unregulated, ICOs are rife with fraud and scam artists looking to prey on overzealous and poorly informed investors. And since they are not regulated by financial authorities like the SEC, funds that are lost due to fraud or incompetence may never be recovered.
The meteoric rise of ICOs during 2020 drew backlashes from a series of governmental and non-governmental entities in early Sept. 2020. The People’s Bank of China officially banned ICOs, slamming them as counterproductive to economic and financial stability.
The Chinese central bank prohibited using tokens as currency and banned banks from offering services related to ICOs. As a result, both Bitcoin and Ethereum prices tumbled, in what many regarded as a sign of more cryptocurrency regulation to come. The ban also penalized already completed offerings. In early 2020, Facebook, Twitter, and Google all banned ICO advertisements.
There is no guarantee that an investor won’t be on the losing end of a scam when investing in ICOs. To help avoid ICO scams, investors should:
- Make sure that project developers can clearly define what their goals are. Successful ICOs typically have straightforward, understandable whitepapers with clear, concise goals.
- Know the developers. Investors should strive for 100% transparency from a company launching an ICO.
- Look for legal terms and conditions set for the ICO. Because outside regulators generally do not oversee this space, it is up to an investor to ensure any ICO is legitimate.
- Make sure that ICO funds are being stored in an escrow wallet. This is a wallet that requires multiple keys in order to be accessed. This is useful protection against scams, particularly when a neutral third party is a holder of one of the keys.
Example of an Initial Coin Offering (ICO)
As the ICO space gets bigger and bigger, so too do the sums raised by the largest projects. When evaluating ICOs, one can consider both the amount of money raised in the ICO as well as the return on investment. Sometimes ICOs with a remarkable return on investment are not the projects that raise the most money and vice versa. Ethereum’s ICO in 2020 was an early pioneer, raising $18 million over a period of 42 days. Ethereum has proven to be crucial for the ICO space in general, thanks to its innovations with regard to decentralized apps (dApps). When it debuted, ether was priced at around $0.30, and as of Nov. 4, 2020, it trades at $185.
In 2020, a two-phase ICO began for a company calledAntshares, which later rebranded as NEO. The first phase of the ICO ended in Oct. 2020, and the second continued until Sept. 2020. During this time, NEO earned about $4.5 million. While it is not one of the largest ICOs in terms of money raised, it has provided exceptional ROI for many early investors. The price of NEO at the time of the ICO was about $0.03, and at its peak, it traded at roughly $10.74.
More recently, ICOs have generated significantly larger amounts in terms of total funds raised. The largest ICO by this metric is Filecoin, a decentralized cloud storage project. During a one-month ICO ending in Sept. 2020, Filecoin managed to raise about $257 million. More recently, the company behind the EOS platform shattered Filecoin’s record by raising a whopping $4 billion.
What Is an ICO?
An ICO Brings New Cryptocurrencies to Market but Is Risky
If there’s been one word on the lips of everyone in finance this past year, it’s cryptocurrency. If you’ve been kicking yourself for not getting in on the ground floor of blockbuster coins like Bitcoin and Ethereum, you might want to consider looking into investing in an initial coin offering (ICO). Be warned, however: ICOs are highly risky even under the best of circumstances and have a high potential for scams.
So What Exactly Is an ICO, Anyway?
Imagine this: You’re a Silicon Valley startup with a great idea for a new cryptocurrency system. Perhaps you want to streamline the Parent/Babysitter payment system so that it can be digital and encrypted. What a great idea! Let’s call it BabyCoin. The only problem is you need people to give you money so you can actually make the currency. Now, you could go to a bank or try getting venture capitalist investors, but what if you could raise money without having to give up any of your ownership of the company? Enter ICO.
Here’s how it works. You create a document essentially detailing exactly how the system would work (usually called a white paper), make a pretty website, and explain why it’s a great idea that could be very useful. Then, you ask for people to send you money (usually Bitcoin or Ether, but you can also take fiat) and in return, you send them back some BabyCoin. They hope that BabyCoin will get used a lot and be in high circulation, which would raise the value of the currency.
It’s important to note that, unlike an initial public offering (IPO), investing in an ICO won’t result in you having an ownership stake of the company you’re giving money to. You’re gambling that the currently worthless currency you pay for now will increase in worth later and make you money.
So Who Can Launch an ICO?
Literally anyone! Currently, there’s very little regulation on ICOs in America, meaning as long as you can get the tech set up you’re free to try and get your currency funded. Right now cryptocurrency as a whole is kind of like the wild west; there’s gold in the hills and relatively little law to speak of. This can work in your favor or it can lead to getting swindled. Of all avenues of funding, an ICO is probably one of the easiest to set up as a scam. Since there’s no regulation there’s nothing stopping someone from doing all the work to make you believe they have a great idea, and then absconding with the money.
