What is an Initial Coin Offering (ICO)? Know All About It Here In a Simple Language

We have all been hearing about bitcoin and cryptocurrency a lot lately. Now let us know about ICOs (initial Coin Offerings).

What is an ICO?

ICO (Initial Coin Offering) is an alternative to raising money from the public through an initial public offering (IPO) or venture capitalists. ICO is a form of crowdfunding, where the company issues a new virtual currency similar to bitcoin, in exchange for bitcoin and other popular cryptocurrencies (it can be fiat money as well), which can be usually used only on the platform the company is building. It is usually done to bypass the legalities and regulations of raising capital through venture capitalists or banks.
The total money raised through ICOs till the end of last year was under $300 million, but now it is more than ten times higher, at $3.8 billion. ICOs started in 2013 with Mastercoin selling the first coins but the mainstream ICO was held in September 2017 with Messaging App Developer Kik, which issued $50 million tokens in “kin” to institutional investors.

How does it work?

ICO works both like IPO and crowdfunding. The startup or the firm issues cryptocoins (also called tokens) to raise capital much like the shares of a company to start a new project. The supporters of the firm buy the newly floated cryptocoins in exchange for bitcoins or other popular cryptocurrencies or fiat money.
In case the capital raised does not meet the minimum required capital by the firm, the ICO becomes unsuccessful and the money is returned to the supporters. If the ICO meets the minimum fund requirement, the startup or the firm uses the funds raised to fund the new project or whatever it raised the funds for.

What does the investor gain?

Investors/supporters buy the cryptocoins in an ICO if they have faith in the growth potential of the new project for which the funds are raised. If the new project does well in the future, the value of the cryptocoins that they purchased would increase in the future and they can earn their profit by selling those cryptocoins at a higher rate than what they purchased them at.

Difference between IPO and ICO:

Share of Ownership
Tokens given during an ICO do not denote a share of ownership in the company.
Shares given during an IPO always denote a share of ownership in the company.
ICOs are untouched by government regulation and can be launched with little preparation.
IPOs are heavily regulated and involve lot of paperwork.

Difference between Crowdfunding and ICO:

Investors invest for a profit in the future.
Funds raised are basically donations, however there are rewards based and equity based crowdfundings as well.

Role of Ethereum in ICO:

Ethereum can be easily used to create a new token which can be transacted on the ethereum blockchain instead of Ether. Hence, Ethereum has become the most popular platform to float a new cryptocurrency for ICOs.

Is it legal?

Presently there is no regulatory body for ICOs in India, cryptocurrencies and ICOs have been under the radar of the government but no concrete decision has been made yet. So, as of now, ICOs fall outside existing regulations. China and South Korea have banned ICOs and other countries could follow suit. Also, the US Securities and Exchange Commission (SEC) has warned investors to beware of scammers using ICOs to execute “pump and dump” schemes.

How to spot an ICO scam?

There have been a number of ICO scams lately but there are some red flags to spot them:
  • The project developers are unknown/anonymous individuals. (Example- The OPAIR ICO scam in 2016 raised more than $1 million with the promise of decentralised debit cards. But it was obvious that how a bunch of anonymous individuals could change the dynamics of the banking system)
  • No escrow wallet for contributions. If all the control of the contributions is in the hand of the project owner, he can run away with the money.
  • Unclear objectives. If the people who are raising money do not have clear cut goals or objectives, it means that they are raising money for something else.

Are ICOs suitable to raise funds for a business?

Some business owners feel that it is an easy option to raise funds without much of formalities and regulations needed to raise funds in a traditional way. But like everything in the cryptocurrency world, some standards (formal or informal) are emerging.
Example- Cryptocurrency industry runs on transparency and hence you need to create value for your investors; an ICO whose motive is only to raise money for selfish gains will not stand for long unlike the former times. So, you need to carefully consider your stance before going in for it. Since no concrete regulations have come up so far, you may consider raising money through ICO if you have the risk appetite. It is also possible that regulations come up during when you are raising funds through an ICO.
In the above article, we have tried to answer all the main questions surrounding an ICO. In case of any query, you can drop us a mail at mailinvestxp@gmail.com, we will be happy to answer.
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Akanksha Goel | LinkedIn