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What Does an Initial Coin Offering (ICO) Mean? Different types and benefits of ICOs?

Key Takeaways

  • ICOs are the first token sales by crypto start-ups and online projects looking to raise capital without selling stock or seeking venture capital.
  • A successful ICO can provide investors with a solid return on their investments.
  • The lack of government oversight makes ICOs more prone to losses and volatility than the stock market IPOs.

Initial coin offerings (ICOs) were quite popular in 2017 and 2018. But what are they, and how do start-ups raise funds from them?

What is an initial coin offering?

Quite akin to an initial public offering (IPO), an ICO is a crowdfunding method where investors purchase tokens released by new cryptocurrency startups and projects. In lieu of selling equity in their company through an IPO or seeking alternative financing, companies can issue tokens and sell them on their own blockchain. This method of raising funds involves selling the underlying tokens of a cryptocurrency project for Bitcoin, Ether, or a fiat currency.

In an ICO, a blockchain company issues digital tokens to fund a project or platform and distributes them. ICO tokens do not give investors shares in a company but instead grant them access to a service or a share of earnings. 

How is an initial coin offering conducted?

Companies that launch ICOs embed a value in their new currency. This happens with multiple rounds of fundraising during the ICO. Tokens often increase in value until the release date, with early investors likely to be rewarded more. The process of ICO goes through the following steps:

Design the tokenomics

The first step a blockchain start-up takes for an ICO is to design its tokenomics. Designing a token begins with identifying its utility and constraints. Utility depends on the token’s role within the product ecosystem. The founders can then decide on the basics, such as the market cap, total token supply, type of consensus protocol to be used, transaction fees, economic model, and so on. 

Write a whitepaper

The next step is to write a whitepaper. A whitepaper highlights details such as the project outline, a thorough breakdown of the project and the solution, detailed market analysis data, development roadmap, valuation, and the duration of the ICO campaign.

Focus on the marketing

Following that, the start-up will generate industry buzz so that the coin is available for sale at a pre-decided date and time. This involves the distribution of the white paper within different communities, social media platforms, and crypto forums to attract potential investors. Interested investors buy the tokens using BTC, ETH, or other preferred cryptocurrencies.

Smart contracts govern token issuance. They are self-implementing contracts that facilitate trustless transactions and, in the case of ICOs, assist in minting new tokens, distributing and reselling them, as well as defining future earnings and responsibilities. The process involves developing ERC-20-compliant smart contracts, auditing them, and deploying them to Ethereum.

The most common blockchain platform for ICO launches is Ethereum since it supports smart contracts that automate the generation and distribution of tokens. There are two popular models for token sales:

  • Soft caps: In a soft caps model, an ICO must raise a minimum amount of funds to succeed, and contributors must request a refund when an ICO does not reach its soft cap.
  • Hard caps: The hard cap refers to the maximum amount that can be raised during an ICO. Once the hard cap is reached, the ICO comes to an end.

A digital currency protocol, Mastercoin, launched the first ever ICO in 2013. It raised about $5 million within the first day of its launch. The Ethereum ICO then followed, which at the time raised about $18 million. ETH’s debut price was $0.30, and the ATH was over $4,000 (at the time of writing).  

What are the types of ICOs?

Getting involved in a new ICO requires knowing what types there are. There are two options at present.

Private ICOs

A private ICO aims to raise capital by engaging a limited number of investors, which often include financial institutions and high-net-worth investors. Founders can set the minimum investment for their ICO.

Public ICOs

An ICO can also take the form of a public initial coin offering, similar to an IPO. It is a form of crowdfunding aimed at attracting institutional investors and the public. The regulations surrounding private ICOs, however, make them more practical than public ones.

What are the benefits of ICOs?

Here are some benefits of ICOs: 

  • Unconventional choice of crowdfunding for blockchain projects and start-ups
  • Scope for networking for crypto investors and start-ups
  • Facilitation of open-source blockchain development
  • Potential positive returns and return-on-investment for early investors

Are ICOs risky?

Initial coin offerings (ICOs) have made a tremendous impact on capital-raising operations. The fact remains, however, that a number of ICOs are launched by unreputable businesses that make colossal sums of money and disappear without following up on their roadmap.

This new fundraising model in finance is highly popular around the world, so unwitting investors have little recourse in the event of fraud.

The future of ICOs depends on how investors and companies respond to regulators’ scrutiny. As an alternative to ICOs, investors can also participate in: 

  • IDOs: Initial dex offerings (IDOs) are token launches through decentralized liquidity exchanges. Example: RAVEN launched on Binance DEX.
  • IEOs: Initial exchange offerings (IEOs) are token launches overseen by a crypto exchange. Example: BitTorrent launched on Binance Launchpad.

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Frequently Asked Questions

1. Are ICOs legal?

There is little regulation of ICOs in most cases. As a result, there is no rule to prevent companies from fleecing investors. However, the U.S. Securities and Exchange Commission (SEC) regulations apply to some ICOs (the U.S. and outside of the U.S.). India does not have a regulatory body for ICOs, unlike IPOs, which are governed by the Securities and Exchange Board of India (SEBI).

2. How can I identify a scam ICO?

Some signs of a fraudulent ICO may include:

  • An anonymous team 
  • Absence of a project roadmap
  • Absence of project code 
  • Absence of PR activities and an active, engaged community

3. How does one participate in an ICO?

Following are the steps to participate in an ICO:

  1. Find the coin you would like to buy along with its release date. 
  2. Create an account with an exchange that lets you trade the token or sign up for or buy a cryptocurrency wallet that supports the token. 
  3. Send assets to your cryptocurrency wallet after making the ICO purchase on the specified website.

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