An initial coin offering, better known by its acronym, ICO, refers to the process where crypto startups raise capital through the creation and sale of digital tokens. It is widely seen by many as a way of bypassing venture capital and its stringent conditions.
A cryptocurrency or digital token is at the heart of any ICO. The digital tokens are sold to the public or private investors in exchange for well-known digital assets such as Bitcoin or Ether. The capital raised is used to fund the project and the development of the promised product.
In a way, the ICO model borrows some of its traits from an Initial Public Offering (IPO), although it skips some major checks and balances.
Who benefits from an ICO?
ICO projects would have not have garnered success if they did not benefit the entities who participated in them. An ICO project is a two-way street in which investors (those who buy the digital tokens at an early stage) and the token issuers benefit from the whole process.
The success of an ICO also indirectly benefits those who will later use the digital token or product offered by the issuer.
The benefits to token issuers are:
- Above all else, ICOs give token issuers access to seed funding with minimal effort
- ICOs act as a success measure for the product or token the issuer is working on
- A quicker method of raising capital
- Unlike an IPO where companies have to give away equity, ICO token issuers maintain their ownership of the firm unless stated otherwise
Benefits to the token holder include:
- Access to a new decentralized service
- Price appreciation – investors buy tokens at a discounted price with the aim of making a profit when they appreciate in value
Risks associated with ICOs
ICOs have been thriving in uncharted waters in which neither the token issuers no holders have complete knowledge of the industry they are in. At the same time, regulators are still trying to figure out how to treat ICOs.
The events of the past few years have shown that there are risks associated with ICOs:
FOMO and hype
ICOs are marketed as explosive projects that will greatly appreciate in value. Investors are afraid of missing out (FOMO) and end up using more money than necessary on the ICO projects. The hype built around these ICO projects persuade people to invest in these projects without doing proper due diligence.
If the project fails, this could lead to big losses for the investors.
Playground for fraudsters
Up until recently, ICOs were unregulated and only a few countries have put ‘proper regulation’ in place.
Anyone with basic coding skills and without even a working product can launch their own ICO. This has attracted fraudsters who collect funds from unsuspecting funds, shut down their projects, and vanish in thin air.
People have lost millions to fraudulent ICO scams.
Lack of transparency
The ICO market lacks transparency although this is changing. ICOs do not provide sufficient information to the investors of what they intend to do with the capital raised. The risks of the projects are not highlighted while potential returns are greatly exaggerated.
This lack of information makes it difficult for investors to separate real projects from fraudulent ICOs.
Lack of investor protection
ICO investors are at the mercy of fraudsters as there are no rules in place to protect investors from failed projects.
Regulatory challenges and uncertainty
The ICO model is operating in a legal grey-area. Project leaders have to worry about regulatory uncertainty as some of them have been fined or imprisoned as a result of their ICOs.
Speculation and manipulation
The crypto market is fueled by speculation and there are some cases of manipulation. ICO issuers can engage in pump and dump schemes and collapse the entire project. Token issuers make off with huge profits while investors have to bear the losses. This conjures up the memories of a zero-sum game.
History and statistics of ICOs
The first token sale was held in July 2013 by a project known as Mastermind. However, ICOs broke on the scene in 2014 when Ethereum raised 3,700 ($2.3 million at the time) BTC in 12 hours.
In 2016, the DAO (Decentralized Autonomous Organization) raised $150 million in a crowdsale. While this was a huge success by any proportions and margins, the projects itself was not yet ready and had too many security vulnerabilities.
Hackers exploited this vulnerability that had been flagged before and siphoned off a third (between $50 million and $60 million) of the funds raised.
The ICO market picked up in 2017 when it experienced its biggest boom in a year in which the price of digital assets reached unprecedented highs. ICOs raised more than $4 billion in 2017 and this number tripled the following year.
By the first half of 2018, crypto projects had raised more than $13 billion. EOS raised more than $4 billion in its year-long ICO while Telegram raised $1.7 billion from two rounds of private funding in which about 81 accredited investors participated.
The boom in prices caught the attention of regulators who moved in swiftly to gain better control of the young market they had been watching but possibly ignoring.
South Korea and China, the two major markets for the crypto industry, banned cryptocurrency activities including ICOs. Many countries followed suit and this had ripple effects on their entire market.
The hostility towards ICOs by regulators subsided and instead of stifling innovation with stringent rules, regulators were willing to learn more about the industry and promote growth while protecting investors.
Countries such as Singapore, Liechtenstein, Switzerland, Malta, Cayman Islands, British Virgin Island, Estonia, Lithuania, etc. drafted crypto-friendly policies.
A report published by PwC and Crypto Valley indicates that the US is the leading destination of the ICO market. Asian countries such as Singapore and Hong Kong have also become major destinations for ICO projects.
ICO bust and future outlook
The hype around ICOs has died down and a more realistic approach is taken by people when investing in new projects. The ICO bust is due to the bear market and the regulatory uncertainty crippling the market.
However, this is expected in a cycle of innovation. The market will learn from past mistakes and work toward compliance and transparency. Security token offerings are also coming onto the picture with the aim of addressing regulatory concerns.
The market is still young. It is growing and evolving. The future, while unpredictable, looks bright.