What Is An ICO? Here’s Everything You Need to Know

Posted By Stephan Jukic – June 21, 2018

The market for ICOs absolutely went crazy throughout 2017 and into the beginning of 2018. However, with a major collapse in the cryptocurrency price bubble in late 2017, and a number of international regulatory crackdowns on new coin offerings, things started to slow down for a while.

Now in mid-2018, with cryptocurrency prices stabilizing, the landscape of new and upcoming ICOs is showing plenty of new promise. Regulatory improvements like the SEC’s recent announcements indicating that “good” ICOs will be allowed to flourish have some blockchain watchers predicting a massively expanding market for this wholly new investment vehicle as blockchain technology continues to mature. The logic here is obvious: Even if specific coins like Bitcoin, Ethereum or Litecoin suffer reputation-staining volatility, a good idea is still a good idea and people will adopt it if it’s useful.  And ICOs as a practical concept are indeed useful.

We definitely tend to agree with this logic, and for those of you who are curious about the future of ICO investment, this basic guide is a great starting point for understanding the fundamentals of what an ICO is and what kinds of ICOs are out there.. Let’s get down to business.

Also look forward to more of our upcoming guides on hot new ICOs and crypto investment in general as we keep them coming.

The Definition of An ICO

First, the most basic thing of all. ICO stands for Initial Coin Offering. This is somewhat similar to the already highly established financial vehicle of an IPO, or Initial Public Offering, in which a company goes public as a corporation with stock shares that can be bought and sold on the open market. Well an ICO is a similar sort of thing only in a much less formal or regulated context and with cryptographic tokens of ownership being made available for purchase instead of corporate stock.

More specifically, much like an IPO, an ICO is a way for a company, startup or other organization to raise funding by issuing cryptocurrency tokens of its own creation at a certain price and selling them off to the public. These tokens can then take on a market value of their own if they are also included for trading on the wider cryptocurrency market alongside established coins like Ethereum, Bitcoin, Litecoin, Monero, Ripple and others.

The typical structure of an ICO goes as follows: An organization that wants to finance some underlying application, business model or activity creates a newly minted crypto token or cryptocurrency unit (just like Bitcoin), which is either based on the organization’s own underlying cryptographic blockchain or on an already established blockchain that allows for alternative tokens to be created over it (Ethereum being a good example of this).

Having created their token and pre-mined a certain large quantity of them, the organization in question offers them up for sale by way of the ICO itself for the sake of financing their planned business model.

When this happens, a certain percentage of the tokens is typically held back by the company for its own use in case their value grows during public trading, or for later sale events. And the remaining coins are usually first distributed to select investors through what is called a pre-sale offering. This is sort of like a private stock equity distribution of the kind that many ordinary companies do before doing an IPO for the public stock market. Once the ICO pre-sale finishes, a wider public of investors is invited to buy as many tokens as they can from a public offering of them that’s usually announced in advance and with a countdown to when it’s going to go live.

The tokens that get released for sale by our hypothetical organization are usually sold off in exchange for established cryptocurrencies like Bitcoin, Ether (Ethereum) and others or for cash in the form of fiat currency (usually U.S dollars).

Furthermore, since the development of something called the ERC20 Standard, creation of new Initial Coin Offerings has become easier than ever. This is because the ERC20 standard essentially consolidates a lot of the preliminary development process for creating a new cryptocurrency into a standardized package that ICO creators can then modify to suit their own particular coin offering.

The Legal Standing of ICOs

Currently, at least in most of the world’s major markets, there are few restrictions on who can start and run an ICO. The field is still open and largely unregulated. As we’ll explain in a bit, this comes with its share of dangers for investors and ICO creators as well. It also however means that the ICO market is still going through some rapid innovations; it’s easy to enter the space and develop new creations on the fly.

In the U.S in particular, SEC Director of the Division of Corporation Finance William Hinman has very recently stated that ICOs designed by a corporate or business entity for the purpose of giving holders “a financial interest in the enterprise” can be considered securities and become subject to U.S securities law as it applies to IPO stock issues. ICO’s done by organizations for the sake of simply releasing a new coin as an open and decentralized project, without ownership claims in a given entity will however not be considered securities.

In other world markets, regulations vary enormously, are often highly ambiguous and also subject to frequent change. China, previously one of the world’s major sources of new ICOs and a huge participant in the overall cryptocurrency trading market, has since late 2017 applied a virtually total ban on trading existing tokens and on the creation of new ICOs within its borders. In basic terms, as far as the legal standing of ICOs goes, the landscape is still largely unstable and unregulated but for the most part, the market remains legal to all-comers.

