Introduction to Initial Coin Offering (ICO)

Cryptocurrencies can allow you to raise funds without opening your capital and in record time throughout Initial coin offering (ICO). But how does ICO, the new way of raising funds, work?

What is an ICO?

An ICO is not a traditional fundraiser but a public participatory financing method based on blockchain technology. It allows a start-up to raise funds by issuing and selling virtual tokens. Investors buy this digital asset most often by exchanging other cryptocurrencies (bitcoin, ether, etc.), although euros or dollars are sometimes accepted. Once the ICO is completed, the company can exchange the Bitcoins it has received for traditional “fiat” currency.

But as there is an absence of a legal framework, each company is free to set its own rules.

What are the tokens used for?


Beware, a token does not correspond to capital shares. In the majority of cases, the tokens just gives the holder the right to use the services sold by  the start-up. Tokens are sold to users attracted by a project, a service or a product: they are its future clients. It does not confer any rights, neither in the capital nor in the dividends of the start-up.

In fact, buyers speculate, for example when a start-up offers to pre-purchase at an attractive price a product that makes the buzz (FOMO)… hoping to resell it at a higher price.

The Importance of the White Paper


No due diligence, pitch and valuation and mandatory for ICOs: in the world of ICOs, the company chooses itself the value of its token and the quantity it wants to put into circulation while guaranteeing its liquidity often through an exchange platform so that it can be resold like a stock! To do this, the start-up pays a fee to the platform – such as Bittrex, Binance or Kraken – to list its tokens.

To learn more about the project, investors should take a deep look into the white paper published by the start-up. It is an essential document that serves as a reference document and contains precise information on the start-up’s team, its project, a detailed development plan and the terms of the ICO.

Advantages of ICOs

Being financed through an ICO brings several advantages to a company compared to conventional financing methods:

Speed and ease of fundraising by ICO


When a start-up launches its ICO, it can set a “cap”, i.e. a ceiling to be reached (e.g. $10 million) and/or a deadline (e.g. 3 months). Thus, the setting up of an ICO and the arrival of funds can be much quicker than venture capital or IPO financing, where several intermediaries have to analyze the project, the business plan, the market or the financial soundness. If the community likes the project more than expected, it is possible that the ICO can raise sometimes astronomical amounts of money in a very short period of time. The ICO, therefore, has the advantage of speed and ease.

ICO: no borders and low cost


ICOs also have the advantage of being able to reach an international audience, beyond the borders of one country. It is thus possible to raise funds from the four corners of the world, the number of different countries can sometimes exceed one hundred! Launch costs are often lower as ICOs bypass the long and costly conventional fundraising process. In France, it is estimated that raising funds through traditional fundraising costs around €500,000, not counting the time and energy spent building up a voluminous file. For an ICO, an expert lawyer may suffice. On the other hand, it is not totally free, many expenses are to be expected as for websites, servers or marketing campaign.

With ICOs, there is no capital dilution


The ICO brings a remarkable advantage since it avoids the phenomenon of dilution of the company’s capital to the benefit of external investors. It is therefore not a question of giving shares in the company to investors as a share, nor does it give them decision-making, management and strategic powers. This allows the decision-making power of the start-up’s directors to remain intact.

Liquidity, earnings and openness


Investors get tokens, which are highly liquid assets on most trading platforms, that they can trade or hold, depending on their earnings and time horizon. Gains can also be multiplied tenfold, since the cryptocurrency markets are highly volatile, with daily variations that are not comparable to the equity markets, for example, and can reach tens, even hundreds, of percent in a few days. It is not uncommon to see the price of a token multiplied by two or three when it enters the exchange platforms!
Finally, a common advantage for investors and entrepreneurs is that ICOs are open to everyone. Investing in an ICO does not require any special accreditation for investors, all you need is a validated virtual portfolio and access to the ICO site. Note that it is nevertheless possible that not all countries have access to all ICOs, depending on the policies and regulations in force in each country.

Disadvantages and Risks of ICO Funding

Risks of scams

The world of ICOs, and generally speaking of cryptocurrencies, is still very little regulated today and therefore the scams exist. After the ICO a company can collect the sums collected and not give any sign of life, it is called an “exit scam”. For example, in April 2018, the Vietnamese company Modern Tech disappeared after raising $660 million during its ICO for the Pincoin Token.

Volatility and loss


By definition, once tokens are issued and sold to investors, they can be traded on online trading platforms (which are increasingly resembling real marketplaces), where their price depends on supply and demand. Thus, on the investors’ side, the high price volatility caused by high liquidity of assets can be a brake on investment in the medium or long term. Short-term speculation and trading can generate rapid but substantial gains. Moreover, since prices are currently unregulated, they are regularly manipulated by groups of individuals with large funds, who can influence the market by placing orders for considerable amounts, thus accelerating losses (but also gains) among the various market players.

Legal regulation


The current legal vagueness reinforces the crypto-skeptical climate of the general public, as investors do not know what legal status to give to crypto-assets that are not considered as “currencies” in the eyes of the law but as intangible assets.

The evolution of ICOs

The first ICO was carried out in July 2013 by the American developer J.R.Willett to finance Mastercoin 10 (now Omni) project. Mastercoin’s ambition was to add functionality to the Bitcoin protocol. In thirty days, an ICO of 4,740 Bitcoins (BTC) was obtained which correspond to more than $500,000. The following year, in 2014, the Ethereum project, developed by Vitalik Buterin in 2015 and raised the equivalent of $18 million.

The number of ICOs increased a lot since then and  today ICO can raise hundreds of millions of dollars. Top biggest ICOs since 2014 are :

Top biggest ICOs since 2014 (in million dollars)
Source: Infogram

Conclusion

 

ICOs have been an extremely hot topic these last years and we hope that we were able to throw some light on the subject for you.  If you think you’re able to make benefits from a new ICO, just make sure to do your homework beforehand. Cryptocurrency is all about high risk and high reward, and ICOs are no different.

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