This means that if you’re really set on getting in on that new ICO that your friend Aiden from work told you about, make sure you do your homework. The first thing to do is make sure that the people putting up the ICO are real and accountable. In the internet age it’s beyond easy to find a stock photo and put together a convincing website, so going the extra mile is important. Some things to look for: What history do the product’s leads have with crypto or blockchain? If it looks like they don’t have anyone with relevant experience that can be easily verified, that’s a bad sign.
- Entrepreneurs looking to launch a new cryptocurrency can do it through an initial coin offering (ICO), a variation on an initial public offering (IPO).
- There is little to no government regulation of ICOs currently, and anyone can launch one, provided they get the technology put in place.
- How? Create a white paper or other document outlining the system, make a website or app describing how it works, and seek funding.
- Advertising is key since there are so many competing coins on the market, so figuring out how to appeal to the target demo is crucial.
- Not looking to launch a new coin, but rather, to invest in a new coin? Make sure to do thorough research, as there are a number of scams.
How Do I Start My Own ICO?
The most important thing you want to do is make sure that either you or someone (probably multiple people) involved have worked in and understand cryptocurrency and blockchain. Even if anyone can make an ICO, it doesn’t mean that everyone should. You need to be able to answer questions on the spot about every little detail pertaining to your ICO.
You should also ask yourself if you really think that your business will actively benefit from an ICO. Basically, after reading this article, you should consult someone who can take a look at your specific idea and tell you if it is a slam dunk or not. If it’s not, you might be better off going through safer avenues of funding.
If you’re determined to move forward, you need a white paper, which is a document that should identify exactly what your currency can offer that has never been done before, or how you’ll make an established idea better than anyone else has. This document should be engaging, informative, and very, very detailed, like the white paper for Ethereum, one of the most successful ICOs yet.
Like any business, you need to hook your buyer by the end of the first page. Ethereum’s white paper takes the time to explain what blockchain is, and then goes on to detail how they intend to build on the progress that Satoshi Nakamoto made and create something exciting. They do all of this by the end of the first page. Now, does every single white paper need to include an unabridged history of blockchain including the time that guy paid 10,000 bitcoins for a pizza? Probably not, but it should be understandable to someone without any knowledge of how these systems work.
An ICO is barely regulated, particularly in comparison to an IPO for a stock, so do your due diligence before you jump in to invest.
Marketing Your ICO
Now that you’ve got your white paper, you need to advertise. You have two targets that you’ll be trying to reach: people with knowledge of how cryptocurrency and ICOs work and people with basically no idea. You’ll want to identify the people that would be most excited by your new venture since they’ll be more eager to give you money if it means a deal for them. In the case of BabyCoin (again, hypothetical) maybe we’d reach out to some popular mommy bloggers/vloggers and see if they would be interested in producing some content to showcase why BabyCoin is the biggest innovation in babysitting since The Babysitter’s Club. Just make sure they disclose the nature of the deal to advertise for you: the SEC released a warning to investors stating that it is illegal for celebrities to use social media to endorse ICOs without disclosing what compensation they received.
You’re also going to want to make your programmers and leads available to answer questions on social media like Reddit and Twitter. You should also consider submitting your ICO to some listings that run databases of what they perceive to be quality ICOs. This is how you get people involved in the crypto-community excited about your product, which will hopefully trickle through the internet.
Great! So the word is out about BabyCoin and people are psyched, all that’s left to do is determine the token pricing and distribution. You also might want to have a prototype in order just to prove you know what you’re doing. Get your website and exchange set up and good luck!
What’s With All These Celebrity ICOs?
If you’ve seen your favorite actors and entertainers like Jamie Fox and Ghostface Killah encouraging their followers to invest in a hot new ICO, you might want to take a closer look.
Boxing superstar Floyd Mayweather, Jr., and DJ Khaled promoted Centra, an ICO that raised $30 million at the end of 2020, but multiple reports claim that Centra is currently embroiled in a class action lawsuit for allegedly selling unregistered securities. It remains to be seen what will happen with the lawsuit, but it’s worth noting that some of Khaled’s and Mayweather’s social media posts about the ICO have been deleted.
How Do I Determine Which ICOs Are Good?
Just make sure to do your homework. Because ICOs are barely regulated, you need to be way more careful than you’d be when investing in an IPO. Read the white paper, research the team members, and make sure they have a history in cryptocurrency.
