An Initial Coin Offering, or ICO as known to many, is a mechanism of fundraising where startups and established firms get an opportunity to merchandise their unmasked crypto tokens usually in exchange for ether or bitcoin. ICO has certain similarities with IPO (Initial Public Offering), which is a situation where investors buy shares of a particular company.
Despite the fact that they are a new phenomenon in the industry, ICOs have managed to become a major topic of discussion in the entire blockchain industry. There are quite a number of people who view Initial Coin Offering projects as unregulated securities that give funders an opportunity to outsource an unjustified amount of money. To another majority, ICO is an innovation that has been introduced in the traditional venture-funding model. An Initial Coin Offering is mainly used by startups who are seeking to bypass the tedious and regulated process of raising capital as required by most financial institutions. In other situations, this mechanism has also been referred to as Initial Public Coin Offering – IPCO.
A Brief History
Back in 2013, a number of projects applied a model of crowdsale in trying to provide funds for their development projects. Ripple, for instance, pre-mined a total of one billion XRP tokens and later sold them to ready investors in exchange for bitcoin or fiat currencies. In 2014, Ethereum, which is one of the major cryptocurrency exchange firm raised over 18 million dollars. This was the largest Initial Coin Offering project that became successful during that time.
Breaking It Down Further
When a small cryptocurrency company wants to use ICO to raise capital, a plan has to be first created on a whitepaper. This plan states clearly the details of the project; the mission of the project, the total amount that is required for the entire project, and how much of the real tokens the initiators of the project will keep for their own use. The plan should also outline clearly the type of money that will be accepted, and the duration that the Initial Coin Offering campaign will take.
As the ICO campaign kicks off, supporters and enthusiasts of the company’s project are allowed to purchase some of the distributed crypto coins using virtual currency or fiat. The crypto coins are what are usually referred to as tokens, and can be likened to shares of a company bought by investors in an IPO transaction. If by any chance the total amount of money that has been raised does not meet the minimum amount that the firm was seeking, the money is given back to the backers and the campaign is declared unsuccessful. What motivates the early investors to take part in the project is the hope that the plan will become successful and earn them higher crypto coin value compared to what they bought it for earlier. Initial Coin Offering projects have numerous similarities with Initial Public Offering and crowdfunding.
During the ICO project, a stake of the firm is sold to get capital for the operations of the entity. This is the exact thing that happens during the IPOs. The only slight difference that exists is that Initial Public Offerings mainly deal with investors, while Initial Coin Offerings on the other hand deal with supporters. These are supporters who are motivated to invest in a new project just like in the case of a crowdfunding event. Crowdfunding, on the other hand, is different from ICO. While in ICOs, the backers are always encouraged by a prospective return on the money they have invested, the funds raised from a crowdfunding event are usually deemed as donations. This explains why Initial Coin Offerings are mostly referred to as crowdsales.
When it comes to who can take part in an Initial Coin Offering project, there are a few restrictions that have been exiting for some time. This is based on the assumption that the token is not security. The sums of money raised from an Initial Coin Offering can be astronomical given the fact that money is obtained from a global pool of investors. The fundamental problem with the Initial Coin Offering is the fact that quite a number of them raise money pre-product. This puts the investment in a very risky and speculative place. But the other counter-argument is that the ICO mechanism is very helpful in incentivizing protocol development.
Are They Legal?
Initial Coin Offerings legally exist in a very gray area. This is because arguments can be both made for and against the main fact they are a new and unregulated form of financial assets. However, part of that gray area was recently cleared up by the Security Exchange Commission. In other cases, the token is simply referred to as a utility token, and this means it gives the owner an opportunity to access certain network or protocol, therefore being classified as a financial security. On the other hand, the token may appear more like a security especially if it is an equity token with the only purpose of appreciating in value. While there are a number of traders who buy tokens to get to the underlying platform in the coming times, it is also very hard to dismiss the idea that most token transactions are for purposes of speculative investment. This is something that is very simple to ascertain based on the valuation of figures for the numerous projects that haven’t released any commercial product.
To Sum It Up…
Whereas the decision of the commission for security exchange may have shed some light to the security tokens and the status of utility, there is still sufficient room for testing the extent of the legalities. Entrepreneurs will, therefore, continue to enjoy this new phenomenon for now and up to the time that further regulatory measures will be imposed.
It is a fact that a number of ICO transactions have succeeded; however, investors are warned in advance that there are certain crowdsale or ICO campaigns that have become fraudulent. It could be really hard to recover funds that are due to the ICOs fraudulent initiatives because they are not regulated by any financial authority.