In the world of blockchain and cryptocurrencies, the number of trends is seemingly limitless. However, if you are looking for the biggest trend in the field, initial coin offerings, or ICOS, are a good place to start.
ICOs are a complex yet effective instrument for raising funds, having been used to collect a sizable amount of money in recent years, bringing in $12 billion in the first half of 2018 alone.. These successes have drawn the public’s attention, and the desire to learn more about ICOs continues to spread.
For those who are interested, we created an in-depth guide to give you an overview of ICOs and help you better understand this rapidly-growing form of fundraising.
The Definition of an Initial Coin Offering
An initial coin offering or initial currency offering is a type of funding where money in the form of an established cryptocurrency is given to the offerers of the coin, generally a company or a cryptocurrency startup, in exchange for an equivalent amount of the new cryptocurrency.
Those who purchase the coins own a percentage of the currency’s total value, similar to how investors who buy shares of a company’s stock own a percentage of the company. By that same analogy, ICOs are the cryptocurrency equivalent of IPOs (initial public offerings). Due to the unregulated mechanism of ICOs, they are usually used to bypass the regulated and rigorous traditional systems for raising capital.
ICOs have been truly revolutionary for their industry. They allow anyone who is interested in a project to become a part of it by purchasing its tokens. In addition, ICOs provide businesses and cryptocurrency startups with the simplest path of getting the necessary funds for their projects while allowing them to retain complete control over the whole process. This ability is not always present with traditional fundraising.
The History of ICOs
The history of ICOs starts in mid-2013 with J.R. Willett and his Mastercoin project. In The Second Bitcoin White Paper, Willet suggested utilizing Bitcoin as a base protocol layer for higher level protocols in the future, similar to the way Ethereum is used as a platform for other cryptocurrencies. The Mastercoin project would go on to be the first project to ever facilitate the ICO mechanism, raising around $500,000 worth of Bitcoin. However, due to the fact that it is not Turing-Complete, Bitcoin was unable to perform multiple important functions necessary for the Mastercoin project to work.
It was not until Ethereum entered the scene that the cryptocurrency community started noticing this funding system. With Solidity, Ethereum’s own scripted language, many issues that Bitcoin initially encountered were solved. Written mainly in a Turing-Complete language, Ethereum allowed everyone to create their own arbitrary rules of transaction and ownership, essentially creating smart contracts. In September 2014, during the project’s ICO, Ethereum raised $18.4 million.
Ever since then, this technological breakthrough keeps growing and advancing into a preferred funding system for companies, startups and other projects.
How Do ICOS Work?
Everything begins with an idea. For a startup to have a need to establish an initial coin offering they first need to come up with an idea for a blockchain project that has the potential to be accepted in the community.
Once the startup finds the traction, the team usually proceeds to draft a white paper. This document includes all of the details of the coin and its surrounding system, ranging from technical aspects to the team behind the project to their future plans. The majority of startups put considerable time and effort into their white paper since it is often a deciding factor for investors.
In order to gain momentum, startups launch marketing campaigns informing the public about the token sale and the date it is scheduled to begin. The participants in the sale are already familiar with the prices of the tokens, as well as the rules of purchase and the use of the tokens.
After the ICO begins, a predetermined amount of time passes during which the coins are offered for sale. After the allotted time has passed, the ICO ends. Following the closure of the sale, the investors receive their tokens and can go live on exchanges for trading purposes.
The result of this process is a group of early investors who hope to make future profits by getting tokens from promising startups. Although this summary is relatively simple, there’s a lot more that goes on behind the scenes of a successful ICO.
The more complicated version of understanding the way ICOs work includes a close-up look at smart contract networks. Varying in their strengths, ideal use-cases and architecture, all of these networks make use of a decentralized blockchain. While there are many famous examples such as NEO, Tron, and EOS, the most popular ICO platform, without any doubt, is Ethereum.
The ERC20 Standard is a principle followed by the majority of tokens launched in Ethereum-based ICOs.. The ERC20 standard includes six constitutional token functions and outlines the programming rules that the tokens must follow. Due to the standardization of these functions, all of the developers know exactly what to expect when they work on ERC20 tokens.
It is crucial to note that smart contracts are of vital importance to the system. The open-source programming guarantees several crucial points are reached, including the receipt of the Bitcoin or Ether that are contributed. In return, the purchaser is given the equivalent amount of the project’s cryptocurrency, and in some cases giving the investment back if the project does not reach the minimum goal of fundraising.
All of the aforementioned tasks of smart contracts are accomplished automatically and without an intermediary. Such a feature is designed to protect investors.
The following is an example of how an Ethereum-based ICO functions:
First, using the Solidity code, the ICO host creates their brand-new cryptocurrency. These coins are later placed in their own wallet. As a participant, you send a specific amount of Ethereum (ETH) to the wallet of the host. Once the Ethereum is received, you receive some of the new cryptocurrency in return. The amount of the cryptocurrency you receive is fully dependent on the value the host gives the currency at the time of its creation. Since both the new token and Ethereum use the ERC20 Standard, the participants are not required to create separate wallets.
The overall process of participating in an ICO is relatively straightforward. Some minor differences are often specific to the cryptocurrency in question or the development language that’s used. However, you should be wary of projects that keep their code hidden. Reputable teams make their smart contracts visible to the public.
