What is an Initial Coin Offering (ICO)?

An Initial Coin Offering is a method of fundraising in which cryptocurrency start-ups and projects create and sell units of a new cryptocurrency to investors in exchange for other cryptocurrencies, usually bitcoin or ethereum. When investors purchase units of this new currency it is similar to when investors purchase shares of a company in an Initial Public Offering (IPO).

An investor may be interested in purchasing units of the new cryptocurrency for one or both of the following reasons:

  • The demand for the new cryptocurrency may increase, pushing up the market price and therefore making the cryptocurrency worth more than the investor purchased it for.
  • The cryptocurrency may have an inherent benefit. For example, it may grant the holder access to a service, a say in an outcome or a share in the project’s earnings.

By creating and selling crypto-tokens or units of a new cryptocurrency, projects and start-ups can therefore raise funds without giving up equity of their company. They can also increase the project’s chances of success by incentivising its use by crypto-token holders.

When an individual invests in an ICO, they send their Bitcoin, Ether or whichever cryptocurrency they want to invest with, to the ICO smart contract. This smart contract then sends them the amount of the start-up’s new cryptocurrency they have paid for. There are varying definitions of a smart contract, but it is basically a form of technology in which a code is stored, verified and executed on a blockchain.

If you are looking to invest in an ICO, the following points should be considered when choosing which ICO to invest in:

  • The competition – Does the project have any competitors and if so, what is this project doing differently to their competitors?
  • How the investment will be used – How is the project planning on using the money they raise from their ICO?
  • The team – Who are the team working on the project and are their backgrounds relevant to the project?
  • The crypto-tokens – What is the price of each token and how many tokens will there be? How many of these tokens will be sold in the ICO and how many will be used for other purposes?
  • Future plans – What does the project plan to do in future years and how long is it going to take them?

The project can answer the above questions in their white paper. A white paper is a document that presents the idea that the ICO is raising money for and contains a lot more detail than the descriptions that can be found on the ICO’s website. A detailed white paper is very important for an ICO to be successful. So if you are an investor and you see an ICO that doesn’t have a white paper, it is not advisable to buy tokens from it.

If you are a business looking to launch an ICO, three of the most important topics to focus on are your team, your goals and the protection of investors’ interests. These three topics should be clearly determined and articulated to the potential investors during the launch of the ICO.

  • The team – An unproven or anonymous team is likely to be seen as a warning sign to investors and may stop them from investing in the ICO. It is therefore important to provide a list of all the major team members along with pictures, their role in the project and their social media profiles. Projects that don’t have high-level professionals on their team could search for relevant professionals in the industry and get them involved as advisors for the project. It is also important to avoid having major shifts in the team immediately before and during the ICO campaign as this may decrease the investor’s confidence in the project.
  • The goals – Unclear or unrealistic goals can make an impression that the team either don’t know what they’re doing or are actively trying to mislead investors and so are untrustworthy. It is therefore crucial to have a white paper and a roadmap in place before the launch of the ICO. A good way to prove your concept to potential investors is to present a working, tested prototype and make this the main focus of the campaign.
  • Protecting the investors’ interests – A good way to guarantee the safety of the investors’ funds is to collect all investments in a multi-signature escrow wallet with the names of all keyholders announced to the public. Some of the keys are required to be held by people otherwise uninvolved in the project. To encourage early investments, it can be a good idea to offer discounts for investors which contribute in the first few days of the ICO campaign. Finally, there should always be a process in place for returning the funds to the investors should the project fail to meet its targets, meaning the campaign has to be rolled back.

Another important factor to consider when setting up an ICO is regulations. An advantage of ICOs is that all business is conducted electronically on global blockchain networks which means it is easy for companies to locate themselves in a country where the regulation is most suited to the project. Some countries such as China have banned ICOs altogether whereas the USA and many countries in the European Union have more open approaches to ICOs. Companies in these jurisdictions seem to have adopted similar approaches towards ICO token classification. Tokens tend to be classified as one of the two following categories:

  • Security Tokens – Tokens which are directly related to the growth of the company. These tokens usually have securities regulations applied to them in these jurisdictions.
  • Utility Tokens – Tokens which have some sort of use in the project which made the tokens such as a discount, a pre-order or a membership. These tokens have an indirect correlation to the growth of the company. There seems to be very little regulatory clarity around these types of tokens.

Whilst there are differing opinions as to which countries are the friendliest towards ICOs, the countries at the top of the list include Gibraltar, Switzerland, Malta, Estonia, Singapore, Lithuania, Luxembourg and Cayman Islands.

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. The Ethereum project was announced in 2014 and the ICO raised $18 million in Bitcoin or $0.4 per Ether. In 2016 the project had an ether value that went up as high as $14 with a market capitalisation of over $1 billion.

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