Types of ICOs (Yep, there’s several of them)

We’ve given a basic definition of a “standard” ICO above but as our section on their legal standing and the SEC’s posture in particular shows, there are some major variations in how Coin Offerings work and the motives behind them. This can make defining types of ICOs into a very tricky thing that’s full of strange overlaps, but here are the basics:

To first put things simply, some ICOs are done by organizations with no intention of offering their tokens for sale on crypto exchanges, while most are indeed firmly geared towards getting those tokens listed on cryptocurrency exchanges for open public buying and selling. If this happens, the token price becomes fluid, with its value being subject to demand or lack of it on the open cryptocurrency market.

Beyond this, while definitions of ICO types are pretty varied and fluid, there are two main types of Coin Offerings as we’ve seen them emerge so far:

First, you have those, like the Ether ICO (also often just called Ethereum), which was launched in 2014 by the Ethereum Foundation as a completely decentralized token and released on the market with no concrete stake, utility or equity in any organization accorded to Ether buyers. A huge number of older ICOs, and many newer ones, work on this basis. Their token release during an ICO is essentially open and decentralized, with mining of further coins also being possible by third parties. Most of these are in fact currency token ICOs and because they’re meant to serve as currency, they’re geared more towards complete decentralization.

Secondly, there are what we’ll call business ICOs, usually unveiled by companies with the specific purpose of offering their buyers a stake in a company or organization.

To make things just a bit more complicated, these business ICOs usually create tokens that fall into even further ICO subdivisions. First you’ve got what are considered utility tokens, and then there are also asset/security tokens. Utility tokens normally offer some sort of utility, or access to services by the organization that issued them as a promise of ownership. Asset/security tokens on the other hand offer a stake of equity or earnings in the organization that releases them. They can mean access to interest payments, dividends or cash payouts down the road. Sometimes both utility and asset tokens are also eventually traded on the open market and thus become cryptocurrency tokens even if they still remain utility or security tokens!

Like we said, defining ICOs by type can get a bit convoluted.

Pros & Cons of ICOs

 

Regardless of evolving ICO definitions and types, what we absolutely can say about Initial Coin Offerings is that they are capable of offering numerous benefits to a broad range of players. These, for both users and issuers can be broken down into some of the following essentials:

Pros For Issuers:

  • Fast access to seed funds with hardly any legal restrictions
  • Totally new decentralized business models can be created
  • Few major legal expenses involved for compliance
  • Arbitrary upper limits on funding
  • No dependence on any one VC funding group or investor
  • No need to give up equity unless ICO involves sharing company assets
  • Access to global body of individual investors

Pros for Holders/Buyers

  • Possibly huge returns on token value
  • Access to much more varied speculation/investment opportunities
  • Easy, accessible participation in innovative new tech projects
  • Investment diversification
  • Minimal buy-in restrictions for most ICOs

Cons for Issuers

  • The vast majority of ICOs completely fail and funds need to be returned
  • Regulatory uncertainties
  • Unstable token values
  • No easy control of who buys and holds tokens (possible criminal owners)
  • Extreme risks of hacker theft

Cons for Buyers

  • Most ICOs fail and the one you bought into probably will too
  • No or minimal regulatory protection
  • Poor access to unbiased information on ICO creator
  • Dangers of asset theft by hackers
  • Poor transparency

What ICOs Mean For Investors

Investors who do buy into ICOs despite all the risks they present can often earn an enormous return on their initial investments as the tokens in question really hit it off with the market and become highly sought after. This applies especially for early investors who buy during a presale. This is also when an ICO is at its riskiest, but as some examples of 2017 ICOs show, These Coin Offerings can sometimes deliver absolutely astronomical returns to their buyers. Some of them have even given token owners returns in the thousands of percentage points on whatever they bought in with. The examples below of famous 2017 ICOs in the cryptocurrency sphere show just how impressive some results can be:

  • 823,750% in DubaiCoin
  • 75,063% in Cryptonite
  • 59,577% in Influxcoin
  • 13,595% in FastCoin
  • 11,328% in Decred coins
  • 8,313% in MediterraneanCoin
  • 8,294% in Quark
  • 7,477% in Golem coins
  • 6,792% in WorldCoin
  • 6,045% in MaxCoin

On the other side of the coin (pun fully intended), the ICO market today as a whole is still EXTREMELY speculative, with a huge percentage of known ICOs either turning out to be outright scams or simply failing in their funding targets and being forced to refund investor money when their due-date for a certain funding goal expires. One study recently done by the website Bleeping Computer in fact showed that at least 81% of all ICOs held last year ended up being outright scams, a further 11% failed or died before fruition and just 8% ended up being listed on cryptocurrency exchanges with potential growth in the value of their tokens. In other words, the ICO market, for all the possibly spectacular returns it can deliver (as shown above) can also be an outright lottery in terms of speculative riskiness.

Story by tokenmaven.com

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