You can also use trusted websites like Coinschedule.com, which only chooses ICOs that they have reviewed and consider to be legit and exciting. While you shouldn’t fully trust any website offering a listing, they can be quite useful.
The most recent count of how many cryptocurrencies exist, with more being added all the time; roughly 1,500 or so are available through exchanges.
Is Someone Going to Regulate ICOs?
The SEC classified tokens from ICOs as securities in December of 2020, with SEC Chairman Jay Clayton saying at the time that they had proved that “a token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”
This means the SEC is gearing up to crack down on ICOs that they deem to be misleading investors. The first strike came on December 11, 2020, when the SEC halted Munchee, a California company with a food review app. Munchee was attempting to raise money to create a cryptocurrency that would work within the app to order food. This is the first instance of the SEC issuing a cease and desist for an ICO for unregistered securities. Does this mean the hammer is about to drop? We’ll see.
The Bottom Line
In the end, ICOs are an incredibly new way of raising money, and everyone is trying to adapt to the new ways without getting screwed over. If you think you’re able to make a killing on a promising new ICO, just make sure to do your homework beforehand. Cryptocurrency is all about high risk and high reward, and ICOs are no different.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date, this article was written, the author owns no cryptocurrency in any quantity.
Spotlight on Initial Coin Offerings (ICOs)
Companies and individuals are increasingly considering initial coin offerings (ICOs) as a way to raise capital or participate in investment opportunities. While these digital assets and the technology behind them may present a new and efficient means for carrying out financial transactions, they also bring increased risk of fraud and manipulation because the markets for these assets are less regulated than traditional capital markets.
[+] ICOs can be securities offerings.
ICOs, based on specific facts, may be securities offerings, and fall under the SEC’s jurisdiction of enforcing federal securities laws.
[+] They may need to be registered.
ICOs that are securities most likely need to be registered with the SEC or fall under an exemption to registration.
[+] Tokens sold in ICOs can be called many things.
ICOs, or more specifically tokens, can be called a variety of names, but merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.
[+] ICOs may pose substantial risks.
While some ICOs may be attempts at honest investment opportunities, many may be frauds, separating you from your hard-earned money with promises of guaranteed returns and future fortunes. They may also present substantial risks for loss or manipulation, including through hacking, with little recourse for victims after-the-fact.
[+] Ask questions before investing.
If you choose to invest in these products, please ask questions and demand clear answers.
What investors need to know
So, what do you need to know about ICOs before investing? Start with some basic research on Investor.gov and take note of the following:
[+] Products can be sold and traded internationally.
Recognize that these products are often sold on markets that span national borders and that significant trading may occur on systems and platforms outside the United States. Your invested funds may quickly travel overseas without your knowledge. Although the SEC actively enforces securities laws, risks can be amplified, including the risk that market regulators may not be able to effectively pursue bad actors or recover funds.
[+] Research your financial professional.
Understand the opportunity that is being presented, and do your homework on the individual who is doing the presenting. Is the offering legal and is the person offering this product licensed to do so? Make sure you visit investor.gov for more resources before you invest. Arm yourself with knowledge from this Investor Bulletin.
[+] If an investment sounds too good to be true, be cautious.
As with any other type of potential investment, if a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost.
[+] Understand how the product is traded.
Many platforms for trading digital assets refer to themselves as “exchanges,” which can give the misimpression to investors that they are regulated or meet the regulatory standards of a national securities exchange.
What market professionals need to know
As SEC Chairman Jay Clayton has stated, tokens and offerings that feature and market the potential for profits based on the entrepreneurial or managerial efforts of others contain the hallmarks of a security under U.S. law.
[+] Use caution before promoting offers and selling coins.
Market participants should use caution when promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions. Similarly, those who operate systems and platforms that effect or facilitate transactions in these products should be aware that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.
[+] The SEC protects Investors, and expects you to.
Gatekeepers and others, including securities lawyers, accountants and consultants, should be guided by the principal motivation for the SEC’s registration, offering process and disclosure requirements: Investor protection and, in particular, the protection of Main Street investors.
[+] SEC Report of Investigation on Coin or Token Offerings.
Market professionals, including securities lawyers, accountants and consultants, are encouraged to read closely the 21(a) investigative report the SEC released in 2020, concluding that a particular token was a security.
[+] Know when an exchange needs to be registered.
If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.
What is An Initial Coin Offering? Raising Millions In Seconds
Initial Coin Offering (ICO) is the cryptocurrency’s world public crowdsale. Whenever a project wants to launch a new coin or dApp, they can conduct an ICO to attract investors into their ecosystem.
