What is an Initial Coin Offering (ICO)?
An initial coin offering (ICO) is the term used to describe the method that a crypto firm or company utilizes to raise capital to fund a particular venture or project through the sale of its tokens. While an ICO is similar to the concept of raising capital by selling shares of stock, it is also different because the crypto firm is selling a digital asset (i.e. a token). The tokens can be utility tokens meaning the investor can use the tokens to access a product or a service or the tokens can be security tokens meaning the investor has some type of an investment stake. Another significant difference is that investors in ICOs do not generally have an ownership interest in the crypto firm, like a purchaser of common stock. Though this difference in investment may change with the advent of equity tokens. Yet, similar to owning stock, investors earn a return as a result of an increase in the value of their tokens, whether as utility or security token holders.
Generally the first step in the ICO process is for the crypto firm to publish a whitepaper that describes the project. Typical details addressed in the whitepaper include (i) the needs that will be met by the project upon its completion, (ii) the amount of capital being raised, (iii) what type of money or currency is accepted, (iv) how many tokens the founders will keep, and (v) how long the ICO will run. The crypto firm sells its underlying tokens, or digital assets, in exchange for Bitcoin or Ether, and in limited cases fiat (legal tender currency). Similar to a crowd fund, if the minimum amount is not raised prior to the ICO deadline the funds are returned to the ICO backers, but if the minimum is met, then the crypto firm founders access and use the funds to develop and complete their project. The investor or backer of the project will send funds to a smart contract that stores those funds (meaning the Bitcoin or Ether) and subsequently distributes to the investors the crypto firm’s new tokens in the future if, or when, the established minimum amount is raised in the ICO.
In essence, ICOs are a way for a startup business to raise capital without having to access and utilize traditional methods such as venture capital funding or SEC crowdfunding. In addition, there are currently no restrictions on who can invest in an ICO though that may change in the near future as the SEC determines its next steps regarding ICO regulation. Lastly, since the investors in ICOs are not generally granted an ownership stake, the founders of the crypto firm do not face the same type of dilution as they would if they raised capital in a traditional manner.
The first ICOs took place in 2013 with Ripple Labs and Mastercoin. Ripple Labs sold approximately 100 billion of its XRP tokens to raise capital in the form of both fiat and Bitcoin currency to create the Ripple platform and payment system. Mastercoin (now known as Omni) raised $500,000 in Bitcoin currency to develop a mechanism for building a layer on top of Bitcoin to allow for decentralized applications. Yet, one of the most well known ICOs happened in 2014 when Ethereum raised approximately $18 million in cryptocurrencies to create an alternative blockchain protocol. Since these early ICOs, the market has skyrocketed. According to Coinschedule, more than $3.8 billion was raised through 210 ICOs in 2017 and more than $9.0 billion has been raised through 348 ICOs since January 1, 2018 with the communications and finance sectors comprising approximately 24% and 14% of the 2018 ICO capital raises, respectively.
While ICOs started out small and were funded primarily by investors or backers who believed in the underlying project or were hoping to make a return by being one of the initial holders of the tokens, that has since changed. In 2016, venture capitalists became actively involved in the cryptocurrency market. According to an article on the website Medium, as of 2017 more than 90 hedge funds focused on cryptocurrencies and engaged in active trading on the secondary markets, and in some cases, participated in ICOs. This same article posits that as of 2017 approximately 5% of millennials had invested in or traded in cryptocurrencies or tokens and that number was expected to grow throughout 2018. What is clear from the current data? ICOs continue to grow and are becoming more commonplace. What is not yet clear is how the SEC in the United States and regulatory agencies in other countries will ultimately regulate the ICO market