Initial Coin Offerings – ICOs
ICOs are a type of crowdfunding or crowd investing tool conducted entirely on the blockchain. Originally, the main idea of an ICO was to fund new projects by pre-selling coins/tokens to investors interested in the project. Entrepreneurs present a whitepaper describing the business model and the technical specifications of a project before the ICO. They lay out a timeline for the project and set a target budget where they describe the future funds spending (marketing, R&D, etc.) as well as coin distribution (how many coins are they going to keep for themselves, token supply, etc.). During the crowdfunding campaign, investors purchase tokens with already established cryptocurrencies like Bitcoin and Ethereum.
As opposed to traditional crowdfunding where the investment is considered to be a donation or a pre-buy of a product, ICOs give the supporters the possibility of a return of investment when selling their coin later at a possibly higher price. ICOs are similar to IPOs only if the token represents a stake in the project.
Crowd Funding or Crowd Investing?
Depending on the white paper, tokens can have very different properties. ICOs are very often compared to crowdfunding or crowdinvesting on the Blockchain. Most cases are hybrid and don’t fall into either category. As opposed to crowdfunding where the investment is considered to be a donation, ICOs give the supporters the possibility of a return of investment when selling the token at a later date for a higher price. ICOs could be seen as a mix between a donation, investment or risk capital.
Investors get coins for supporting a startup idea. If a startup is successful, the token will be worth more in the future but is usually not a stake in the system. An ICO is similar to an IPO if the token represents a stake in the project. Unlike IPOs most ICOs that have been conducted in 2016 and 2017 didn’t give investors a traditional stake in the startup. These investors can be seen as supporters of a project who are solely motivated by the return of their investment.
TheDAO in 2016 was the token sale closest to an IPO and an exception to that rule. Every token holder had a stake in the TheDAO proportional to the owned number of tokens with attached voting rights. Please note that depending on the white paper, tokens can have very different properties and value propositions and legal status!
- Role of the Token: Take your time to understand what the role of the token is. More info on the Role of a Token.
- How to Evaluate an ICO: Read more about how to evaluate and ICO in our ICO Infographic.
Until recently, the way an ICO was set up depended entirely on the team behind the blockchain project. Currently, ICOs still lack government regulation or community standards, and this can be regarded as hazardous for uneducated investors.
In most cases, buying the new token does not give investors stake in the company but rather the hope that if the project becomes successful, investors will be able to sell their coins at a much higher price. Critics argue that many current ICOs are based more on FOMO (Fear Of Missing Out) than on rational investor decision giving an advantage to those who understand the system better than others with no kind of investor protection.
The fact that most countries currently lack any type of government regulation for these blockchain based token sales can produce a lot of risks for the stakeholders involved – for entrepreneurs and investors alike. However, the situation is rapidly changing, and more and more governments are starting to regulate or at least look into regulating ICOs. The recent SEC statement regarding The DAO and China’s might bring a different momentum into the current ecosystem.
Types of ICOs?
Due to lack of regulation, developers have so far had total freedom on how to run an ICO. There have been different approaches on how these campaigns are set up. Hardly any ICO has been conducted in the same way as another and covering every possible ICO scenario is almost impossible.
However, the price of a token during ICO period often runs through different stages. In general, we can distinguish between four different pricing mechanism:
- Price increases: ICO runs in stages where the team sets a fixed exchange rate for the tokens. The rate could increase incrementally with time. This way early investors who take the biggest risk get the best price per coin ratio. Backers send Bitcoins or Ethereum to the provided addresses and get the new token.
- Price decreases: Another option would be a dutch auction as presented by the Gnosis team for the first time, where the sale starts at the highest price per token proportionally decreases until the end of the auction. Gnosis, for example, used a dutch auction mechanism to raise funds for their project.
- Price is fixed: If the exchange rate of the issued token is fixed, this gives investors the opportunity to get as many tokens as they like at that fixed price. This mechanism is appealing to large investors because they don’t have to worry about influencing the price by purchasing a big number of tokens. After a token sale ends, there is a cool-off period where tokens might be frozen (investors are not allowed to transfer their coins for a certain amount of time) or kept away from exchanges. After the end of the cool-off period, exchanges can start listing the token thus allowing other people to trade it at a market price.
- Price not determined. A developer might decide not to sell his tokens at a fixed exchange rate but rather let people invest in his startup and then distribute the new tokens proportionally by giving each person a percentage of the tokens corresponding to the portion of his investment which is part of total investments. In the EOS token sale, the total money invested got divided by a number of available tokens in order to determine the price. In this case, if a startup gets a single investor he/she will get 100% of the tokens.
As you can see from the examples stated above most token sales so far, have been time capped. However, some startups like Tau-Chain decided to leave their campaign running without a cap and an end date. So before you invest into an ICO make sure you understand how much tokens will be in circulation and what the pricing mechanism will be.
History of ICOs
It all started with the Mastercoin campaign where people could support the Mastercoin project by burning Bitcoin and getting Mastercoin tokens in exchange. This was conducted entirely P2P and inspired other projects that followed to use the Bitcoin blockchain for P2P crowdfunding purposes.
The Ethereum project used the Bitcoin Blockchain in 2014, successfully raising 18 Mio USD in Bitcoin within a four-week period and breaking all crowdfunding records to date, the Ethereum blockchain has become the platform that simplified the process of issuing tokens, sparking a series of record-breaking ICOs in 2016 and 2017.
Initial Coin Offerings are still a relatively new concept and still represent a small amount of the total crowdfunding capital worldwide. Global crowdfunding volume in 2015 was around $34 Billion, whereas the ICO volume was less than a percent of the total volume with $240m raised. The most notable ICO in the blockchain space happened in 2016 where a project called The “DAO” managed to raise $150 Million.
Crypto Currency Funds & Fund Management Platforms
How to Evaluate an ICO – Part1 by Shermin VoshmgirHow to Evaluate Initial Coin Offerings by William MougayarCryptoassets: Evaluation & Due Diligence framework, crowdsourced10 Steps for Evaluating Digital Asset Crowdsales, TokenmarketInvestment Guide To ‘Crypto’ Coin Offerings Rating Blockchain Startups, Forbes
WeTrust: Lending Circles Going Blockchain, Daniel Zakrisson, WeTrust
ICOs, Token Sales, Crowdfundings, Smith & Crown
What is an initial coin offering?, Blockgeeks
What is an Initial Coin Offering (ICO)?, Ben Dickson
Initial Coin Offering, Investopedia
An Introduction To Initial Coin Offerings (ICO’s) – The Venture Capital Disrupters, Tim Lea