Companies and individuals are enthusiastically considering initial coin offering (ICO) as a way to raise capital for their crypto coins. What exactly is an ICO and how does it work?
The expansion of digital assets such as cryptocurrencies continues to provoke start-up companies to participate in spawning their own version of crypto coins. However, the high cost required to create crypto prompts these companies to hold ICOs.
What is ICO and how does it work? Let's find out everything you need to know about ICO and the pros and cons below.
What is an ICO?
Initial Coin Offering or ICO is similar to crowdfunding where businesses raise funds for cryptocurrency projects. The system works the same as an initial public offering (IPO), except for the fact that ICOs are largely unregulated and give investors little or no rights.
Usually, a company that wants to raise money to create a new coin, app, or service will launch an ICO as a way to get funds. In exchange, interested parties investing in the project would receive a new crypto coin or token issued by the company.
You may be wondering what is this token used for? Tokens function like units of currency that provide investors with certain benefits from projects run by issuing companies. Tokens could also be in the form of cryptocurrency provided. They can give their holders access to corporate services, grant them rights to corporate dividends, and many others.
A Brief History of ICO
ICO was first started in 2013 by Mastercoin, a digital currency and communications protocol. At that time, Mastercoin raised approximately $5 million. The success was then followed by Ethereum's ICO, which raised around $18 million.
The ICO market continued to grow and peaked in the 2017-2018 era. In 2017, 875 projects were holding ICOs, about 30 times more than in 2016. In 2018, there was an additional 1,200 ICOs with revenues amounting to $7.85 billion.
Today, the skyrocketing price of cryptocurrencies has boosted the popularity of ICOs. In 2017 alone, companies raised more than $7 billion using ICOs. In 2018, the number has doubled. The record for the largest ICO of all time is still held by Telegram, an instant messaging service provider. During the private ICO, the British company managed to raise more than $1.7 billion in funds.
See also: Best Performing Cryptocurrencies
How Does ICO Work?
To make it easier to understand how ICOs work, let's imagine that you are the owner of a startup company who wants to create a new cryptocurrency for parking payment. Say, you name it as CarCoin. To complete this fantastic project, you need funds. You can go to the bank, but there is a high chance that the loan request will be denied. This is the moment you need to launch an ICO.
See Also: How do Crypto Airdrops Work?
The first step is to create a document detailing exactly how the system will work (usually called a white paper). The white paper explains the description of the project, the usefulness of the coin after the project is completed, how much it will cost, how many virtual tokens will be generated, and how long the ICO campaign will run. To further highlight your project, you may prepare a functioning website. When the ICO time arrives, all of the details will be taken into consideration by investors so they can decide whether to invest in the project or not.
If many people are interested, you can ask them to send funds in crypto or fiat currency. Assuming you already have several pieces of early CarCoin, you are entitled to share it with investors as a token of return.
What if the fundraising is far below target? As a consequence of that, the money can be returned to investors and at this point, your ICO is declared as failed.
Types of ICO
- Private ICO: In the private initial coin offering, only a few investors can participate. Generally, accredited investors (financial institutions and high net worth individuals) are capable of entering private ICOs, so the ICO initiator may set a minimum investment amount.
- Public ICO: It is a form of crowdfunding that involves the general public so anyone can contribute as an investor to the project.
Initially, the factor that causes investors excited to participate in an ICO was the hope that the crypto coin would be successfully launched and well received by the public. If everything happens according to plan, the value of the tokens investors bought during ICO will go up and they can make a large profit.
Are you interested to be an investor? For that matter, there are many other ICO benefits you need to know:
- Opportunity to buy crypto when the price is still cheap since it is not yet well known; it's just like buying Bitcoin in 2011.
- Preferential access to certain products and services or the crypto coins themselves.
- The diversity of ICOs gives investors the freedom to choose their preferred project and team to support.
- Crypto coins backed up by the Ethereum network usually generate additional buzz so they are quite likely to be sought after.
- So far, the ICO regulations have not been too strict.
- As first-time users, investors can use coins as a form of payment. Following the illustration above, no matter how CarCoin is traded in the market, you can still use it to pay for parking, right?
Meanwhile, as an ICO initiator, you will get the following benefits:
- Investors come from all over the world to provide more income without geographical restrictions. In consequence, fundraising will run faster so the project can reach the targets quicker.
- As ICO invitations are spread all over the world, the potential publicity for the company is huge.
- The absence of regulations opens the door for the initial funding transfer to run smoothly.
- You can capture crypto enthusiasts who want to test out the service.
ICOs are becoming more and more accepted since many people are interested in hopes of quick and strong returns. Unfortunately, ICOs can be misleading for investors because they also bring challenges, risks, and unexpected cases such as:
- ICOs are not regulated and do not have affirmed protection, so it is not surprising that ICOs are full of scammers who prey on novice investors. Without regulation and compensation schemes from financial authorities, funds lost due to fraud or negligence are nearly impossible to recover.
- Products and projects presented by companies are usually not that convincing.
- Since the company hosting the ICO will receive most of the investment up-front, they could be misappropriating the invested money instead of improving the product thus.
- A relatively inexperienced team is typically unable to guarantee that the project will deliver on its promises.
- Even if tokens are fully legal with trusted companies, crypto exchanges and crypto wallets are always at risk of being hacked and stolen every day. Since you're dealing with cryptocurrency, if your money is lost, there is practically no way to get it back.
- Lack of transparency from companies can be stressful due to the fact that they have no obligation to notify investors of the project's progress.
- Your investment may be vulnerable to artificial pump-and-dump schemes. It is essentially an illegal act to increase the price of crypto coins based on false, misleading, or exaggerated recommendations that usually target cryptocurrencies with small market caps.
Not only investors, but ICOs are also risky for ICO initiators because:
- Regulators may come after you at any time. This is what SEC (US Securities and Exchange Commission) always does in order to eliminate bad ICOs; they would charge against many companies who violated federal securities law. This is why being a licensed crypto company is important.
- The spread of investors around the world would push you to spend extra effort to manage communication, in which communication barriers and internet connections can be some big hurdles to get over.
- Most ICO investors tend to be impatient. They have a preference to chase or encourage companies to make rapid progress in a short period of time. You just received millions of dollars invested from them, obviously, they want to make sure their money is used properly and not robbed.
- Unclear regulation on ICOs means you can break the law without even knowing it.
- Information about ICO investors tends to be anonymous. Supposed there is an investor who misuses your coins, it will be hard to investigate the perpetrator.
Bear in mind, ICO is a new concept that raises a lot of concerns: the value of the tokens issued, no regulations, and the potential of fraud. However, not all ICOs are scams, and many do provide a legitimate means of raising project funds.
Thus, in the future, raising capital through ICOs is expected to be more complex in such a way that not everyone can become an initiator or investor, as the crypto market grows and new official regulations are introduced. Sooner or later, time will tell whether an ICO is bound to be a promising crypto funding business or just a "get rich" scheme by scammers.