The most alluring part of ICOs is the lack of red tape and formality. More often than not, a company simply has to submit a whitepaper to qualify for an ICO. Companies have been able to raise millions of dollars in mere seconds, thanks to ICOs.
In fact, the amount of money that ICOs have raised over the last two years is truly astonishing. In 2020, ICOs raised a total of $5.6 billion. If that sounds shocking to you then think about this.
ICOs have already raised $6.3 billion, 4.5 months into 2020 alone!
After seeing all these stats, it makes sense as to why more and more people are getting intrigued with ICOs. Our guide gives an overview on Initial Coin Offering- ICO and presents the hottest past, current, and future ICOs.
What is An Initial Coin Offering?
ICOs are basically blockchain crowdsales, the cryptocurrency version of crowdfunding. The ICOs have been truly revolutionary and have managed to accomplish many amazing tasks:
- They have provided the simplest path by which DAPP developers can get the required funding for their project.
- Anyone can become invested in a project they are interested in by purchasing the tokens of that particular DAPP and become a part of the project themselves.
It was in July 2020 when ICOs well and truly came into the public’s attention. That was when the ICO Ethereum raised $18.4 million and ushered in a new age of ICOs.
Since 2020 ICOs are often used to fund the development of new cryptocurrencies. The pre-created token can be easily sold and traded on all cryptocurrency exchanges if there is demand for them.
With the success of Ethereum, ICOs have become the de-facto method of funding the development of a crypto project by releasing a token which is somehow integrated into the project.
Short History of Initial Coin Offering
Maybe the first cryptocurrency distributed by an ICO was Ripple. In early 2020 Ripple Labs started to develop the Ripple called payment system and created around 100 billion XRP token. The company sold these token to fund the development of the Ripple platform.
Later in 2020, Mastercoin promised to create a layer on top of Bitcoin to execute smart contracts and tokenize Bitcoin transactions. The developer sold some million Mastercoin token against Bitcoin and received around $1mio.
Several other cryptocurrencies have been funded with ICO, for example, Lisk, which sold its coins for around $5mio in early 2020. Most prominent however is Ethereum. In mid-2020 the Ethereum Foundation sold ETH against 0.0005 Bitcoin each. With this, they receive nearly $20mio, which has become one of the largest crowdfunding ever and serves as the capital base for the development of Ethereum.
As Ethereum itself unleashed the power of smart contracts, it opened the door for a new generation of Initial Coin Offering.
Ethereum – The Initial Coin Offering? ICO Crowdfunding Machine
One of the easiest application of Ethereum’s smart contract system is to create a simple token which can be transacted on the Ethereum blockchain instead of Ether. This kind of contract was standardized with ERC#20. It made Ethereum host of such a wide scope of ICO that you can safely say that Ethereum found its Killer App as a distributed platform for crowdfunding and fundraising.
The most prominent demonstration of the potential of Ethereum’s smart contracts has been The DAO. The distributed investment company was fuelled with Ether worth $100m. The investors received in exchange against Ether Dao Token which had their own market price and enabled the holder to participate in the governance of the DAO. After it was hacked, the DAO however failed.
The concept of funding projects with a token on Ethereum became the blueprint for a new and highly successful generation of crowdfunding projects. If you already tried out, you know that investing in token on top of Ethereum is charmingly easy: You transfer ETH, paste the contract in your wallet – and, tata: The token appear in your account and you are free to transfer them as you want.
Before we go any further, let’s understand what tokens mean.
Tokens = ICO Cryptocurrency?
The word “token” gets thrown around a lot, however, more often than not, people simply don’t know what it means. To be honest, it can be extremely difficult to pinpoint an exact definition. Let’s at least start with a very broad definition:
A token is a representation of something in its particular ecosystem. It could value, stake, voting right, or anything. A token is not limited to one particular role; it can fulfill a lot of roles in its native ecosystem
Having said that, there is a difference between cryptocurrency coin and token. Coins like Ethereum, Bitcoin, and Bitcoin Cash are examples of cryptocurrency coin, since they have value outside their native environment.
However, projects like OmiseGO and Golem are tokens because they exist on top of an existing smart contract platform, like Ethereum.
According to the U.S. Securities and Exchange Commission (SEC) there are two kinds of tokens out there:
- Security Tokens
- Utility Tokens
A crypto token that passes the Howey Test is deemed a security token. For a token to pass the Howey Test, it must fulfill the following conditions:
- Is it an investment of money?
- Is the investment in a common enterprise?
