What is an Initial Coin Offering?

In the last post in Digital Distributed Asset I have hinted at the need to define as precisely as possible what an Initial Coin Offering (ICO) is. I decided not to wait any other post and here it goes today. Initial Coin Offerings appeared recently in the traditional Venture Capital space as new way of funding new innovative businesses. But this is something itself innovative from the point of a traditional capitalist view. It is a new crowdfunding model where the monetary unit is a cryptocurrency token, and where the money raised does not guarantee ownership of the venture.

This article from the website dedicated to cryptocurrencies and blockchain technologies CoinTelegraph provides a good complete description of what is involved in an ICO:

What is an ICO?

An ICO is a recently emerged concept of crowdfunding projects in the cryptocurrency and Blockchain industries.

ICO stands for Initial Coin Offering. It’s an event, sometimes referred to as ‘crowdsale’, when a company releases its own cryptocurrency with a purpose of funding. It usually releases a certain number of crypto-tokens and then sells those tokens to its intended audience, most commonly in exchange for Bitcoins, but it can be fiat money as well.

As a result, the company gets the capital to fund the product development and the audience members get their crypto tokens’ shares. Plus, they have complete ownership of these shares.

As such the original entrepreneurs maintain full equity stakes in the venture. The details of what will be the future equity structure of a possible business might later be encoded in a smart contract. But in the beginning and in actual ICO process, most of the ventures aren’t full established businesses yet.

The important distinctions with an Initial Public Offering were also nicely outlined in the CoinTelegraph article:

How is ICO different from IPO?

There are indeed some parallels between the concepts of Initial Public Offering and ICO. However, there are several key differences.

For one, a company’s shares, released during an IPO, always denote a share of ownership in the respective company. This is not, by default, a case with crypto-tokens that are sold to the public in an ICO. Crypto-tokens can be used to transfer voting powers – a larger share of tokens giving more voting power – in some projects, but more often those tokens are just that – units of currency that you can send to other users and exchange for other currencies.

The other crucial difference is that IPO’s are heavily regulated by the government. This requires a partaking company to prepare large amounts of paperwork before releasing its shares. It also implies severe consequences in the case of non-compliance. Conversely, cryptocurrency crowdfunding is a new scene, largely untouched by government regulation. That means that any project can launch an ICO at any time with little preparation and any person can take part in it and contribute their money, no matter what country they are from. This liberal environment carries both new opportunities and risks when compared to the more conservative IPO’s.

The main Blockchain platform used in ICOs has been Ethereum. Ethereum is a perfect fit for ICOs given its highly flexible Turing complete compute capacity and its smart contract  and decentralized applications capabilities.

And the business opportunities that ICOs promise to open are without doubt attractive. There is inherent in this development a flexibility for new business models, revenue streams and innovative new ways to partner with entrepreneurs, investors and bright innovative minds that it will come and may stay and dominate new business landscapes:

What’s in ICO for me?

There are many possible benefits to taking part in an ICO. The obvious one is: you are helping the company launch its product. There is also an opportunity to make a profit selling ICO tokens after you’ve purchased them.

Just like with Kickstarter, the key goal for every ICO participant is to help fund a project that they personally consider interesting and appealing. However, there is an additional opportunity to make a profit in the process.

In most cases, the crypto-tokens released during an ICO are sold at a fixed price denominated in Bitcoins or US dollars. That price isn’t backed by anything but the community’s faith in the development team to release a finished product at some point in the future, so it’s usually pretty low. After the project is developed and launched, the tokens’ value becomes secured by a real, working product. And that almost always leads to an increase in price. When this happens, the original backers may sell their tokens for a substantial profit.

However, you should keep in mind that any profits aren’t guaranteed. An ICO campaign may fail and in that case, all contributions will be returned to their senders. Even if it does succeed, there is a chance that the developers will not be able to deliver a final product and the price of tokens will never go up. This is a risk that all ICO participants have to take into account when they decide to contribute to any campaign.

In addition to the CoinTelegraph article I share below a conversation in a panel of speakers in a FinTech Week event. It is from FinTech Week YouTube channelFinTech Week YouTube channel, featuring some experienced entrepreneurs and investors in this space. This video took place in London at the beginning (January) of 2017:

This was a good panel to listen to, given the experience and relevance of the speaker’s own ventures. They detailed what the pitfalls of ICOs and the new Venture Capital landscape may be (the regulatory authorities are one such possible problem), providing additional input to the possible interested reader eager to know more and to possibly venture him/herself in ICOs.

featured image: ICO, Explained

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