ICO (Initial Coin Offering) in Blockchain

An initial coin offering (ICO) is a type of capital-raising activity for any cryptocurrency or blockchain based environment. The ICO can be viewed as an equivalent to initial public offering(IPO) but uses cryptocurrencies. However, it is not the most precise comparison, as there are some crucial differences between the two fundraising activities. Startups primarily use an ICO to raise capital to create a new coin, app, or service.

An ICO allows interest investors to buy and receive a new cryptocurrency token issued by the company. This token may have some utility related to the product or service that the company is offering, or it may just represent a stake in the company or project.

Key Takeaways

• Initial coin offerings are a popular way to raise funds for products and services usually related to cryptocurrency.
• ICOs are similar to IPOs, but coins issued in an ICO can also have utility for a software service or product.
• Some ICOs have yielded massive returns for investors. Numerous others have turned out to be fraudulent or have performed extremely poorly.
• To participate in an ICO, you usually need to first purchase a more established digital currency, plus have a basic understanding of 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.

The main advantage of ICOs is that they remove third party involvement from the capital-raising process and create direct connections between the company and investors. It also benefits both.

Crowdfunding

Blockchain ICOs are often compared to crowdfunding or crowd investing on the Blockchain. Most cases are hybrid and don’t fall under either class. As critical crowdfunding wherever the investment takes into account donations, ICOs offer the supporters the likelihood of a return of investment of the token at a later date for the next value. ICOs can be seen as a mixture of a donation, investment or venture capital.

Most ICOs that were conducted in 2016 and 2017 didn’t offer investors a conventional stake in the startup. These investors will be seen as supporters of a project and are entirely driven by the return of their investment.

History of Initial Coin Offerings

The first token sale (also known as an ICO) was held by Mastercoin in July 2013. Ethereum then raised money with a token sale in 2014, raising around 31,000 BTC in July, equal to approximately $18.3 million at the time. ICOs and token sales started gaining popularity back in 2017. There were at least 18 websites tracking ICOs before mid-year by then.

In May, the ICO for a new web browser called Brave generated about $35 million in just under 30 seconds. As of November 2017, there were around 50 offerings a month,with the highest-grossing ICO as of January 2018, being Filecoin, raising $257 million (and $200 million of that within the first hour of their token sale). By the end of 2017, ICOs had raised almost 40 times as much capital as they had raised in 2016, although still amounting to less than two percent of the capital raised by IPOs.

ICOs are sometimes called “token sales“. Amy Wan, a crowdfunding and syndication lawyer, described the coin in an ICO as “a symbol of ownership interest in an enterprise—a digital stock certificate” stating that they are likely subject to regulation as securities in the U.S. under the Howey test. Ethereum is (as of February 2018) the leading blockchain platform for ICOs with more than 80% market share.

An initial stake-pool offering (ISPO), also known as an ISO, is a novel variation of an ICO for funding cryptocurrency projects. In an ISPO, users stake their cryptocurrency holdings (mostly notably ADA) through a stake-pool operated by the cryptocurrency project.

The first formal ISPO, and so far the most successful, was launched on July, 1st, 2021. By October 2021 more than 35,000 participants across the world contributed more than 600 million ADA (worth more than $1 billion USD in October 2021). Participants receive 0.065 $MELD/$ADA stake/epoch while keeping full ownership of their ADA.

Types of Initial Coin Offerings

The two types of initial coin offerings are listed below:

1. Private ICO

In private initial coin offerings, only a limited number of select investors can participate in the process. Usually, only accredited investors (such as those associated with financial institutions or high net-worth individuals) can participate in private ICOs, and a company can choose to set a minimum investment amount.

2. Public ICOs

Public initial coin offerings are a form of crowdfunding that is aimed at the general public. It follows a rather democratic process for investing because almost anyone can become an investor. However, due to regulatory concerns, private ICOs are becoming a more viable option relative to public offerings.

Who Can Launch an ICO?

An Initial Coin Offering (ICO) may be started by anybody with a good concept and the technical know-how to build a cryptocurrency and the blockchain infrastructure that supports it. Cryptocurrency entrepreneurs utilise ICOs as a method of raising money for their initiatives. It’s crucial to keep in mind that the legislative landscape around ICOs differs greatly between nations. In fact, several countries have outright banned ICOs because they are worried about investor protection and potential fraud.

Launching an ICO would need abiding by applicable securities rules and regulations in various regions. This involves, among other responsibilities, giving adequate disclosure of the project’s specifics, possible dangers, and financial statements. Companies may also need to register their ICOs with financial regulatory authorities in some countries.

Many cryptocurrency companies increasingly use alternate fundraising techniques including Security Token Offerings (STOs), Initial Exchange Offerings (IEOs), or private token sales to approved investors due to the difficulties and potential legal repercussions of conducting an ICO.

To guarantee compliance and reduce any potential legal concerns, it is essential to get legal advice and engage with professionals who are knowledgeable about the regulatory environment in your area if you are thinking about launching an ICO. In any fundraising effort inside the bitcoin ecosystem, comprehensive due diligence and openness with potential investors are also crucial stages.

