INITIAL COIN OFFERINGS (ICOs)

An initial coin offering (ICO) is the cryptocurrency industry’s equivalent of an initial public offering (IPO). A company seeking to raise money to create a new coin, app, or service can launch an ICO as a way to raise funds.

As a type of digital crowdfunding, ICOs enable startups not only to raise funds without giving up equity but also to establish a community of incentivized users who want the project to succeed so their presale tokens rise in value.

While ICOs can offer an easy funding mechanism and an innovative approach for startups to raise money, buyers can also benefit from both access to the service that the token confers as well as a rise in the token’s price if the platform is successful (big IF!)

These gains can be realized by selling the tokens on an exchange once they’re listed. Or, buyers can double down on the project by purchasing more tokens once they hit the market.

How Do Initial Coin Offerings (ICOs) Work?

When a company decides to have an ICO, it announces the date, rules, and buying process in advance. On the date of the ICO, investors can buy the new cryptocurrency.

ICOs can be structured in a few different ways, including:

• Static supply and static price: A company can set a specific funding goal or limit, which means that each token sold in the ICO has a preset price, and the total token supply is fixed. For example, the company sets both of these ahead of time, such as offering one million tokens at a price of $1 per token.

• Static supply and dynamic price: An ICO can have a static supply of tokens and a dynamic funding goal—this means that the amount of funds received in the ICO determines the overall price per token. For example, the company sells a fixed number of tokens and prices them based on the amount of funds it receives. More funding results in a higher token price. If it's selling one million tokens and raises $2 million, each token would have a price of $2.

• Dynamic supply and static price: Some ICOs have a dynamic token supply but a static price, meaning that the amount of funding received determines the supply. For example, the company sets a fixed price but doesn't limit the number of tokens it will sell. An example would be if a company sells tokens at $0.50 apiece until the ICO ends.

If the money raised in an ICO is less than the minimum amount required by the ICO’s criteria, the funds may be returned to the project’s investors. The ICO would then be deemed unsuccessful. If the funding requirements are met within the specified period, the money raised is spent in pursuit of the project’s goals.

Ethereum’s ICO was one of the first real success stories using this relatively new type of fundraising mechanism, raising $15.5 million in 2014. Fifty million ether tokens (ETH) were sold at $0.311 each, and on May 12, 2021, it hit an all-time high of $4,382.73, offering investors a 1,408,903% return on investment. Now not only is it one of the most valuable cryptocurrencies, but it has enabled an entire ecosystem of decentralized applications (dapps) to blossom from its technology.

White Paper Release

Alongside structuring the ICO, the crypto project usually creates a pitchbook—called a white paper in the crypto industry—that it makes available to potential investors via a new website dedicated to the token. The promoters of the project use their white paper to explain important information related to the ICO:

• What the project is about

• The need that the project would fulfill upon completion

• How much money the project needs

• How many of the virtual tokens the founders will keep

• What type of payment (which currencies) will be accepted

• How long the ICO campaign will run

The project releases the white paper as part of its ICO campaign, which it designs to encourage enthusiasts and supporters to buy some of the project’s tokens. Investors can generally use fiat or digital currency to buy the new tokens, and it’s increasingly common for investors to pay using other forms of crypto, such as Bitcoin or Ethereum. These newly issued tokens are similar to shares of stock sold to investors during an IPO.

ICO vs. IPO

ICOs are often compared to initial public offerings (IPOs), a new stock offering by a private company. Both ICOs and IPOs allow companies to raise funds.

The primary difference between ICOs and IPOs is that IPOs involve selling securities and are subject to much stricter regulations. A company that wants to conduct an IPO must file a registration statement with the U.S. Securities and Exchange Commission or the relevant regulatory authority in the country of operation and get its approval. The registration statement should include a prospectus that provides financial statements and potential risk factors.

An ICO is the sale of a cryptocurrency, not a security. For that reason, it doesn't have any formal requirements like IPOs do. But if a company tries to get around requirements by conducting an ICO for something that fits the definition of a security, it could run into legal troubles.

Although both ICOs and IPOs have their risks, IPOs are safer because they're regulated. If you're overwhelmed by all the ICOs out there, the best IPO stocks are worth a look as an alternative.

Advantages and Disadvantages of ICOs

ICOs have their pros and cons. Here are the advantages they offer:

• They offer high potential profits if you can determine which cryptocurrency is a good investment. Since you're buying early, prices are often lower, and some ICOs offer tokens at discounted rates.

• ICOs are accessible to anyone. Unlike some IPOs, there aren't any restrictions on who can invest.

• It's a fast, efficient way for start-ups to raise funds.

Here are the disadvantages of ICOs:

• Because cryptocurrency projects are volatile, there's a significant risk that the token loses value or ends up failing entirely.

• The lack of regulation results in more scams and mediocre projects. Just sorting through upcoming ICOs for a quality project can feel like searching for a needle in a haystack.

• It usually takes some knowledge of crypto wallets to invest in ICOs. For those who are new to crypto, it's often easier to stick to cryptocurrency stocks or publicly traded coins.

Investors are drawn to ICOs for the dream of buying in early to a successful cryptocurrency. Although this is possible, it takes considerable research and time sorting through the vast numbers of upcoming ICOs. Considering the risk involved, it's best to approach with caution. Any token sold via an ICO is considered a high-risk investment. The market is still under-regulated, scam ICOs are rife, and investors have no protection if an ICO fails or turns out to be fraudulent.

Investing in cryptocurrencies and other initial coin offerings (ICOs) is highly risky and speculative, and this article is not a recommendation to invest in cryptocurrencies or other ICOs. Each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Blockchain Africa Brief makes no representations or warranties as to the accuracy or timeliness of the information contained herein.