What is an ICO?
An ICO is an Initial Coin Offering or Initial Currency Offering. Similar to an Initial Public Offering (IPO) where a smaller private company offers shares to the public as a means of seeking funds for the purpose of expansion, an ICO allows investors to buy a certain amount of underlying crypto tokens from a new project in exchange for other cryptocurrencies such as bitcoin or ethereum as a means of funding the new project.
Though relatively new, ICOs are quickly shaping how startups raise money for their projects. In 2017, for instance, ICOs raised a whopping $4 billion according to statistics. An even better statistic is that 56% of companies that participated in the ICOs are still doing business successfully. The conversation around ICOs is ongoing and heated, many argue that ICOs are too unregulated allowing founders to raise a large amount of money while others insist it is just an innovative technology similar to the traditional venture-funding model. Either way ICOs are here to stay and they will be an integral part of landscape for future funding operations.
The ERC20 Token Standard has made it especially easy to structure an ICO because a lot of the necessary development is included. Additionally, ICOs work because the money is sourced from a global pool of investors allowing founders to raise a substantial amount of money. The investors send the money often in form of a cryptocurrency to a smart contract that stores the money and reissues the equivalent amount in a new currency at a later date. Observers in the industry have raised an issue that because an ICO raises the money before a product is launched, then the venture is particularly risky. Proponents of ICO counter that it is a useful tool for the sake of development.
Before deciding whether an ICO is a sound investment or not, it is important to understand the history.
History of ICO
In 2013, several new projects raised money via crowdfunding in a bid to fund development. That same year, Ripple sold XRP tokens in exchange for bitcoin or fiat. To facilitate the sale, Ripple pre-mined $1 billion XRP tokens. Building on the success of Ripple, a little later in 2014, Ethereum participated in an ICO that raised over $18 million.
In 2016, DAO, whose goal was to create a decentralized model that would fund other blockchain projects attempted an ICO based on Ethereum. The ICO was successful and DAO raised over $150 million. Unfortunately, an anonymous hack drained the money due to security vulnerabilities.
Despite the hack, many realized that thanks to the ERC20, launching a token via the Ethereum platform was easier compared to the traditional route. There are some who actually say that crowdfunding is Ethereum most successful application. The argument holds an element of truth if one is to consider the number of startups that have raised a lot of money in a short time. Aragon, for instance, raised roughly $25 million in fifteen minutes while status.im raised around $270 million in a couple of hours.
Are ICOs Legal?
Yes and No. In essence maybe. ICOs exist in a grey area that no one can quite define. Though the recent SEC decision has shone some light on the legality of ICOs, a bit of confusion still remains. In a situation where the token is an asset to be used within the constraints of a particular network as a utility, then it cannot be considered as a security and hence not subject to SEC laws. However, if the token’s only goal is to appreciate in value for the investor’s benefit, then it can be considered as a financial security.
Whether legal or not, until the SEC imposes further limits, many are taking advantage of this phenomenon and making reasonable profits.