An Initial Coin Offering (ICO) is a crowdfunding method aimed at raising capital in the cryptocurrency and blockchain environment. An ICO is an initial offering of digital tokens created on a blockchain platform that will be exchanged for cryptocurrencies. Conducting an ICO allows you to finance the development of the company, and the investor receives tokens in exchange for his investment. As a way to raise capital, ICOs are mainly used by startup projects. This type of activity provides a direct link between the company and potential investors. In ICOs, cryptocurrencies or digital assets are sold to early investors before they are advertised and promoted in a broader market, such as exchanges.
Thus, ICO is a method of crowdfunding that appeared in the blockchain system and is called crowdsale. An integral part of a successful ICO project launch is the description of the offer/product.
How does an ICO work?
There are two types of Initial Coin Offering:
- Private ICO. In the process of ICO implementation under this model, a limited number of investors take part in the initial coin offering. Most often, investors are accredited financial market operators, such as specialized financial institutions and wealthy private investors. At the same time, the organizing company can set the initial (initial) investment amount.
- A public initial coin offering is a form of crowdfunding that is aimed at a wide range of potential investors. A distinctive feature of an open ICO is a democratized approach, in which anyone can become an investor. Practice shows that private ICOs are a more effective form of attracting investment compared to public offerings due to the specifics of the regulation of the digital asset market.
Market experts distinguish several categories of tokens that are used to attract investments through ICOs:
- utility tokens;
- investment tokens;
- equity tokens;
- Asset-backed tokens.
Registering a company for an ICO begins with a digital campaign. There is no entry barrier for either sellers or buyers – the project is open for crowd investment. Startups raise funding by issuing and selling their own digital currency (token).
Once the ICO is launched and has a specific schedule, investors can buy tokens. Later, the tokens are distributed in a simple automatic way using smart contracts. In any case, before registering a company for ICO in Europe, Asia, the United States, and other regions, it is recommended to enlist the support of qualified professionals.
The stable growth of the cryptocurrency industry and blockchain technology contributes to the increase in the popularity of ICOs and the emergence of new token sale formats. Crypto market statistics show that during 2017-2018, about 90% of token sales were implemented using the ICO model. But in 2019, due to the high percentage of fraudulent placements, ICOs were replaced by IEOs, which are implemented through centralized exchanges. IEO token sales have significantly minimized the risks of deceiving investors. The trend towards the development of the DeFi decentralized finance segment since 2020 has led to the emergence of IDO token sales. As of the end of 2022, token listings on decentralized exchanges cover more than 50% of the market volume.
Differences Between ICO and IPO
When traditional companies want to get a quick cash flow, they can enter the IPO market. This method of raising capital allows you to get money from individual investors by selling them shares through an IPO.
An ICO is a crypto analogue of an IPO and serves the same purpose, but at the same time, a share in the company represents a token. However, there are differences between registering a company for an ICO and launching an IPO. ICOs are largely unregulated in most countries. Due to the decentralization and lack of regulation of ICOs in different countries, this method of attracting investment in a project has more freedom in terms of structure than an IPO.
By their nature, ICOs and IPOs are used as an initial offering of financial assets to attract investment for newly established companies. One of the most significant differences is the investor's ultimate benefit in exchange for funding. So, in the case of an IPO, the accredited investor is entitled to a certain share in the company, as well as the right to vote in relation to the company. Whereas in an ICO, a private or public investor will claim exclusively the ownership and use of the coin issued during the ICO process. An ICO investment scheme does not involve capital ownership or voting rights in the underlying company.
The following are the most significant differences between an ICO and an IPO:
- Stages of implementation. Most often, ICO is held at a very early stage of the development of a company/project in order to raise capital for the implementation of a new idea and/or business concept. Hence, ICOs are riskier and require a higher return on investment than IPOs. At the same time, IPO investments take place at later stages of the company's development. In most cases, the public sale of a company's shares at an IPO is carried out in order to attract long-term capital for the development of a product, a new direction, etc.
- Control system. An important difference between an ICO and an IPO is the regulation of these investment processes. In most cases, ICOs do not have proper government regulation. Control and regulation of attracting investments through ICO is carried out on the basis of smart contracts on the blockchain. Whereas IPOs are strictly regulated by government regulators, which guarantees safety for investors and crowdfunding participants.
- Listing Requirements. An ICO can be launched without actually listing the base token on specialized exchanges. Consequently, investors risk investing their funds in assets that they cannot sell. Most crypto tokens never make it to the open market. Unlike ICOs, to conduct an IPO, shares are subject to mandatory registration with the exchange, which ensures that investor risks are minimized.