- Is there an expectation of profit from the work of the promoters or the third party?
Note: “Common Enterprise” is still open to interpretation. However, the majority of the federal courts define it as a horizontal enterprise where investors pool in their
Since most ICOs are investment opportunities in the company itself, the tokens classify as security. Security tokens are subject to federal securities and regulations since they derive their value from external, tradable assets.
On the other hand, if the token doesn’t pass the Howey test, then it classifies as a utility token. These tokens simply provide users with a product and/or service. Think of them like gateway tokens which can:
- Give holders a right to use the network
- Give holders a right to take advantage of the network by voting
So, now we know what an ICO is and what tokens are. Let’s actually look into the mechanism of how an ICO works.
How Does the ICO Crowdsale Work?
Smart Contract platforms like Ethereum and Neo allow developers to create their Dapps on them. Think of them like a decentralized supercomputer and the Dapps as the applications that one can execute inside.
In order to gain funding for the project, the developer issues a limited amount of tokens (could be utility or security). It is important that the tokens have a limited amount because:
- It makes sure that the ICO has a goal to aim for
- As the demand rises and the supply of token diminishes, it makes sure that the value of the tokens will go up. The tokens have a predetermined price which may go up or down depending on the demand.
ICO trading is pretty simple and straightforward. If you want to buy some tokens, then you send some cryptocurrency (Ether if the platform is Ethereum) to the crowd-sale address. The moment you do that, you get the corresponding amount of tokens sent to your wallet.
Obviously, this is just a general overview. There is a lot of marketing that goes on leading up to the date of the ICO. In fact, paid advertising used to be so rampant that social media giants like Facebook and Twitter had to ban ICO-related ads on their platforms.
Pros and Cons of ICO Explained
- Most importantly, ICOs give promising projects an opportunity to shine. The prime example of this has to be Ethereum. Look at what it has achieved over the last 3 years. Not only has it become a part of our zeitgeist, they have provided an ideal platform for other projects to develop on top of them.
- Many projects in the “centralized world” never get to do their IPOs (Initial Public Offerings) because of the sheer amount of unnecessary paperwork involved. However, blockchain projects can simply take part in an ICO by presenting a good quality ICO whitepaper.
What is ICO whitepaper you ask?
It is a concisely written piece of documentation which presents the problem that the project is aiming to solve and the method that they will be following in order to solve it. Upon reading the white paper, the potential investors can choose to invest or not in the project.
- Another brilliant thing that an ICO manages to do is to establish a rapport between the project and their community. Any ICO creator worth their salt will tell you how critical it is for them to develop a healthy community.
Quantstamp is a perfect example of this. They were able to raise all their ICO money organically because of their healthy relationship with their community.
- The fact that blockchain crowdfunding was able to collect $6.8 billion in 4.5 months just goes to show how much hype and demand there is behind these projects. Such kind of exposure will do wonders for them.
- In a similar vein, ICO funding provides a huge incentive for developers to go the extra step and come up with more exciting and innovative projects.
- For investors, ICOs provide an opportunity for them to invest and discover the “next big thing.” Let’s give you the perfect example, Ethereum. During the ICO, 1 Ether was trading for 40-50 cents. As of right now, they are trading for $477 each.
- Remember how we told you earlier that one of the biggest pros of ICOs is the lack of paperwork involved? Unfortunately, it is a double-edged sword. Loads of scammers have entered this space hoping to make a quick buck.
They simply create a bogus white paper or omit some of the more important details off their whitepaper to make their projects seem more important and intricate than what they actually are.
- When you are investing in a project’s ICO you are not actually investing in the project, you are investing in the idea of the project. As such, it works on pure speculation which is based on the quality of the white paper and the credibility of the team. So, you simply have no idea whether the project is actually going to be a success or not when you invest.
This is where certain cold-hard facts should be considered. 90% of the startups fails. Either the product doesn’t work or the developers get lazy. Also, as the DAO attack has shown us, even if everything is in place, a slight mistake in the code could be enough to send a project crashing down.
- During the ICO sale, the presence of “crypto whales” could be problematic. The most infamous example of this is the BAT ICO . The ICO was able to raise a staggering $35 million in 24 seconds! It turned out that majority of the tokens were owned by certain individuals, which simply defeats the purpose of decentralization.
These individuals are called “crypto whales” or simply “whales.” These individuals use their significant financial clout to pay exorbitantly high transaction fees to “cut in line” of the waiting queue. During the BAT ICO whales paid as much as $2220 in transaction fees!
- An ICO is an extremely laborious event for the blockchain, at least the way it is designed right now. The fact remains that blockchains are simply not scalable enough to take up heavy duty activity.
