From 2016 to 2017, crypto startups raised funding in two ways: with the help of venture capital or through ICO (Initial Coin Offering) – cryptocurrency crowdfunding. The main difference between these methods was not in technical features but in the investors’ approaches. Venture capital funds carefully analyzed business models and looked closely at startup teams. Funds and angels asked the founders of the newly minted questions like: Is there enough demand for the product? Is the MVP (minimum viable product) ready? Can the startup team turn the idea into a business?
What is an ICO?
An Initial Coin Offering (ICO) is a way to raise and raise investments for projects related to cryptocurrencies. The team creates its blockchain-based tokens to distribute to early investors as part of the ICO. The initial coin offering acts as crowdfunding: users receive tickets that they can use (immediately or in the future), and the project gets development funding. This model became popular in 2016 when it was used to fund the development of the Ethereum network. Since then, hundreds of projects have resorted to ICOs (especially during the boom in 2018) with varying degrees of success. Although the name of such crowdfunding is reminiscent of an initial public offering (IPO), the two methods are entirely different ways of raising funds.
ICOs can be a possible alternative to traditional tech startup funding. IPOs are usually applied to existing businesses that sell their shares, which provide partial ownership of the company, to raise funds. In turn, ICOs are used as a fundraising mechanism that allows companies to attract investments for their project at the earliest stages. When ICO investors buy tokens, they do not acquire ownership of the company. Often, new entrants struggle to get investment without any functioning product. In blockchain technologies, well-known firms rarely invest in projects that have only one whitepaper.
Moreover, the lack of regulation of cryptocurrencies prevents many investors from taking blockchain startups seriously. However, this practice applies not only to startups. Some existing companies choose to launch a reverse ICO functionally like the regular one. In this case, the business already has a product or service and offers tokens to decentralize its ecosystem. Alternatively, they can also use ICOs to attract a broader range of investors and capital to form a new blockchain-based product.
How ICOs work
You can organize initial coin offerings in different ways. Sometimes the project team has a functional blockchain that will evolve over the upcoming months and years. In this case, users can buy tickets immediately sent to their addresses on the blockchain. If the project does not have its blockchain, tokens are issued on an already existing network with a good reputation (for example, Ethereum). After the launch of the new chain, users will be able to exchange their tokens for new ones. Most often, tokens are issued on a blockchain with support for smart contracts. The Ethereum network is used for this since many solutions use the ERC-20 token standard. There are now over 200,000 different Ethereum tokens, although not all of them started with an ICO.
In addition to Ethereum, other popular blockchains can also be used for this purpose, such as Waves, NEO, NEM, or Stellar. Given the flexibility of these protocols, many organizations do not plan to migrate to another platform, preferring to continue working within the current one. This approach allows them to leverage the network effect of the existing ecosystem and gives developers access to means that have already been tried and tested. The rules for conducting an ICO are announced before the direct collection of investments. The team can determine the duration of the offer or set a hard cap – a limit on the number of tokens sold. The project may also introduce an allow list in which users must register before participating in the ICO. Users then send funds to the specified address. Most payments are accepted in bitcoin and Ethereum due to their popularity.
Buyers deliver a new address to receive the tokens, or the tokens are automatically sent to the address from which you created the charge.
Differences between ICO and IEO
An Initial Coin Offering is like an Initial Exchange Offering (IEO). The fundamental disparity between them is that the IEO is placed not only by the project team but in cooperation with the cryptocurrency exchange. The partnership with the exchange allows users to buy tokens directly on the exchange platform. This can be beneficial for all participants in the process. When a reputable deal supports an IEO, users can expect the project to be subject to strict scrutiny. The team behind the IEO benefits from a lot of attention, and the exchange benefits from the project’s success.
Security token offerings were once referred to as a new type of ICO. From a technological point of view, they are identical, tokens are created and distributed in the same way, but these are entirely different approaches from a legal point of view. Due to some legal uncertainty, there is no consensus on how regulators should qualify ICOs (more on that below). As a result, the industry still does not feel any meaningful regulation. Some companies decide to use STO to offer shares in tokens. The issuer of tokens registers its offer as an offer of securities with the relevant government authority, which equates this type of asset to traditional securities. In addition, it can help them avoid some client uncertainty about the project’s legal status.
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