What is an ICO?
An Initial Coin Offering (or ICO) is a means by which many teams raise funds for projects in the cryptocurrency space . In an ICO, the team generates tokens based on the blockchain and sells them to early backers. During this crowdfunding phase, users receive tokens that can be used (either immediately or in the future), and projects receive development funds.
The practice was first used to fund the development of Ethereum in 2014, and has been highly sought after since. Hundreds of businesses have adopted this approach (especially at its peak in 2017), with varying degrees of success. An initial coin offering (ICO) may sound a bit like an initial public offering (IPO), but it’s actually two very different ways to raise money.
IPOs are often used by established companies that raise capital by selling a portion of their equity shares. In contrast, ICOs are more like a fundraising mechanism that allows companies to raise funds for projects in their early stages. The purchase of tokens by an ICO investor does not constitute a purchase of ownership of the business.
For tech startups, ICOs can be a viable alternative to traditional fundraising methods. Typically, new entrants face considerable funding hurdles if they have yet to launch any functional products. In the field of blockchain, mature companies rarely invest in projects based on the advantages of white papers. In addition, the lack of regulation of blockchain has caused many investors to hardly consider blockchain startups.
However, startups are not alone in this practice. Certain established businesses occasionally choose to issue reverse ICOs, which function very similarly to regular ICOs. In this case, the business has launched a product or service and will issue a token to decentralize its ecosystem. They may also hold an ICO to attract more investors and raise funds for new blockchain projects.
ICO vs. IEO (Initial Exchange Offering)
An ICO shares many similarities with an ICO . The key difference is that the IEO is not hosted directly by the project team, but is conducted on a cryptocurrency exchange.
The trading platform cooperates with the team so that users of the platform can purchase tokens directly on the platform. All parties involved benefit. If a reputable trading platform supports IEO, it means that the project has been strictly audited and can often meet the expectations of users. The team behind the IEO can increase exposure, and the trading platform can achieve project success, which is the best of both worlds.
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ICO and STO (Security Token Offering)
Security token offerings were once referred to as “the new ICO.” Since both create and distribute tokens in the same way, there is no difference from a technical point of view. But from a legal point of view, the status of the two is quite different.
Due to the ambiguity of some laws, there is no consensus on how regulators should define ICO qualifications (discussed in more detail below). As a result, the industry has yet to come up with any robust regulations.
Therefore, some businesses decide to adopt STO and offer shares in the form of tokens. Also, doing this helps them avoid uncertainty. Issuers register their securities with the relevant government agencies, giving them the same treatment as traditional securities.
How does an ICO work?
ICOs come in many forms. Occasionally, the team responsible for hosting the ICO creates a functional blockchain that they continue to develop for months or even years to come. In this case, the user can buy tokens, which will be sent to the user’s on-chain address.
However, if the blockchain is not officially live, the tokens will be issued on a mature blockchain such as Ethereum. Once the new chain goes live, holders can exchange their original tokens for newly issued tokens on the chain.
However, the most common practice is to issue tokens on a smart contract-type chain. Again, these operations are mostly done on Ethereum. Today, many applications follow the ERC-20 token standard. Although not all tokens originated from ICOs, it is estimated that there are more than 200,000 types of Ethereum tokens to date.
In addition to Ethereum, Waves, NEO, NEM, Stellar, etc. are all popular blockchains. Given the high flexibility of these protocols, many organizations are not prepared to migrate directly, opting instead to build on an existing foundation. In this way, they benefit from the network effects of a mature ecosystem while providing their developers with a rich set of proven tools.
ICOs are often announced in advance, and the operating rules will have relevant provisions. These may include upcoming timeframes, imposing hard caps on the number of tokens to be sold, or both. At the same time, a whitelist may be introduced, and participants must register in advance.
The user then sends the funds to the specified address. Generally speaking, Bitcoin and Ethereum are popular coins, and buyers have high acceptance of both. Buyers can receive tokens in two ways: one is to provide a new receiving address, and the other is to have the tokens automatically sent to the payment address.
Who has the right to initiate an ICO?
Although the technology of creating and distributing tokens is widely used by the masses. But in practice, there are many legal factors to consider before holding an ICO.
After all, the cryptocurrency space currently lacks regulatory guidelines, and some key questions remain to be answered. In particular, some countries explicitly prohibit launching ICOs, and even the most crypto-friendly jurisdictions have yet to establish clear regulations. Therefore, you must understand the laws of your country before considering launching an ICO.
What regulations apply to ICOs?
In fact, with so many variables to consider, it is difficult to give a one-size-fits-all answer. Also, regulations vary across jurisdictions, and each project may have nuances, so any factor could affect how government entities view ICOs.
It should be noted that despite the lack of regulation in some regions, this is not a free pass for crowdfunding projects through ICOs. Therefore, if you need to choose this form of crowdfunding, be sure to seek professional legal advice.
It is not uncommon for certain teams to raise funds through improper means, which have since been characterized as securities offerings, but have been sanctioned by regulators. If authorities rule that a token is a security, then the issuer must comply with the strict regulations that apply to such traditional assets. In this regard, the U.S. Securities and Exchange Commission (SEC) offers shrewd insights.
Overall, regulatory development in the blockchain space is indeed quite slow, especially as the development of related technologies seems to be riding the trail, far outpacing the slow-turning wheels of the legal system. Nonetheless, most government entities have never interrupted discussions on related issues, working to implement a more transparent framework for blockchain technology and cryptocurrencies.
While many blockchain enthusiasts are concerned that the government may be overly involved in the field (which could lead to hindering development), most agree on the need for investor protection. After all, blockchain is different from the traditional financial category, and since anyone anywhere in the world can participate, it inevitably presents some major challenges.
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What are the risks of an ICO?
Going forward, new tokens may offer high returns, which is very attractive. However, the various tokens are not equal in value. There is no guarantee of a positive return on investment (ROI) regardless of the cryptocurrency investment .
The process of determining the feasibility of a project is often tedious and lengthy due to the large number of factors that need to be assessed. Potential investors should do their due diligence and conduct thorough research on tokens they are considering buying . The process should include conducting a thorough fundamental analysis. The following table includes some questions, but is not exhaustive:
- Is the concept feasible? What problem can be solved?
- How to distribute supply?
- Is a blockchain/token a necessary prerequisite for starting a project? Or dispensable?
- Is the team in good standing? Do they have the ability to put the project into practice?
The most important rule is that the investment intensity should be consistent with the level of risk tolerance. Because the cryptocurrency market is highly volatile, there is a significant risk that the value of your tokens will plummet.
Conclusion
ICOs are a great way for investors to raise capital for early-stage projects, and they are extremely efficient at raising capital. Following the success of the Ethereum ICO in 2014, many organizations have used this method to raise significant funds to develop new protocols and ecosystems.
However, buyers should be aware of what they are investing in. Investments do not necessarily pay off. Given the late start of the cryptocurrency space, this investment is extremely risky. If the investment project does not provide a viable product, there is almost no way to protect the rights and interests of investors.
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April 24, 2024
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