The $100 million Status ICO clogged up the Ethereum blockchain so badly that a lot of people simply weren’t able to participate because their transactions didn’t come through.
This can work in reverse as well.
The SophiaTX ICO had to postpone its date because the Cryptokitties game had clogged up and slowed down everything in the Ethereum blockchain.
- Ethereum based ICO tokens are easy to store because they can be stored in any Ethereum wallet. However, things get tricky when it comes to other platforms. More often than not, these tokens may not be compatible with your wallet and storing them may be an extremely tiring and annoying exercise.
- Also, as you may already be aware of, ICOs are increasingly coming under the radar of regulatory bodies like SEC and CFTC. They have already made their presence known by making it compulsory for US-based ICOs to declare whether their tokens are securities or not.
- Finally, the next step to increased regulation is government intervention. Because of the vast amount of unregulated money that ICOs are dealing with, the government may consider them unsafe and simply ban them in their countries. China and India are ideal examples of this.
Legality of ICOs
The legal state of ICO is mostly undefined. Ideally, the token is sold not as a financial asset but as a digital good like many other things. This is why ICO is often called “crowd sale”. In this case, in the most jurisdiction, the funding with an ICO is not regulated, which makes it extremely easy and paperless, given a lawyer experienced with the issue is on board.
Having said that, ICOs have increasingly come under the scrutiny of regulatory bodies like the SEC and the CFTC because of the fact that most of the ICOs are securities. This gained a lot of traction when the SEC declared the Dao ICO as security.
Ash Bennington from Coindesk, breaks down why the Dao was deemed a security in the form of a tale:
“Not so long ago, a group of developers started a DAO.
The DAO developers said:
“There are all these decentralized projects and there’s no way for them to get funding – because they need money to make money.”
Tell you what. We’re going to write code and sell a token and, in exchange, people who buy the token will get whatever profits are made from those projects.
We’ll work the code. They’ll pick the projects. The projects will flourish and everyone will profit.
The SEC said: “That’s a security.”
The DAO developers said: “No, no. That’s just selling tokens.”
Ultimately, the SEC said: “That’s a security” – because of the application of the Howey Test: There was an investment of money. And a common enterprise. With the expectation of profit, primarily from the efforts of others.”
So, why was this investigation and ruling done in the first place?
This is where we come to another reason as to why this space has become and will become increasingly regulated. The Dao was supposed to be the biggest ICO ever, however, a flaw in its code made it vulnerable and it imploded quite spectacularly.
We have covered this in detail before, but just to give you an overview:
- There was a flaw in the Dao smart contract
- The hacker exploited that flaw to execute a re-entrancy attack.
- Over $150 million worth of ether was siphoned away.
Because a lot of people invested and got back nothing in return, the SEC intervened to “protect” the interest of the investors and deemed the tokens a security.
As SEC CEO Jay Clayton puts it, “The SEC is studying the effects of the distributed ledger and other innovative technologies and encourages market participants to engage with us. We seek to foster innovative and beneficial ways to raise capital, while ensuring – first and foremost – that investors and our markets are protected.”
This decision was met with a mixed reception in the Crypto community:
Brad Garlinghouse, Ripple Ceo, said,
“Regulators aren’t going away – and shouldn’t. For generations, they have protected from fraud (some is happening w/ the ICO market).”
Roger Ver, Bitcoin.com founder, however, disagreed with the decision,
“Call this what it is: A bunch of strangers in a far-off land threatening peaceful people all over the world with violence if they don’t obey.”
The Hottest Initial Coin Offering of Yesterday, Today and Tomorrow
Let’s have a look what’s going on of the market for ICO. In the past years, there have been a couple of wildly successful ICO.
Ripple Labs created 100 billion XRP-token which serve as an anti-spam mechanism in the payment network Ripple, as you have to pay your network fees in XRP. The XRP are sold by Ripple Labs; their value doesn’t move in a clear direction, while the trend is more downwards. It started with around 5,000 Satoshi, sometimes felt below 1,000 Satoshi, raised above 7,000 and finally fell again to a new low of 600 Satoshi, before again raising on 3,000.
In 2020 Mastercoin announced to build a layer on top of Bitcoin and sold the Mastercoin-token to investors. The developers received around 10,000 Bitcoin, which has been worth $1mio at this time. Mastercoin token gained value some month later; some investors made huge profits. Later Mastercoin merged with Counterparty and Omni.