ICO Tokens Explained
ICO tokens, generally called crypto tokens, are the most talked-about part of ICOs. It can be difficult to pinpoint the exact definition of a token, so we decided to present a definition that is generally accepted in the industry.
A token is a representation of value that is not set by objective market criteria. It can be a stake, service, redeemable reward system, entitlement or anything else that can meet its value. In short, tokens are entities that carry an agreed-upon value specified by the parties involved in the transaction.
To be clear, tokens are not a currency. To create and issue tokens, you do not have to create a blockchain, something cryptocurrencies require in order to function as designed. Instead, you will need to use an existing blockchain to create tokens and smart contracts. Examples of cryptocurrencies are Bitcoin, Bitcoin Cash and Ethereum. Examples of tokens are projects like Golem and OmiseGo that exist on established contract platforms such as Ethereum.
According to the U.S. Securities and Exchange Commission (SEC) there are two types of tokens—security tokens and utility tokens.
Security tokens are tokens that pass the Howey Test. For a token to pass this test, it has to be an investment of money, an investment in a common enterprise and has to include the expectation of third parties and promoters to make a profit from it. Securities tokens are regulated by federal financial authorities since their value is derived from tradable, external assets.
Contrary to securities tokens, utility tokens do not need to pass the Howey Test and therefore do not meet the necessary criteria. Simply providing the users with specific products and services, these tokens are often thought of as gateway tokens.
Utility tokens provide the holders with the right to use a certain network and take advantage of it by voting. In most cases, ICO systems operate with utility tokens, because the systems generally are not regulated by government agencies.
Pros of ICOs
Among the strong points of ICOs is the opportunity for promising projects to shine. The best example of this is Ethereum. This cryptocurrency project has achieved so much over the last three years, none of which would have been possible without the funds raised in their initial coin offering.
Additionally, ICOs establish a rapport between the community and the projects. Due to the healthy relationships within many blockchain communities, a number of startups are able to raise ICO money organically.
ICOs are also beneficial to the investors not only because they provide them with a sense of security but also because they have the potential to profit from the next big development in the cryptocurrency scene.
For the developers, ICOs provide an encouragement to be creative and go a step further with more innovative and exciting projects. In a similar vein, blockchain crowdfunding continually profits from the hype and demand for crypto projects.
Cons of ICOs
While a sense of security is present when investing in legitimate ICOs, that same sense may be misplaced in other cases. Since ICO systems lack actual paperwork, numerous scammers have entered the scene in hopes of making quick money. This is why the open-source method is a double-edged sword.
An additional critical feature of ICOs is that the investors are not actually investing in a project but in the idea of it. That, however, is a prevailing investment risk because no one can truly know whether the project is going to be a success or not.
A final downside worth mentioning is the presence of “crypto whales.” Crypto whales are individuals that invest in a huge number of tokens, which defeats the ICO’s decentralization purpose.
Other points can also be categorized as disadvantages, including the future possibility of government intervention and regulation, as well as the expendability of ICO events.
Are ICOs Legal?
ICO regulations differ from country to country. For instance, the United States is still working out the regulatory kinks while countries like Malta and Switzerland have taken a more hands-on legislative approach.
The Commodity Futures Trading Commission has classified the tokens used in ICOs as virtual currency. With this classification, the tokens require a specific set of licensing. The Internal Revenue Service has also classified tokens and has set rules governing how they will be taxed.
Given the regulatory variation from country to country surrounding ICOs, it is advisable to seek specific information about the regulations in your country before attempting an ICO.
How to Find ICOs
If you have never invested in cryptocurrencies and you are looking to buy into ICOs, we highly recommend familiarizing yourself with the industry before doing so. Since ICO tokens require purchase using existing cryptocurrencies, investors must already have a crypto wallet set up. These are details you as an investor must pay attention to and educate yourself on. It may be a small step, but it is necessary to participate in any ICO.
For those who are already familiar with cryptocurrencies, but have never participated in an ICO, this is what you need to know. The first step to becoming involved is to sign up for a digital currency exchange. While there is a multitude of options from which you can choose, we suggest using Coinbase.
Then, figure out which cryptocurrency you will need in order to buy into the ICO and purchase an appropriate amount. The digital wallet to which you will transfer your holdings must be compatible with the ICO. This means that if the ICO requires Ether payments, your wallet needs to be able to hold Ether.
Following this, you will need to do your research. Always make sure you are signing up through the official page and have read all the information available on the website. Browse through the terms of the ICO, their whitepaper and everything else they have made available. There is no such thing as knowing too much.
Once you are ready to begin, look for entry buttons labelled with phrases such as “Participate now” or “Enter the token sale.” Then you will be asked to register for the ICO and to provide the address to your wallet.
On the launch day of the token sale, follow the instructions on the site regarding the purchase of the tokens. Most often, these instructions will follow the process we outlined above As soon as you receive your tokens, you can hold onto them or exchange them for other digital currencies or traditional currencies. There are also cases when you will need to hold the token until it is placed on the exchange’s list in your region.
ICOs are a major development in the blockchain industry and it will be interesting to see what the future will bring for them.
As of now, we can only hope the increased legislation regarding ICOs will bring peace to the system and flush out the fraudulent ICOs instead of hurting the structure irreversibly.