Initial Coin Offering (ICO)
What Is an Initial Coin Offering (ICO)?
An initial coin offering is essentially the crypto version of an initial public offering (IPO). When a crypto company is designing a new token, it needs a way to obtain funds for developing its digital assets. Some companies have relied merely on word of mouth, letting any interested people gradually join by mining coins. However, many prefer to start with a more straightforward method.
In an ICO, a crypto organization starts a campaign to describe their project and explain their goals. Users can then choose to purchase coins as a means of investing in the company. Depending on the type of launch, they can keep these coins as an investment, use them as a currency or sell them to others.
Though ICOs and IPOs have the same general purpose, ICOs tend to be a little more complicated. Generating coins requires a few additional steps, and since ICOs often occur earlier in an organization's launch, it requires more marketing and investment presentations. Since crypto tends to be more versatile, some ICOs may be conditional campaigns where investors' money is returned if the campaign doesn't live up to its initial promise.
History of ICOs
Initially, most cryptocurrency groups launched their coins simply by opening mining to the public. However, as cryptos became associated with stocks, some companies began borrowing concepts from the finance industry. In 2013, Mastercoin decided to mimic the concept of an IPO for their crypto release.
The concept of ICOs quickly took off. In 2017, ICOs were able to raise 40 times as much capital as they had the previous year. Since then, the majority of new cryptos have chosen to include some version of a coin offering during launch. There has been growing recognition that some government regulation is required, and starting in 2019, the SEC has started to focus on preventing fraudulent scams.
To better understand the role ICOs play in the crypto market, let's take a look at three of the most notable ICO events.
Ethereum was the first major cryptocurrency to generate funds with a coin offering. In 2014, Ethereum offered interested buyers the chance to exchange Ether (ETH) for Bitcoin (BTC). This deal proved wildly popular. Within the first 12 hours, roughly $2.2 million worth of money was collected. Overall, 50 million Ether were sold during Ethereum's ICO, making it one of the most successful ICOs to date.
Ethereum is especially of interest because it's become a critical part of many other ICOs. ERC-20 tokens are fungible coins that are often considered the standard for smart contracts. Therefore, many companies that haven’t been able to actually generate their own assets use ERC-20 for their ICO.
Cardano is another early platform, which utilizes blockchain technology, to benefit greatly from adopting the ICO format. Its crypto, ACA, was one of the first to be almost solely funded by a coin offering. Its initial offering attracted investors by describing the blockchain's energy-friendly philosophy and highly-credentialed founders.
The marketing strategy paid off, and the platform launched with an impressive market cap of $600 million. The crypto continued to grow, so early investors have seen very impressive returns. Cardano is currently the largest crypto to use a proof of stake (PoS) blockchain. Its current market cap is $16 billion.
The ICO that Tezos held in July 2017 was both highly successful — and highly controversial. The technical papers distributed at the time promised that Tezos would be able to evolve, implement new changes with time, and avoid hard forks. This wildly popular project managed to raise $232 million worth of funding with its ICO.
However, despite breaking records for funding raised through a coin offering, Tezos was off to a rocky start. Months after the initial offering, investors still hadn't received their tokens. It turned out that there were internal disputes between founders, which resulted in board members stepping down, halts on internal salaries and lawsuits from investors.
How Does an ICO Work?
When a company decides they want to generate funds with an ICO, they usually need to start by attracting investors. They’ll typically create a white paper, or some other sort of report that details the goals and plans they have for their crypto. After generating industry buzz, they'll set a date and time for the coin’s initial sale.
Since ICOs aren't heavily regulated, there is no set process that companies need to follow. Anyone can launch one, and tokens can be offered at any price. Investors are often free to use either digital or fiat currency. Though some platforms do offer the option of refunding money if enough funding isn't raised, this isn't necessarily an industry standard. There are several different techniques used to create an ICO event.
Fixed Number of Tokens and Fixed Price
This involves a limited number of tokens that are all sold for one specific price. It can be a great way to generate buzz, due to the scarcity of coins. Just keep in mind that selecting a good price is essential. Companies that fix tokens at a high price may struggle to attract enough buyers, while companies that select a low price might not raise enough funds.
Fixed Number of Tokens and Variable Price
This is a more flexible option that involves releasing only a set amount of coins, but allowing prices to fluctuate based on demand. The nice thing about this coin offering setup is that it offers a small preview of how a company’s crypto will function. If users see prices rising sharply, they may feel more pressure to purchase soon before prices increase again.
Variable Number of Tokens and Fixed Price
For this method, platforms generate as many tokens as needed, and offer them at a single set price. Since a company can sell as many tokens as they want, their potential to generate funds is almost limitless. Meanwhile, the fixed price allows them to keep the costs low and help investors feel like they're getting a good deal.
Benefits and Risks of an ICO
Working with these techniques comes with some pros and cons.
Benefits of an ICO
For investors, ICOs have a very high potential for strong returns. If an investor manages to purchase coins that later become very popular, they could make a lot of profit on their investment. For example, the Ethereum coin offering sold coins at a price of $0.31 USD per ETH. Four years later, ETH prices soared to over $1,000 per coin, so early investors made millions of dollars.
ICOs are an excellent way of getting necessary startup funds when a group is trying to launch a new crypto. Since a coin offering doesn’t actually even need to generate its own coins, there’s almost no startup cost associated with this fundraising method. As long as there’s a sound business plan that a coin’s group can explain clearly to others, their ICO may go well.
A coin offering is also a great way to generate hype. When an ICO is successful, more people are likely to hear about the crypto — and more people are likely to invest in it as well. This affords a lot more opportunities for growth. In fact, some companies that didn't need the funding of an ICO still chose to use one as a publicity method.
Risks of an ICO
The primary risk of ICOs is that they're unregulated. Starting around 2019, there were several major scams and involving companies promising big returns, encouraging people to buy tokens — and then disappearing with investors' funds, becoming failed ICOs. Even if a company isn’t actively scamming investors, there’s always the chance its scheme will fail. This is why it’s so important to do your research carefully before purchasing any ICO tokens.
Even though the lack of regulation might make ICOs seem convenient for new crypto organizations, it's worth noting that there are still some legal issues. The SEC has taken action against certain ICOs because it views them as unregistered securities offerings. To avoid these sorts of legal consequences, companies have to be very careful about both their verbiage and the products they sell.