The largest ICO by now was made by Ethereum. With a presale of around 60mio ETH, the Ethereum Foundation raised around 31,500 Bitcoin. This event has become one of the biggest crowdfunding ever and the start of a wildly successful cryptocurrency. The investors of the ETH-presale profited massively.
The blockchain startup Block.one launched the ICO for its EOS platform in June 2020 and concluded the token sale in June 2020. Yup, you read that right, it was a year-long ICO which raised a record-breaking $4.1 billion. This is far and away the biggest ICO of all time.
EOS’s X-Factor lies in the fact that this is Dan Larimer’s latest pet project after Steemit and BitShares. EOS plans to become the platform for industrial-scale Dapps. Lately, they have faced some setbacks due to some vulnerabilities. However, EOS still has a lot of potential.
Remember that old game show “Who Wants To Be A Millionaire?” Every participant on that show had 3 lifelines, one of which was audience poll. Basically, if they were stuck on a question, they could ask the audience that question. The audience was then supposed to vote on the option that they felt (or knew) was to be correct. More often than not, the audience got it right. This phenomenon is called the “Wisdom Of The Crowd”, which states that groups of people, in general, are correct more often than individuals.
Augur is using this property to create a prediction market and raised $5.2 million in their ICO.
The company behind the popular end-to-end encrypted messaging app Telegram managed to raise $1.7 billion during a private sale involving SAFT agreements, which led to the company scrapping its public sale. Pavel Valerievich Durov aka the Zuckerberg of Russia is the CEO of Telegram.
There were two sales of $850 million each and the funding was done to develop the Telegram Open Network (TON), which will be supported by the GRAM token.
They are planning to create a scalable blockchain network which can process millions of transactions per second through the use of “infinite sharding” and “hypercube routing”.
Despite its rumored association with a Macau-based gangster and its business relationship with Cambridge Analytica, Dragon has managed to become one of the most successful ICOs in history raising a staggering $320 million. It was the first ICO that conducted to fund a floating casino in Asia’s gambling haven Macau. The Dragon Coin, DRG, is a digital currency targeted at VIP gamblers in Macau and its value is driven by the success of a large gambling venture.
Through the Dragon Coin, Dragon is aiming to help users save money by letting them convert their currency into money that they can use to gamble in Macau without going through a middleman.
Conclusion: Initial Coin Offering
ICOs have been an extremely hot topic for a couple of years now and we hope that we were able to throw some light on the subject for you. It will be interesting to see how future ICOs pan out and the regulations become more and more strict. Let’s hope that the increased regulations are going to have a positive effect by flushing out scammy ICOs.
What Is an ICO (Initial Coin Offering)?
What is an ICO?
An Initial Coin Offering (or ICO) is a method for teams to raise funds for a project in the cryptocurrency space. In an ICO, teams generate blockchain-based tokens to sell to early supporters. This serves as a crowdfunding phase – users receive tokens that they can use (either immediately or in the future), and the project receives money to fund development.
The practice was popularized in 2020 when it was used to fund the development of Ethereum. Since then, it has been adopted by hundreds of ventures (particularly during the 2020 boom), with varying degrees of success. While the name sounds similar to an Initial Public Offering (IPO), the two are fundamentally very different methods of acquiring funding.
IPOs usually apply to established businesses that sell partial ownership shares in their company as a way to raise funds. In contrast, ICOs are used as a fundraising mechanism that allows companies to raise funds for their project in very early stages. When ICO investors purchase tokens, they are not buying any ownership in the company.
ICOs can be a viable alternative to traditional funding for tech startups. Often, new entrants struggle to secure capital without an already functional product. In the blockchain space, established firms rarely invest in projects on the merits of a white paper. What’s more, a lack of cryptocurrency regulation deters many from considering blockchain startups.
The practice isn’t just used by new startups, though. Established enterprises sometimes choose to launch a reverse ICO, which is functionally very similar to a regular ICO. In this case, a business already has a product or service and issues a token to decentralize its ecosystem. Alternatively, they might host an ICO to include a broader range of investors and raise capital for a new blockchain-based product.
ICOs vs. IEOs (Initial Exchange Offerings)
Initial Coin Offerings and Initial Exchange Offerings are similar in many ways. The key difference is that an IEO is not hosted solely by the project’s team, but alongside a cryptocurrency exchange.
The exchange partners with the team to allow its users to buy tokens directly on its platform. This can be beneficial to all parties involved. When a reputable exchange supports an IEO, users can expect the project to have been rigorously audited. The team behind the IEO benefits from increased exposure, and the exchange stands to gain from the project’s success.
