ICOs are blockchain-based tokens sold to early supporters of a project as a form of crowdfunding. They are different from IPOs, as early-stage companies use ICOs as a fundraising mechanism, and supporters do not gain ownership of the company. Established firms may also use ICOs to raise capital for a new blockchain-based product or to decentralize their ecosystem. ICOs are different from Initial IEOs as IEOs are conducted alongside cryptocurrency exchanges. STOs are another form of fundraising where equity is offered in the form of tokens, subject to traditional securities regulations. Before launching an ICO, it is essential to consider the legal implications, as regulations for ICOs vary by jurisdiction. ICOs are risky, and investors must conduct extensive research before investing.
When teams need to raise funds for a cryptocurrency project, they may turn to an Initial Coin Offering (ICO). This method involves creating blockchain-based tokens that are sold to early supporters, serving as a form of crowdfunding. Supporters receive tokens that they can use at a later time, while the project receives funds for development.
The popularity of ICOs began in 2014 when Ethereum used the method to fund its development. Since then, hundreds of ventures have utilized ICOs to varying degrees of success, particularly during the 2017 cryptocurrency boom. While an IPO and an ICO may sound similar, they are fundamentally different methods of acquiring funding.
IPOs typically apply to established businesses that sell partial ownership shares in their company to raise funds. In contrast, ICOs are used by early-stage companies as a fundraising mechanism. Those who purchase ICO tokens do not gain any ownership of the company.
ICOs are an attractive alternative to traditional funding for tech startups that may struggle to secure capital without a fully functional product. In the blockchain space, established firms may not invest in projects based solely on a white paper. Additionally, a lack of cryptocurrency regulation may discourage investment in blockchain startups.
ICOs aren't solely used by new startups, however. Established enterprises may choose to launch a reverse ICO, similar to a regular ICO, to decentralize their ecosystem. Alternatively, they may host an ICO to attract a broader range of investors and raise capital for a new blockchain-based product.
ICOs vs. IEOs
Although ICOs and IEOs or Initial Exchange Offerings share similarities, there is a critical difference between the two. An IEO is not solely hosted by the project team, but instead, it is conducted alongside a cryptocurrency exchange.
In an IEO, the exchange partners with the team, allowing users to purchase tokens directly on the exchange's platform. This partnership can benefit all parties involved. Users can trust that the project has undergone a thorough audit when a reputable exchange supports the IEO. The project team benefits from increased exposure, while the exchange can profit from the project's success.
ICOs vs. STOs
STOs or Security Token Offerings were once hailed as the "new ICOs." While they are similar from a technological standpoint (tokens are created and distributed in the same way), they differ significantly in terms of legality. Regulators have not reached a consensus on how to categorize ICOs due to legal ambiguity, resulting in a lack of meaningful regulation in the industry.
To avoid this uncertainty, some companies opt for STOs, which allow them to offer equity in the form of tokens while adhering to traditional securities regulations. To achieve this, the issuer must register their offering as a securities offering with the relevant government body, subjecting them to the same rules as traditional securities.
How Does a Typical ICO Work?
When it comes to an ICO, there are several different ways it can be carried out. One way is when the team responsible for the ICO has an operational blockchain that they plan to further develop over time. This allows users to purchase tokens that will be sent to their address on the chain.
Another option is when the blockchain is not yet active, and tokens are distributed on an established chain, like Ethereum. Once the new chain is up and running, users can swap their tokens for new ones issued on the new chain.
However, the most common method of launching an ICO is to create tokens on a chain that is smart-contract-enabled. Many applications use Ethereum's ERC-20 token standard, and while there are over 200,000 Ethereum tokens today, there are other chains such as Waves, NEO, NEM, or Stellar that can also be used. This is because these protocols offer flexibility and allow organizations to build on established foundations, providing access to tested tools and the network effects of an existing ecosystem.
Before an ICO begins, it is typically announced in advance and specifies the rules for how it will operate, including any timeframe or hard cap for the number of tokens to be sold. Participants may also have to sign up for a whitelist before the sale. The accepted payment methods are generally Bitcoin and Ethereum, and buyers can either provide a new address to receive tokens or receive tokens automatically sent to the payment address.
Can I Launch an ICO?
Before holding an ICO, it's important to consider the legal implications. While the technology to create and distribute tokens is widely accessible, the lack of regulatory guidelines in the cryptocurrency space means that important questions remain unanswered. Some countries have outright banned ICOs, while others have yet to deliver clear legislation. Therefore, it's crucial to understand the laws of your own country before considering an ICO.
Regulations Around ICOs
Legal regulations for holding an ICO can vary depending on the jurisdiction and specific project nuances. Seeking legal advice is crucial before embarking on an ICO. In some cases, regulators have sanctioned teams for not complying with securities regulations. The US Securities and Exchange Commission (SEC) has provided insights on this issue. The development of blockchain regulation has been slow, but some government entities are discussing implementing more transparent frameworks for cryptocurrencies. While some blockchain enthusiasts worry about government overreach, many recognize the need for investor protection, as global participation in ICOs presents significant challenges.
Risks Associated With ICOs
Investing in new tokens can be tempting, but not all tokens are created equally, and there are no guarantees that you'll make a positive return on investment. To assess the viability of a token, there are many factors to consider, making it challenging to determine if a project is feasible. For this reason, prospective investors must perform due diligence and conduct extensive research on the tokens they're considering. This should include a thorough fundamental analysis that considers aspects such as whether the concept is viable and what problem it solves, how the supply is allocated, whether the project needs a blockchain/token, or if it can be done without one, and whether the team is reputable and has the skills to bring the project to life. However, this list is by no means exhaustive.
The most crucial rule when investing is never to invest more than you can afford to lose. Cryptocurrency markets are highly volatile, and there's a significant risk that the value of your holdings will decrease.
Since Ethereum's 2014 ICO success, ICOs have been a reliable way for early-stage projects to acquire funding. Nevertheless, investors should be aware of the risks involved and the lack of guaranteed returns. The cryptocurrency space is still in its early stages, and as such, investments in ICOs are highly speculative and offer little protection in the event of a failed project or product.