Special Considerations

ICO activity began to decrease dramatically in 2019, in part because of the legal gray area that ICOs inhabit. Investors can research and find ICOs in which to participate, but there is no surefire way to stay abreast of all the latest initial coin offerings. You can use websites that compare different ICOs against one another.

ICOs can generate a substantial amount of hype, and there are numerous sites online where investors gather to discuss new opportunities. Investors seeking to participate in ICOs should first familiarise themselves broadly with the cryptocurrency space and become educated about any ICO before participating. Because ICOs are barely regulated, prospective investors should exercise extreme caution when investing.

There is no guarantee that an investor won’t be on the losing end of a scam when investing in an ICO. To help avoid ICO scams, you can:

1. Make sure that project developers can clearly define what their goals are. Successful ICOs typically have straightforward, understandable white papers with clear, concise goals.

2. Look for transparency. Investors should expect 100% transparency from a company launching an ICO.

3. Review the ICO’s legal terms and conditions. Because traditional regulators generally do not oversee this space, it is an investor’s responsibility to ensure that an ICO is legitimate.

4. Check that ICO funds are stored in an escrow wallet. This type of wallet requires multiple access keys, which provides useful protection against scams.

Initial Coin Offering (ICO) vs Initial Public Offering (IPO)

Initial public offerings of stock raise money for companies that are becoming public and result in the distribution of shares of the company’s stock to investors. For ICOs, crypto companies raise funds through the sales of coins or tokens. In both cases, investors are bullish, whether about the company or the cryptocurrency, and invest based on some belief that the asset’s value will increase over time.

The primary difference between an ICO and an initial public offering of stock is that investing in an ICO doesn’t secure you an ownership stake in the crypto project or company. ICO participants are gambling that a currently worthless currency will later increase in value above its original purchase price.

IPOs are highly regulated by government organisations such as the Securities and Exchange Commission, while ICOs are largely unregulated. This lack of regulation coupled with the often decentralised nature of crypto projects means that an ICO’s structure can vary significantly. By contrast, the structure of most IPOs is largely similar.

Though IPOs are funded by generally more conservative investors anticipating a financial return, ICOs may receive funding from risk-tolerant supporters who are keen to invest in a new, exciting project. An ICO differs from a crowdfunding event because it offers the possibility of financial gain over time, whereas crowdfunding initiatives essentially just receive donations. ICOs are also referred to as “crowdsales” because of the possibility of financial gain.

Advantages and Disadvantages of Initial Coin Offerings

Online services can facilitate the generation of cryptocurrency tokens, making it exceptionally easy for a company to consider launching an ICO. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute the tokens by transferring the coins to individual investors. But because ICOs are not regulated by financial authorities like the SEC, funds that are lost due to fraud or incompetence may never be recovered.

Early investors in an ICO are usually motivated by the expectation that the tokens will gain value after the cryptocurrency launches. This is the primary benefit of an ICO: the potential for very high returns.

But the legality of cryptocurrency or digital assets is not guaranteed to persist. In 2017, the People’s Bank of China officially banned ICOs, slamming them as counterproductive to economic and financial stability.7 The Chinese government in 2021 went on to ban cryptocurrency mining and declared all cryptocurrency transactions illegal.8

SEC Introduces the HoweyCoin

The SEC in 2018 introduced a fake coin called the HoweyCoin to display the dangers of ICOs. The SEC’s HoweyCoin is named after the agency’s Howey’s Test, which is used to determine whether an investment qualifies as a security.9 The SEC then used the Howey Test to charge Kik, a messaging service that raised $100 million in an unregistered ICO, with unlawful sales of a security.

The first instance of the SEC cracking down on an ICO occurred on Dec. 11, 2017, when the agency halted an ICO by 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. The SEC issued a cease-and-desist letter, treating the ICO as an offering of unregistered securities.

Types of ICOs in Blockchain

1. Price increases: The ICO runs little by little wherever the team sets a hard and fast rate for the tokens. The speed might increase incrementally with time. Investors of the WHO take the risk and get the most effective worth per coin magnitude relation. Backers send Bitcoins or Ethereum to the provided addresses and acquire the new token.

2. Price not determined: A developer will decide to not sell his tokens at a high rate. However, rather let folks invest in his startup and so distribute the new tokens proportionately by giving all. A proportion of the tokens, like the portion of his investment, a component of total investments. During this case, if a startup gets one capitalist he/she can get 100% of the tokens.

3. Price is fastened: If the rate of the issued token is fixed, this provides investors with the chance to induce as many tokens as they like at that fastened worth. This mechanism is appealing to giant investors. As a result, they don’t need to worry about influencing the value by buying an enormous variety of tokens. Once a token sale ends, there’s a cool-off amount wherever tokens may freeze far from exchanges. Once the top of the cool-off amount is reached, exchanges will begin listing the token. Therefore, permitting others to trade it at market value.

4. Price decreases: Another choice would be selling as conferred by the intuition team for the primary time. Whenever the sale starts at the best value per token, proportionately decreases till the top of the auction. Gnosis, as an example, used a selling mechanism to lift funds for his or her project.