The role of intermediaries. The distinctive advantage of ICO is higher ROI and efficiency due to the absence of intermediaries - exchanges, financial agents, brokers, underwriters, regulators, etc.). In return, IPOs are required to pay commissions and fees.
Requirements for investors. Investor participation in IPOs is strictly regulated by the rules, regulations and regulations of regulators and brokers. In this case, there is strict compliance with KYC/AML legislation. While many ICOs do not have mandatory requirements for investors. At the same time, recent trends indicate a change in the approach to regulation and the basic requirements for implementing ICOs.
There are many different ICO structures that can be applied depending on the company's goals and the needs of the project. Funding objectives, token supply, and token price can be static or dynamic, resulting in a wide range of ICO structuring.
Difference Between ICO and STO
ICOs were the first crowdfunding option to appear in the blockchain system. This method of fundraising allowed anyone to fund the development of a company or project. In exchange for their investment, the investor will receive a number of utility tokens, which represent future access to the company's product or service.
The STO offering is a relatively new concept that opens up additional investment opportunities. The first STOs were created in 2017 after the cryptocurrency market capitalization fell by more than $750 billion. United States. Security tokens were created as coins that comply with the legal norms and rules for securities as much as possible. According to financial statistics, the market capitalization of security tokens in 2020 increased by 500% and amounted to about $449 million. United States. Security token infrastructure companies are constantly increasing the amount of capital raised. Plutoneo predicts that the average annual growth rate of the token market in the EU for the period 2018-2024 will be 85%.
So, STO security tokens function as a digital expression of real-world assets such as bonds, stocks, and other derivatives. Therefore, the investment offering of security tokens allows you to tokenize assets for a variety of global and national companies.
An STO is actually a public event where tokens are sold through cryptocurrency exchanges. The tokens can then be used to trade real-world financial assets such as stocks.
Registering a Company to Launch an ICO: Basic Process
The effectiveness of ICO projects directly depends on the correct organization and launch of the ICO. A detailed roadmap can ensure a significant part of the success of an ICO. The creation of a commercially attractive concept begins with the development and detailing of the idea, the analysis of the competitive environment, the market situation, as well as the assembly of a team to implement the startup and attract investors. An important stage of an initial coin offering is the incorporation of a company to launch an ICO.
If you are planning to conduct an ICO abroad, you should pay attention to such aspects as:
Before launching an ICO in the United States, Europe, or other regions, it is necessary to determine the purpose of the project. It can be any blockchain-related concept that the company would like to implement and offer to society.
The next stage is the compilation of a white paper, which outlines all the details of the project: the objectives of the ICO project, its mission and significance, the implementation mechanism, the amount of necessary initial funding or capital, the technological features of the project, its differences from similar competitor startups, etc.
Depending on the structure you want to use to issue tokens, you will need to decide which platform to use, as well as choose a country to register your ICO company. Here it is important to consider countries whose legislative framework really allows investing in ICOs, and government agencies have a positive attitude towards working with cryptocurrencies. The countries that most often appear on the lists that recognize and allow ICOs include the United States, Australia, Singapore, Hong Kong, and Liechtenstein.
The implementation of ICO projects has a significant impact on the processes of raising capital in the cryptocurrency industry. At the same time, the intensification of the use of ICO mechanisms has shown that national and global regulators were not ready to introduce a new model of fundraising in finance. The study of the experience of many countries shows that approaches to regulating the initial coin supply have differences. For example, the state policy in the financial sector of China and South Korea prohibits ICOs. Most European countries, the United States, and Canada are constantly working on the development of specific rules and regulations governing ICOs. There is also a group of countries where ICO rules, guidelines and regulations have been developed. These countries include Australia, New Zealand, Hong Kong, and the United Arab Emirates (UAE).
Once the whitepaper is drawn up and the jurisdiction is chosen, marketing campaigns are launched and the ICO date is set. Once an investor decides to invest in a project, they can receive the project's cryptocurrency (in the form of tokens) in exchange for the investment. Tokens can be bought in exchange for other cryptocurrencies or for "real" fiat money, including USD, EUR, and others (depending on the nature of the project and arrangements).
In most cases, the organizers and developers of ICO projects publish open reports on the results of the initial coin offering. The document contains a final assessment of the effectiveness of the crowdsale, the degree of achievement of the goals set, and other information about the ICO.