ICOs vs. STOs (Security Token Offerings)
Security Token Offerings were once branded the “new ICOs.” From a technological standpoint, they’re identical – tokens are created and distributed in the same manner. On the legal side, however, they’re completely different.
Due to some legal ambiguity, there is no consensus on how regulators should qualify ICOs (discussed in more detail below). As a result, the industry has yet to see any meaningful regulation.
Some companies decide to take the STO route as a way to offer equity in the form of tokens. Also, this could help them steer clear of any uncertainty. The issuer registers their offering as a securities offering with the relevant government body, which subjects them to the same treatment as traditional securities.
How does an ICO work?
An ICO can take many forms. Sometimes, the team hosting it will have a functional blockchain that they’ll continue to develop in the coming months and years. In this case, users can buy tokens that are sent to their addresses on the chain.
Alternatively, the blockchain might not have launched, in which case the tokens will be issued on an established one (such as Ethereum). Once the new chain is live, holders can swap their tokens for fresh ones issued on top of it.
The most common practice, however, is to issue tokens on a smart-contract-capable chain. Again, this is done predominantly on Ethereum – many applications use the ERC-20 token standard. Though not all originate from ICOs, it’s estimated that there are upwards of 200,000 different Ethereum tokens today.
Besides Ethereum, there are other other chains that can be used – Waves, NEO, NEM, or Stellar are some popular examples. Given how flexible these protocols are, many organizations make no plans to migrate away but instead opt to build on existing foundations. This approach allows them to tap into the network effects of an established ecosystem and gives developers access to tools that have already been tried and tested.
An ICO is announced ahead of time and specifies rules for how it will be run. It might outline a timeframe it will operate for, implement a hard cap for the number of tokens to be sold, or combine both. There might also be a whitelist that participants must sign up to beforehand.
Users then send funds to a specified address – generally, Bitcoin and Ethereum are accepted due to their popularity. Buyers either provide a new address to receive tokens, or tokens are automatically sent to the address that the payment was made from.
Who can 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 holding an ICO.
Overall, the cryptocurrency space is lacking in regulatory guidelines, and some crucial questions are yet to be answered. Some countries prohibit launching ICOs outright, but even the most crypto-friendly jurisdictions have yet to deliver clear legislation. It’s therefore imperative that you understand your own country’s laws before considering an ICO.
What are the regulations surrounding ICOs?
It’s difficult to give a one-size-fits-all answer because there are so many variables to consider. Regulations vary from jurisdiction to jurisdiction, and each project likely has its own nuances that may affect how government entities view it.
It should be noted that the absence of regulation in some places is not a free pass to crowdfund a project via an ICO. So it’s important to seek professional legal advice before choosing this form of crowdfunding.
On a number of occasions, regulators have sanctioned teams that raised funds in what they later deemed to be securities offerings. If authorities find a token to be a security, the issuer must comply with rigorous measures that apply to traditional assets in this class. On this front, the US’s Securities and Exchange Commission (SEC) has provided some good insights.
In general, the development of regulation is slow in the blockchain space, particularly as the tech outpaces the slow-turning wheels of the legal system. Still, numerous government entities have been discussing the implementation of a more transparent framework for blockchain technology and cryptocurrencies.
Though many blockchain enthusiasts are wary of possible government overreach (which might hamper development), most of them recognize the need for investor protection. Unlike traditional financial classes, the ability for anyone around the globe to participate presents some significant challenges.
What are the risks with ICOs?
The prospect of a new token granting huge returns is an appealing one. But not all coins are created equal. As with any cryptocurrency investment, there are no guarantees that you’ll have a positive return on investment (ROI).
It’s difficult to determine whether a project is viable, as there are many factors to assess. Prospective investors should perform due diligence and conduct extensive research into tokens they’re considering. This process should include a thorough fundamental analysis. Below is a list of some questions to ask, but it is by no means exhaustive:
- Is the concept viable? What problem does it solve?
- How is the supply allocated?
- Does the project need a blockchain/token, or can it be done without one?
- Is the team reputable? Do they have the skills to bring the project to life?
The most important rule is never to invest more than you can afford to lose. The cryptocurrency markets are incredibly volatile, and there’s a major risk that your holdings will plummet in value.
Initial Coin Offerings have been tremendously effective as a means for projects in their early stages to acquire funding. Following the success of Ethereum’s Initial Coin Offering in 2020, many organizations were able to acquire capital to develop new protocols and ecosystems.
Buyers should, however, be conscious of what they’re investing in. There are no guaranteed returns. Given the nascency of the cryptocurrency space, such investments are highly risky, and there’s little by way of protection if the project fails to deliver a viable product.
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