Initial coin offering (ICO)

The initial coin offering is a way to attract investment in new projects that involve the use of cryptocurrencies. Most often it is used in small startups, which, nevertheless, look promising to potential investors. It is most often carried out through Bitcoin or Ethereum, however, in some cases, the use of fiat currency is allowed.

The interest of investors is that even small initial investment amounts can subsequently pay off if the project begins to gain momentum. This is called “return on investment” (ROI) and is a good motivating mechanism.

How ICO works

Some consider this process has a lot in common with another investment mechanism — IPO (Initial Public Offering). However, the difference between them is significant. IPO involves the partial sale of company’s shares as part of raising capital for private investors. And ICO is solely the sale of “potentially profitable in the future” tokens without receiving a share of ownership of the company.

The basis of ICOs are pre-developed interaction protocols and smart contracts. For example, Ethereum-based ICOs by default comply with the ERC-20 standard — a special set of rules that any company planning to use this blockchain as its support must comply with. If this does not suit the company, there are other alternatives: Stellar, NEM, NEO, Waves, etc. However, there are clearly defined rules. In extreme cases, you can create your own blockchain and create rules for its use independently.

When the tokens are registered, the creator company proceeds to the next important stage — attracting investors. They must be convinced that this project has a future and that the initial supply of coins will bring profit. Fortunately, many are content with an official document (whitepaper) where all this is written, as well as recommendations of other respected investors. That is, the project may not be formally launched yet: there is only an idea, general rules and a website with information, but some investors are already ready to interact with it.

Why is this even being done?

The fact is that small companies with original and promising ideas do not have many other options for raising capital. As a rule, large credit organisations and banks do not give money only under the “promise of profit”. They need both guarantees and clear definitions of potential financial risks. No one wants to invest in a failed project, risking losing everything completely. In addition, weak regulation of the cryptocurrency sector also prevents from cooperating with official financial organisations.

On the other hand, the initial offer of coins allows attracting capital from individuals and companies, providing them with some ROI guarantees due to cryptological protection mechanisms.

Experience shows that this is quite enough. Moreover, some large financial institutions are beginning to recognize the effectiveness of decentralisation and the blockchain system, so they are also slowly switching to cryptocurrency resources, investing their own assets in the project. This process is called reverse ICO.

Who can do this?

Absolutely anyone. If, of course, he/she can come up with an efficiently working system, create technical documentation and convince others that this business can develop and make a profit. You know, each of the stages is quite complicated. In the same way, anyone can invest their money in ICO.

Legal regulation

It can be argued that ICO is one of the varieties of crowdfunding. And this way of financial interaction is still poorly regulated. In the USA, for example, two organisations are working on this issue — the Commodity Futures Trading Commission and the Securities and Exchange Commission. The results, however, are not particularly significant.

Nevertheless, a little success has been achieved in this matter. For example, some ICOs are now recognized as a variety of securities, and therefore should be regulated accordingly. But for each such situation, the decision is made on an individual basis because it is when the difficulties begin.

On the one hand, the lack of regulation is an obstacle for large financial institutions to interact with cryptocurrencies. On the other hand, it is precisely the lack of external regulation that makes blockchain systems so relevant for users. Now they gradually come to the conclusion that it is necessary to somehow keep balance. An alternative approach was adopted in South Korea and China — cryptocurrencies are completely illegal there.

Why is it important?

The idea of a primary offer of coins is naturally ambiguous. On the one hand, it makes it possible to start new ideas based on the blockchain system and new functional cryptocurrencies. And there are a lot of such effective projects at the moment. On the other hand, the opportunity to “promise the mountains of gold and then run away with the invested funds” gave rise to many so-called “scam-ICOs”. As well as some interesting ideas that began to develop but then stalled and went broke.

However, the principle has not yet discredited itself. And in other areas of activity, attracting private capital against certain guarantees is a fairly common occurrence. Therefore, it already makes sense to consider the ICO practice as an alternative to traditional investment.