The concept of ICO became very popular lately in the blockchain world. No one could have ignored the recent headlines in the news of some successful ICOs hitting record of fundraising in millions of USD within less than an hour. Such enthusiasm even started to spread over to the venture capital and startup ecosystem. As ICOs emerge everywhere and speculations are rising on its use (i.e. some believe that it disrupts the fundraising industry for startups and more) let’s get some clarity on this new concept before diving into it.
(Author: Audrey Baverel is a consultant advising startups and with a strong track record in corporate financing and tax. In each issue of SILICON magazine she’s clarifying a concept relevant for the industry and you, the readers / Image Credit: Photo by Cris DiNoto on Unsplash)
WHAT is an ICO compared to an IPO?
Initial Coin Offering derives from the more well-known acronym IPO (Initial Public Offering, the action of offering the shares of a private company to the public) and is used to designate a fundraising in cryptocurrency, usually for early stage blockchain projects. (i.e. decentralized apps).
Aside from being both (ICO and IPO) fundraising tools, the similarities of both tools are very limited. Indeed, as opposed to IPOs that are highly regulated, ICOs so far are constrained by virtually no regulations. Instead of issuing shares or bonds that entitle the holders of specific rights, token (also called coins or digital assets) are issued against existing and tradable cryptocurrencies (e.g. Bitcoins, Ethereum). Such tokens originally solely give their owner the future right to conduct transactions on a new decentralized application (usually detailed in a white paper and automatized through protocol), whereas the funds raised are used to finance the development of the project (e.g. humanIQ, Ethereum, Gnosis). This is why ICOs are also commonly called crowdsales.
Which use? Easy fund raising but high risk asset for investors
It is therefore a great alternative funding tool to explore especially for startups. ICOs seem to be easy to operate with limited regulation to observe and provide much faster financing than standard bank loans or venture capital funds. It however requires that the blockchain technology is at the core of the operational model of the company.
From an investment point of view, it is clearly not designed for risk adverse investors. Indeed, most of the time the ICO is initiated before the project is up and running and thus investors are fully dependent on the potential achievement and success of the project. Participants of ICOs are rather highly motivated persons in the suggested projects or speculators betting on the increasing value of the issued token right after the ICO.
ICOs are also not saved from scams or hacking (e.g. DAO hacking scandal in 2016). In this context, a clear understanding of the protocols of the project, credentials of the team members and ICO organizers and access to the code are some of the elements that should be analyzed with extra caution. It is therefore important to get familiar with the basics of how an ICO works.
HOW does it work? some standard features
Step 1: Presentation of the project in a whitepaper highlighting the purpose, the roadmap, introduction of the team and their experience;
Step 2: Issuing price;
Step 3: Duration of the crowdsale with some caps (maximum and minimum of token to be issued), distribution rules of the tokens (date the token will be available, locking time (if any);
Step 4: Marketing and communication campaign of the fundraising via social media and specialized press;
Step 5: Collection of funds in cryptocurrency (i.e. typically Bitcoin or Ether);
Step 6: End of the ICO and project launching.