ICO Launch: Advantages
There are several benefits of an initial coin offering that you should be aware of if you want to set up a company to launch an ICO. One of the main advantages of launching an ICO project is the opportunity to invest in innovative technologies. Most ICOs aim to revolutionize various industries.
The advantages of ICO as a tool for raising investment for founders are that with the help of ICOs, founders can raise capital faster compared to traditional methods of funding. In addition, the costs of marketing and settlements with ICOs are significantly lower than using traditional methods.
Another advantage is the possibility of making a profit after the successful implementation of the project. If the project goes ahead, the value of the tokens purchased during the initial coin offering will increase. However, it should be borne in mind that ICO is accompanied by certain risks. Therefore, investors need to get acquainted with the developers of the project, conduct due diligence of the ICO of the project and the company, as well as carefully study the legal terms and conditions of the agreements.
Here are a few more reasons why ICOs can be a smart investment for companies:
- the possibility of exponential growth. In the world of cryptocurrencies, players use tokens to purchase goods or services offered by a company. Today, tokens have a combined market cap of billions that continues to increase every day;
- an innovative way of investing capital that provides protection against political and economic risks;
- the possibility of diversification of the investment portfolio;
- Worldwide access and connectivity. ICO does not set geographical barriers. The cryptocurrency platform does not discriminate between professional capitalists and small investors, allowing each of them to develop their network.
Trends in the development of the crypto market contribute to the development of the investment direction in this segment. According to CoinGecko's quarterly market report, the total cryptocurrency market capitalization doubled to $1.2 trillion in the first quarter of 2023, an increase of $406 billion from the end of 2022. In addition, analytics show that since 2018, the intensity of raising funds in the form of cryptocurrencies through ICOs has increased. Today, the diversity of ICO-based projects is unevenly distributed across 24 areas (see illustration below).
The vast majority of projects (74%) are focused on the creation of blockchain platforms, but projects in the financial sector are also popular. Given the positive aspects of the Initial Coin Offering and the inevitability of the development of financial technologies, the government authorities of most countries are developing coordinated approaches to the regulation of cryptocurrencies and ICOs.
What are the risks of conducting an ICO abroad?
Investing in cryptocurrencies and other Initial Coin Offerings (ICOs) is very risky and speculative. ICOs have their own set of risks, which are related to consumer protection, market risks, and regulatory compliance. The main ones are the following:
- low level of consumer protection, as no formal processes or systems are in place to audit companies;
- The lack of clear token valuation systems in ICOs can put consumers at risk, especially when buyers are unaware that token prices and values are based on expected resale profits, which can be unpredictable;
- The volatility of token prices, which leads to high risks for investors. Blockchain technologies are subject to various market fluctuations and changes in the cryptocurrency market. It is important to take into account the high degree of competition among ICOs. These factors lead to the dynamism of the current value of assets, which is extremely difficult to predict;
- risk of fraud and low liability of ICO project organizers. Quite often, ICOs are created by start-up companies, individuals, and other organizations that do not have enough working capital and funds to launch their potential projects. Such ICOs announce a high return on investment. But in reality, the organizers of the initial coin offering do not provide any guarantees that the investment will be profitable, and the tokens will be listed on crypto platforms;
- Compliance with KYC principles in the crypto business can be difficult, but such requirements are essential to ensure compliance with existing anti-money laundering regulations;
- lack of perfect consulting and legal support for the ICO project, which entails both losses and subsequent confusion in relations with partners and problems with registrars, etc. In many cases, the problem is a lack of understanding of the fine line between Security and Utility tokens, as well as a number of other problems;
- lack of full-fledged legal regulation of cryptocurrency crowdsale at the international level, since each jurisdiction uses internal rules and regulations for conducting ICOs.
When entering an ICO, it is important to pay attention to:
- the reputation of the organizers and participants of the ICO project;
- quality of execution and reliability of technical and accompanying documentation;
- Availability of a working prototype, escrow agent, or bank money-back guarantee.
Both a startup and a potential investor need to understand which category the tokens will fall into. You can enlist the support of lawyers and carefully work out the project to minimize the risks of falling into the category of security tokens, since conducting an STO and activities related to digital securities require licensing.
If you are planning to invest in Initial Coin Offering, it is worth learning all the intricacies of the project beforehand. First of all, take a close look at the Token Sale Agreement. Often, it contains points that the project participants do not voice during negotiations. You should also familiarize yourself with the business reputation of your potential partners in order to avoid the implementation of fraudulent schemes.
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