What is an ICO (Initial Coin Offering)? - FX Leaders

Home / Cryptocurrency / What is an ICO?

What is an ICO?

What is the first thing that comes in your mind when you read the term ICO? You probably think of greedy investors trying to make a quick buck, or you might think of it what it really is: a new, uncomplicated and easy fundraising model. In fact, many founders of start-ups with great and innovative ideas who lack the capital to kickstart their business idea made hay while the sun shones and used ICOs to fundraise their company. But what is an ICO?

 

Definition

ICO stands for initial coin offering and is very similar to an initial public offering (IPO), but with a few differences. First and foremost, ICOs are an unregulated process and therefore, there is no protection of the investors. Secondly and because of that, investors of ICOs are not granted any rights while stock investors usually own a percentage of the company and have voting rights. Neither of those features are involved in an ICO investment. Another important point to mention is the fact that investing in ICOs is a much easier and faster process. For instance, you don’t need to be an accredited investor and you don’t even need to involve your bank. All it usually takes is that you buy cryptocurrencies which you then send to the smart contract address of the ICO.

And that’s what makes ICOs so convenient. It capitalizes blockchain technology which secures safe, transparent and an unforgeable allocation of the funds. However, it certainly comes with a potential risk factor, as you need to send your money by yourself to the right wallet address. If you fail to send it to the correct address, for example, if one letter of the wallet address is wrong, your money is gone forever without a chance of a refund. 

 

Associated Costs of ICOs

So why would you choose an ICO over an IPO? Generally speaking, an ICO is much cheaper and doesn’t require loads of starting capital.

In fact, according to a PwC study conducted by Oxford, 83 percent of CFOs surveyed evaluated the costs associated with an IPO to be more than one million U.S. dollars on one-time expenses. Furthermore, Jay Swob, an ICO attorney, stated that “the overall legal costs associated with creating an ICO if a company creates one on U.S. soil, which is, therefore, subject to U.S. Securities law, is approximately $100-$150k. However, an ICO conducted off-shore in, for example, the Cayman Islands which means no U.S. investor participation could cost as low as $50-75k. That means the possibility of using an ICO as a startup mechanism is now more accessible to more founders.”  according to Forbes. Bernhard Blaha, who raised two million U.S. dollars through an ICO, supported these estimates.

 

How Does an ICO Work?

Unbelievable, but true: Tenx, a blockchain start-up which used an Initial Coin Offering (ICO) as their fundraising method, has raised $80 million in under seven minutes, and EOS, another blockchain start-up, has raised four billion U.S. dollars in the course of a couple of months. Globally speaking, ICOs have raised $13.7 billion during the first five months of 2018, according to a report by PwC in collaboration with the Crypto Valley Association.


Nevertheless, this is still a comparatively tiny amount in contrast to the $188.8 bln which were raised by traditional Initial Public Offerings in the previous year, according to the E&Y IPO Global trends report.

 

Yet, it’s important to recognize that companies which went the traditional fundraising model of an IPO have come a very long way before they were given the opportunity to raise money in a public context. Start-ups, on the other hand, are often facing a very hard time seeking out investors, often getting rejected countless times by discerning investors. Then again, start-ups in the real world often have a real product and are solving real problems, while ICOs were known to deliver nothing more than a website and a vision, regardless of how far away from the practical reality.

Of course, great ideas need great resources and, as such, appropriate funding definitely play a significant role in getting things to work. As a result, startups often depend on the investors’ willingness to fund them, and raising money through the blockchain technology is a walk in the park compared to the struggles which come along with convincing smart investors.

In fact, all it takes is to implement a funding page with a correct setup of a smart contract, which issues tokens after someone contributes money to the smart contract, on your website. For blockchain professionals, it is a matter of days to weeks to integrate such a fundraising model.

 

Thus, raising capital through the blockchain can be a very cost-efficient and easy way to raise money for start-ups. Given the fact that token offerings issue no right for token holders and the SEC recently hinted that ICOs might not be declared as security issuing, it might be the cheaper and less risky way, especially when it comes to legal expenses.

 

How to Join Initial Coin Offerings?

There are plenty of websites ranking and listing various different ICOs, whether they are ongoing or taking part in the future. For example, Icobench, lists all kinds of different ICOs, declaring the start date and the end date of the ICO, how much they will raise, the website of the project and their individual rating.

But before you are able to invest, you should buy cryptocurrencies. The easiest way is to go to Coinbase and buy Ethereum directly with credit cards. Most ICOs are Ethereum-based ERC20 tokens, which is why most of the ICOs accept Ethereum as payment. Also, the smart contracts to receive and send the tokens are set up by the Ethereum blockchain, which runs so-called smart-contracts. 

 

Should I Invest in ICOs?

No, it is no longer advised to invest in ICOs if you are interested in growing your investment capital. In fact, the Satis Group released a paper which concluded that nearly 80 percent of ICOS conducted in 2018 were scams:  “on the basis of the above classification, as a percentage of the total number of ICOs, we found that approximately 78% of ICOs were Identified Scams, ~4% Failed, ~3% had Gone Dead, and ~15% went on to trade on an exchange.”


In addition, you can only make a profit on ICOs if they start trading on exchanges. However, it is no longer enough to be listed on a small exchange; it needs to be a major exchange like Binance or Kraken to see a significant effect on the price.

But those exchanges take a huge listing fee, which is why most ICOs can’t afford to be listed on them. 

 

Initial Exchange Offerings

Interestingly enough, there is currently a new hype in 2019 about blockchain token issuing. However, it is no longer called ICO, but IEO, which stands for Initial Exchange Offering. Those token offerings are just the same as ICOs, blockchain start-ups raising funds, but are managed and promoted by an exchange like Binance.

Binance had eight Initial Exchange Offerings so far, which most of them had a positive and very high ROI (Return of Investment). Thus, we can certainly see IEO replacing ICOs as a powerful investment tool.

 

Future Outlook

Regardless of the current possibility of conducting an ICO, blockchain enables companies to cost-efficiently issue securities which will inevitably lead to security token offerings (STOs) in the future. Although ICOs may be not be conducted in the future, IPOs will definitely be replaced by STOs through the numerous benefits of the blockchain technology, such as the incredibly fast transaction speed, the redundancy of third parties, and the elimination of trust due to an evidence-based database. The digitization and tokenization of stocks is the logical next step in order to adapt to the changes in technology and to transform the traditional system into a more efficient one.

While big players like Facebook, IBM and many others declared their interest in blockchain technology, they didn’t show any signs of conducting an ICO. ICOs are still an unregulated process and none of them were declared as an STO.

About the author

Konstantin Kaiser // Professional Analyst and Day Trader
specializing in the Cryptocurrencies market. Konstantin is also a popular financial writer covering the blockchain for websites like fxleaders.com and investing.com.