Initial Coin Offering (ICO)

This article talks about Initial Coin Offering (ICO), a type of crowdfunding, which uses cryptocurrencies as a means of raising money for an early-stage company.

· 5 min read
Initial Coin Offering (ICO)

In this Article:1. What is Initial Coin Offering (ICO)?2. How does an ICO work?3. What are the Types of ICOs?4. What are the Advantages and Disadvantages of ICOs?5. Conclusion

You must be aware of the Initial Public Offering (IPO), which is a method of raising capital from the public and getting listed on the stock exchange by a company. An Initial Coin Offering (ICO) is not very different from the concept of IPO. In fact, ICO is considered as the cryptocurrency industry’s equivalent to an IPO. An ICO is a type of crowdfunding, which uses cryptocurrencies as a means of raising money for an early-stage company. Let us understand what ICO is and how does it work.

What is Initial Coin Offering (ICO)?

An ICO is a form of capital raising activity, which operates in the cryptocurrency and blockchain environment. Any cryptocurrency or blockchain company, planning to raise capital to fund their App development, services, or new coin can use the process of ICO. Initial Coin Offering (ICO) is widely viewed as the crypto industry’s response to the Initial Public Offerings (IPO). The process of ICO includes offering coins or tokens to the investors in exchange for money. These tokens may offer utility to its investors, as investors can exchange them for access to certain goods and services. In rare instances, these tokens may even represent an ownership stake in the start-up that launched the ICO. ICOs try to eliminate mediators from the capital-raising procedure, and thus allowing the companies and the potential investors to communicate directly in a transparent environment. An ICO is an introduction of a new coin or token (a form of digital asset), which is typically initiated through the process of mining. An ICO gives a significant number of venture capitalists an opportunity to invest in the new currency. Coins in an ICO are manufactured and offered to investors via blockchain technology. One of the key drawbacks of ICO is the ease through which it can be launched without any regulatory oversights, which may draw in inexperienced investors. Other methods such as Initial Exchange Offerings and Security Token Offerings are widely used as an alternative to ICO.

How does an ICO work?

ICO involves a complex process requiring extensive knowledge of technology, law, and finance. The basic objective of an ICO is to leverage the decentralized systems of blockchain technology in the process of raising capital. The various steps in the ICO process are:

  • Identification of Capital Requirement and Investment Targets: An ICO process starts with the intention of a company to raise funds. The company needs to identify its capital requirements and the targets for its fundraising campaigns.
  • Token Development: After identifying the investment targets, the company needs to focus on creating their token for the ICO. These tokens represent an asset or utility in the blockchain network. Tokens are freely tradeable and are fungible, but they should not be confused with actual cryptocurrencies as they are just a modification of the existing cryptos. As mentioned earlier, unlike stocks, these tokens rarely offer an equity stake in the company, rather these tokens deliver investors with some stake in a product and services developed or offered by the company. The tokens are developed with the help of blockchain technology. The existing cryptocurrencies or blockchain platforms allow the creation of these tokens with only a minor modification of the code of the existing cryptocurrency such as Bitcoin, Ethereum, etc.
  • Promotional Campaigns: In order to attract potential investors to their ICO, companies generally run promotion campaigns. Normally, these campaigns are run through online platforms to reach the widest possible investor reach. However, several online platform giants such as Google, Meta, etc. have banned the advertising of ICO on their platforms as ICO is largely unregulated.
  • Initial Offering: Finally, after developing the token and making investors aware of the ICO through promotional campaigns, they are offered to the investors. Usually, the offering is structured in multiple rounds. After completion of the ICO process and raising capital, the company can use it to launch new products or services while the investors can use the acquired tokens to benefit from the product or service of the company or can wait for the appreciation of the value of the token held by them.

A successful ICO can benefit everyone involved in the process. For example, Ethereum was offered through an ICO in 2014. The inaugural auction generated more than 7 million new Ethereum coins worth around $2.2 million. At that time, Ethereum was worth just $0.30 and today it is worth around $4,300, representing an excellent return on investment.

What are the Types of ICOs?

Broadly there are two types of Initial Coin Offering (ICO):

  • Private ICOs: As the name suggests, in a private ICO only a limited number of investors are allowed to participate in the process. Normally, only authorized investors such as financial institutions and high Net-Worth individuals are permitted to participate in a private ICO. Under this type of ICO, companies can choose to set a minimum investment amount.
  • Public ICOs:  Public ICOs are a form of crowdfunding aimed at the general public. It is considered a liberalized type of investment as anyone can participate in a public offering. But due to regulatory issues, private ICOs are becoming a more viable and realistic alternative to public ICOs.

What are the Advantages and Disadvantages of ICOs?

Initial Coin Offering (ICO) benefits both the company and the investors in the following ways:

  • Cryptocurrency Token: In the case of ICOs, investors do not get any shares per se, but instead companies provide them with blockchain equivalent to shares i.e., cryptocurrency tokens.
  • Ease of Creating Tokens: The process of creating tokens for the purpose of ICO has been made really simple and easy by online platforms allowing the generation of tokens within a few seconds.
  • High Returns on Token: Early investors are motivated to buy tokens in the hope that the plan succeeds after its launch. In the event when the plan actually succeeds, the value of tokens may climb significantly above the price set during the ICO, thus offering good returns to the investors.

Despite the various benefits offered by ICO; many investors are reluctant to participate in such a process. The primary reason is that the ICOs are largely unregulated and thus are susceptible to frauds and scam artists, who can easily prey on poorly informed investors. Moreover, if the company raising capital through ICO fails, the value of the associated token may lose most of its value. Thus, investors ought to gather proper information before considering investing in any ICO.

Conclusion

The Initial Coin Offering (ICO) is relatively a newer concept both in the areas of technology and finance. Investors with high-risk tolerance, who do not mind speculative risk and volatility, can invest in ICOs, but only after gaining adequate knowledge about the offering and the entire process. The introduction of the ICO process had made a significant and much-needed impact on the capital-raising procedure. However, it is yet to be seen how the regulatory authorities react to this new phenomenon.