Examples of Initial Coin Offerings

1. Ethereum’s ICO in 2014 is an early, prominent example of an initial coin offering. The Ethereum ICO raised $18 million in 42 days.

2. In 2015, a two-phase ICO began for a company called Antshares, which later rebranded as Neo. The first phase of this ICO ended in October 2015, and the second continued until September 2016. During this time, Neo generated about $4.5 million.

3. During a one-month ICO ending in March of 2018, Dragon Coin raised about $320 million.

4. In 2018, the company behind the EOS platform raised a whopping $4 billion during a yearlong ICO.

Sometimes ICOs with remarkable return on investments are not the projects that raise the most money, and vice versa. The amounts raised by ICOs reached a peak in 2017 and 2018 but has declined over the years. When evaluating the success of an ICO, you can consider both the amount of money raised in the ICO and the return generated on investment.

How Does an ICO Work?

When a cryptocurrency project wants to raise money through ICO, the project organisers’ first step is to determine how they will structure it.

ICOs can be structured in a few different ways, including:

1. Static supply and static price: A company can set a specific funding goal or limit, which means that each token sold in the ICO has a preset price, and the total token supply is fixed.

2. Static supply and dynamic price: An ICO can have a static supply of tokens and a dynamic funding goal—this means that the amount of funds received in the ICO determines the overall price per token.

3. Dynamic supply and static price: Some ICOs have a dynamic token supply but a static price, meaning that the amount of funding received determines the supply.

Moreover, initial coin offering is a complex process that demands in-depth knowledge of technology, finance, and the law. The main idea of ICOs is leveraging the decentralised systems of blockchain technology in capital-raising activities that will align the interests of various stakeholders.

The steps in an ICO are listed below:

1. Identification of investment targets

The intention behind launching an ICO is to raise capital so companies identify the targets for its fundraising campaign and create the relevant materials about the company or project to attract potential investors.

2. Creation of tokens

The next step in the initial coin offering is the creation of tokens. Essentially speaking, the tokens are representations of an asset or utility in the blockchain, they are fungible and tradeable but should not be confused with cryptocurrencies because the tokens are just modifications of existing cryptocurrencies. Unlike stocks, the tokens generally do not provide an equity stake in a company. Instead, most of the tokens deliver their owners some stake in a product or service created by the company.

The process of the creation of tokens is relatively simple because a company is not required to write the code from scratch as in the creation of new cryptocurrency. Instead, existing blockchain platforms that run existing cryptocurrencies such as Ethereum allow the creation of the tokens with minor modifications of the code.

3. Promotion campaign

Publicity and public awareness regarding the ICO plays a very important part in its success. It attracts potential investors and allows accredited investors to gain interest in the project as well. Note that the campaigns are commonly executed online to achieve the widest investor reach. However, currently, several large online platforms such as Facebook and Google ban the advertising of ICOs.

Alongside structuring the ICO, the crypto project often also creates a white paper , which is made available to potential investors via a new website dedicated to the token. The promoters of the project use their white paper to explain important information related to the ICO:

• Aim of the project
• Applications of the project
• Projected costs
• How many of the virtual tokens the founders will keep
• What type of payment (which currencies) will be accepted
• How long the ICO campaign will run

The company releases the white paper as part of its ICO campaign, which it designs to encourage enthusiasts and supporters of the project to buy some of the project’s tokens. Investors can generally use normal or digital currency to buy the new tokens, and it’s increasingly common for investors to pay using other forms of crypto such as Bitcoin or Ethereum. These newly issued tokens are similar to shares of stock sold to investors during an IPO.

If the money raised in an ICO is less than the minimum amount required by the ICO’s criteria, then all of the money may be returned to the project’s investors. The ICO would then be deemed unsuccessful. If the funding requirements are met within the specified time period, then the money raised is spent in pursuit of the project’s goals.

4. Initial offering

After the creation of the tokens, they are offered to the investors. The offering may be structured in several rounds. The company can then use the proceeds from the ICO to launch a new product or service while the investors can expect to use the acquired tokens to benefit from this product/service or wait for the appreciation of the tokens’ value.

ICO Regulations

The initial coin offering is a radically new phenomenon in the world of finance and technology. The introduction of ICOs has made a significant impact on capital-raising processes in recent years. However, regulatory authorities around the world were not prepared for the introduction of the new fundraising model in finance.

Approaches to the regulation of initial coin offerings vary among different countries. For example, the governments of China and South Korea prohibit ICOs. Many European countries, as well as the United States and Canada, are working on the development of specific regulations to govern the conduct of ICOs.

At the same time, there are already published guidelines governing ICOs in a number of countries, including Australia, New Zealand, Hong Kong, and the United Arab Emirates (UAE).

Conclusion

In this tutorial, we learnt about ICOs, what they mean and even discussed key takeaways. We also discussed the different types of Initial coin offerings and how exactly it works, as in what steps a company has to follow. We then even discussed the ICO regulations that need to be followed.