What are initial coin offerings?
An initial coin offering (ICO) is a way to raise funds usually used by startups or projects that are at the start of their development. To raise money tokens are offered to investors and the money from them is used to gain additional capital that will be used for developing a project or a new product.
Investors buy them (which finances the project) because they expect their price to become higher in the future when the project is developed. In that process of raising funds, there are no intermediaries between the company and the investors. It is an innovative way of getting capital to develop a project.
However, it’s underregulated meaning that investors often can be subject to fraudulent actions. To avoid scams investors must look at the project’s goals, see the portfolio of the developers (it’s desirable for them to have experience in creating competitive and successful business models), review the whitepaper, and also see if the project is audited by a third party. If it is audited, the project is more likely to be trustworthy. Also, investors always must look at the website because if there are typos in it, probably the project is a scam. When such websites are made in a hurry small errors may be committed which must be a big red flag for every investor.
How an Initial Coin Offering Works
The whole process is complex and requires to have a deep knowledge of technology, finance, and the law. Its main idea is to leverage the decentralized systems of blockchain technology in capital-raising activities that will align the interests of various investors. The steps of it are:
- Set targets – the creators of the project must set targets for its fundraising campaign. It’s very desirable to provide whitepaper for the potential investors;
- Creation of tokens – they will be the representation of an asset or utility in the blockchain and must be tradeable and fungible. Unlike shares, they don’t provide partial ownership of the project. They also aren’t cryptocurrencies because their code is based on the blockchain code of already existing cryptocurrencies;
- Marketing campaign – to get the attention of investors the project must become enough well-known. That’s why advertising is important. Some platforms like Facebook ban such advertisements but there are still plenty of other options;
- Initial offering – after the tokens are created and advertised they are offered to investors.
Initial Coin Offering (ICO) vs. Initial Public Offering (IPO)
As we said Initial coin offering doesn’t include selling shares of the company but tokens. On the other hand, an initial public offering refers to a private company that sells shares to the public to raise funds. This type of offering is much more regulated meaning that the chance of scams is lower. To be able to make an IPO the company must be audited by regulatory and financial experts.
Another benefit of IPO is the fact the company’s employers can be shareholders. This can serve as an incentive for them to work harder and improve the company. In general, IPO is more used by already established businesses because startups have little to no value on the stock market.
The potential returns from ICO are much higher than IPO usually because the price of the token can skyrocket easier in comparison with the company’s value. However, the risk in ICO is much higher, meaning that the higher potential return comes with a higher chance of failure or scam. Due to the low regulations in ICO, it’s virtually impossible to get part or all of your investment back.
Types of Initial Coin Offerings
The types of ICO can depend on the type of investors the startup is looking for:
- Private – a limited number of investors (usually only accreted like financial institutions or wealthier people) can purchase tokens. The company also can choose the minimum amount of money to be invested;
- Public – basically everyone can participate in it. It’s a type of crowdfunding. Because of regulatory issues and concerns private options are becoming preferred.
The way money is raised is also important. Based on the way it’s done there are 3 other types of ICO:
- Static supply and static price – the company sets a specific funding goal or limit. As a result, each token that is sold has a constant price and the supply is also fixed. When using this type of raising money it’s the easiest to predict correctly how much funds you will receive;
- Static supply and dynamic price – the amount of money that is received determines the overall price;
- Dynamic supply and static price – the supply depends on the funds that are received but the price stays the same.