ICO – what is it?
The development of digital economy and cryptocurrencies has given birth to a new fund-raising tool called Initial Coin Offering or ICO. How does it work? What goals does it pursue? Which stages does it undergo?
What is an ICO?
The term was created by analogy with the well-known notion of IPO – Initial Public Offering. The difference is that during the ICO process, cryptocurrency tokens are issued instead of securities.
In fact, tokens are similar to cryptocurrencies, but have some significant distinctions. A company that issues tokens can provide them with speculative value only. In other words, token holders do not receive any privileges except the possibility to sell tokens at a higher price on exchange. In this case, tokens don’t differ from cryptocurrencies.
However, companies can also equal their tokens with shares. Such tokens can generate dividends, allow holders to take part in the company management and get other bonuses, envisaged in the public offering.
What’s the purpose of ICOs?
The issuance of tokens always pursues one goal – to attract investments for business development. Usually, ICOs are chosen by startups that, in the best case scenario, have a good concept, but don’t have funds for implementation. They issue tokens and sell them on a cryptocurrency exchange for digital currencies (Bitcoin, Ethereum, and others) or fiat money (usually dollars or euros). Then, the raised funds go for development, marketing, and salaries.
- Announcement. A startup, willing to raise funds through an ICO, needs to announce itself. Everything starts from the announcement of the concept in the cryptocurrency community. It can be made on such community forums as Bitcoin Talk, Reddit, and others. Startup representatives start a topic to present the project: they describe the general idea, goals, development stages, and potential benefits for investors. It often happens that major investors get interested at this stage.
- Public offer. This stage is sometimes called Pre-ICO. The startup already knows the interested investors and starts preparing the agreement. The document stipulates all project nuances: investment sum, liability terms, timeframes, and other important aspects. In accordance with the agreement, investors transfer funds to the startup and receive a definite number of tokens, which they can use at their own discretion.
- PR campaign. To attract the wide audience, companies often turn to PR agencies to launch an advertising campaign. An adequate PR strategy can boost the efficiency of the ICO.
- ICO. The startup makes arrangements with the selected cryptocurrency exchange and launches tokens for trading. After the minimum sum is raised, the startup has to start fulfilling the contractual obligations. It is important to sustain the functionability of the platform and payment processing system at this stage. Usually, the PR campaign is still running during the stage.
What’s the difference between ICO and IPO?
Tokens issued by a startup are launched on a cryptocurrency exchange. Shares issued by a company are traded on a traditional stock exchange. Traditional IPO is very expensive and costs at least $200,000. Whereas, an ICO can require $10,000-$20,000. At the same time, ICOs can turn out to be significantly more effective than IPOs.
The largest ICOs raise tens of millions of dollars within few days:
- the most successful ICO was held by Tezos. The company raised $232 million with $206 million invested just in the first four days after the ICO launch;
- EOS company managed to raise $170 million in five days;
- Bancor startup raised $153 million not even having a clear business plan;
- The DAO managed to raise $150 million, one third of which was stolen by hackers.
The main dangers of losing money that investors can face are connected with the unregulated nature of ICOs. Today, not a single country has officially introduced rules for holding ICOs. Even the USA, where the Securities and Exchange Commission has equaled ICOs with IPOs, has not introduced any further changes.
As a result, there are risks to lose the invested funds. Some startups, not burdened with obligations, can simply take the money and go on a vacation. And there will be no way to bring them to responsibility, as there are no laws that regulate ICOs.
Investors often invest money without looking through the business plan and analyzing the startup’s activity. Many hope to gain income by selling the purchased tokens at a higher price, but that does not always happen.
Nevertheless, the global financial community acknowledges the existence of the problem and is trying to solve it. Some countries are preparing legislative changes. Besides, there are startups that create platforms for holding ICOs with rules and restrictions.
ICO is a tool that will continue gaining popularity. Its advantages can outweigh disadvantages. However, investors should take a very careful approach to ICOs. It is necessary to profoundly analyze the project’s team, the substance of the proposal, options for satisfaction of liabilities, and the business strategy.