INITIAL COIN OFFERING (ICO) --- AN UNDERSTANDING

INITIAL COIN OFFERING (ICO)

What is Initial coin offering?

An initial coin offering is similar in concept to an initial public offering (IPO), both a process in which companies raise capital. In the IPO, the company raises fund from the local / foreign market which is highly regulated, while an ICO is an investment that gives the investor a crypto coin, more commonly known as a coin or a token in return for investment, which is quite different to the issuance of securities as is the case in an IPO investment.

History and Evolution of ICO

The first ICO was by Mastercoin back in 2013, which raised approximately US $600,000 for a project to create a Bitcoin exchange and platform for transactions, while Bitcoin led the way on Cryptocurrencies, becoming the first decentralized cryptocurrency back in 2009, other cryptocurrencies sometime referred to as Altcoins, essentially Bitcoin alternatives have hit the market.

What is a Blockchain?

A blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record, not just financial transactions, but anything of value. It’s essentially a digital spreadsheet that is duplicated across a network of computers. The network is designed to update the spreadsheets on a regular basis. As the information is shared and regularly updated and not stored in a single location, it’s considered to be truly public and easily reconciled.

What are Tokens?

Tokens are coins that are offered during an ICO and would be considered an equivalent to shares purchased in an IPO and are also referred to as crypto coins.

What are Cryptocurrencies?

Cryptocurrencies are a digital or virtual currency that uses cryptography for security. It is not issued by any central authority, such as a central bank, taking it out of the reach of governments who can interfere or manipulate. The transactions are anonymous in nature.

Tokens issued from an ICO will have a value, with the ICO allocating equivalent to equity to the token, which gives the investor ownership with voting rights and, in certain cases, qualifying for dividends.

While this will be the closest format of an ICO to IPOs, the vast majority of ICOs issue tokens that are an asset giving investors access to the features of a particular project rather than ownership of the company itself.

It’s ultimately the process of crowdfunding a new cryptocurrency project, involving a token sale, with the cryptocurrency project raising capital to fund operations, with investors receiving an allocation of the project’s tokens in return.

ICOs tend to be open from between a few weeks to a month, though some have been open for longer and fundraising for a particular ICO possibly taking place on multiple occasions, unlike an IPO which is a onetime event.

Some key characteristics of an ICO include:

·         Participation in a project, Decentralized Autonomous Organization (DAO) or an economy.

·         Coin ICOs generally sell participation in an economy, while token ICOs sell a right of ownership or royalties to a project or DAO.

·         Owning tokens do not always give the investor a right to vote on the direction of a project or DAO, with the rights of the investor embedded within the structure of the ICO, though generally, the investor will have input throughout a project lifespan.

·         The majority of ICOs involve the creation of a defined number of coins or tokens prior to sale.

·         ICO prices are usually established by the creators of the economy, project or DAO.

·         ICOs may have multiple rounds of fundraising, with coins or tokens on offer, increasing in value until the release date, with early investors likely to have greater rewards embedded within their tokens as an incentive.

·         ICOs conclude once the coins or tokens are tradable on the open market.

If we were to compare the key features of ICOs and IPOs, some of the similarities and differences would be as follows:

·         An IPO gives you ownership of the company based on the number of shares acquired, whilst an ICO may only give you rights to a particular project, not the company launching the project.

·         Decision making in IPO companies are centralized with the CEO and the board involved in the day to day running of the business, whilst with ICO companies/projects, decision making is decentralized, giving the investor a material decision making position.

·         Financial data is released as per the rules of the exchange on which the IPO took place, whilst for ICOs, these will either be public by way of the blockchain or as outlined within the white paper and agreement with the investors.

·         Companies launched by way of an IPO must pay taxes, with investors having to pay capital gains tax, whilst for ICOs, the company may not be subject to direct tax, only the investor is required to pay capital gains tax.

·         An IPO is a onetime sale with multiple intermediaries involved in the process of determining the conditions, pricing, etc., whilst ICOs can have multiple rounds of fundraising, with few if any intermediaries, the white paper the blueprint.

·         And finally, stock exchanges and companies listed by IPO are heavily regulated, whilst the exchanges on which ICOs are launched are quite the opposite.

For companies raising capital through ICOs, the advantages include:

·         The project, DAO or economy is not necessarily subject to direct taxation, which in contrast to companies fundraising through IPOs.

·         Sales of coins or tokens are direct, including multiple rounds, with few if any intermediaries required in the process, investors basing investment decisions on the content of white papers prepared by the fundraising entity.

While ICOs are to mainly raise capital for a startup, they are also used to kick-start the sale of a service to be taken to market or the use of a new cryptocurrency.

On most occasions, the investor becomes the consumer of the service being offered by the company raising funds through an ICO, which allows investors to buy coins at a discount, though valuation will ultimately be dictated by supply and demand once released to market.

Before getting into the details, it’s worth providing some detail on blockchains, tokens, and cryptocurrencies.

BREAKING DOWN 'Initial Coin Offering (ICO)'

When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for. During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed crypto coins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering(IPO) transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the fund requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.

Early investors in the operation are usually motivated to buy the crypto coins in the hope that the plan becomes successful after it launches which could translate to a higher crypto coin value than what they purchased it for before the project was initiated. An example of a successful ICO project that was profitable to early investors is the smart contracts platform called Ethereum which has Ethers as its coin tokens. In 2014, the Ethereum project was announced and its ICO raised $18 million in Bitcoins or $0.40 per Ether. The project went live in 2015 and in 2016 had an ether value that went up as high as $14 with a market capitalization of over $1 billion.

ICOs are similar to IPOs and crowdfunding. Like IPOs, a stake of the startup or company is sold to raise money for the entity’s operations during an ICO operation. However, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return on their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are referred to as crowd sales.

Although there are successful ICO transactions on record and ICOs are poised to be disruptive innovative tools in the digital era, investors are cautioned to be wary as some ICO or crowd sale campaigns are actually fraudulent. Because these fund-raising operatives are not regulated by financial authorities such as the Securities Exchange Commission(SEC), funds that are lost due to fraudulent initiatives may never be recovered.

In early September 2017, the People's Bank of China officially banned ICOs, citing it as disruptive to economic and financial stability. The central bank said tokens cannot be used as currency on the market and banks cannot offer services relating to ICOs. As a result, both bitcoin and ethereum tumbled, and it was viewed as a sign that regulations of cryptocurrencies are coming. The ban also penalizes offerings already completed. 

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Drawback in investing in ICO

The Cryptocurrencies are not regulated by the regulators and hence there will not be any legal support in case of default.

In vetting ICOs, there is no guarantee or sure-fire way of distinguishing the good from the bad, investors needing to avoid scammers who are using ICOs to dupe investors out of funds.

There’s plenty of interest at present from an investor perspective, attributed to sizeable returns that investors have enjoyed to date, demand driving prices, with large prices gains incentivizing investors to lock in profits, which can lead to mass sell-offs that could ultimately wipe out investor money, not to mention the company.

How to Join Initial Coin Offering?

There are a number of sites that list current and up and coming initial coin offerings including Reddit, Cyber Fund and even social media sites such as Facebook.

To invest, the first step of the process is to identify which project or company launch is of most interest and while searching through the ever-increasing number of ICOs hitting the worldwide web, set up a cryptocurrency wallet.

With a lack of formal structure, each ICO will likely have a different set of requirements, though ultimately it’s a simple process of sending tokens upon payment by cryptocurrency to the blockchain identified and listed on the ICO website, which will also provide the investor a step-by-step guide into the investment process.

Public sites, such as Blockchainhub, advise that before investing it is important not to use any kind of an online wallet or exchange. Backers are generally required to export their private keys into another wallet in order to access their new coins, so it is vital to ensure that the wallet’s private keys are exportable.

Companies have looked to facilitate the process by making available functioning online wallets for their ICOs, where the investor can send the money directly to the wallet established, the funds exchanged for tokens using the exchange rate at the time of purchase, with the tokens deposited into the wallet. Others remit the purchased tokens to the address from which the funds were sent.

Investors will also need to be aware that certain wallets may be incompatible with the tokens and are therefore not visible following purchase and receipt. For this reason, it’s essential to have a wallet which permits the export of private keys, so that it is permissible to transfer the tokens to a new compatible wallet.

It’s become far simpler since the launch of Ethereum, with creators setting up user-friendly campaigns, with Ethereum’s wallet supporting multiple tokens, making access to purchase tokens far easier than before.

Outside of identifying the ICO itself, due diligence is also recommended in the interest of avoiding scams and Ponzi schemes, with ICO Rating providing would-be investors with a full assessment of the project or company in question and other companies providing some additional background should more details be needed.

Conclusion:

ICO is one more option for the new ventures to raise funds, besides IPO, Venture capital. The IPO is in a highly regulated market and the company has to comply with many regulations and the process is time-consuming. The venture capital is a costly affair. The ICO balance both and hence the company can raise funds with less paperwork and at a cheaper cost. However, for the investor, it is the risky venture and it is invested only to get a higher return on the investment.

based on articles on webpage and readings