ICOs – What Are They?
Digital currencies have gone from being tools for purchasing and investing to crowdfunding. For the last few years, tech-savvy entrepreneurs have developed their own digital currencies to raise capital for their startups. This mechanism is called an Initial Coin Offering or ICO. The first ICO was set up way back in 2014.
How an ICO works
A new business develops its own tokens for sale on a blockchain. They seek funders who will purchase these tokens in order to provide capital for their business. Token purchases are similar to investor share purchases in an Initial Public Offering (IPO).
What sets token purchases and share purchases apart is ownership. Token purchases don’t guarantee investors a stake in the company. It’s just another way for investors to diversify their digital currency “investments”.
The best thing about ICOs lies in the value of the digital currency tokens. If the tokens increase in value, so does a business’ capital, as well as funders’ investments. Additionally, entrepreneurs and businesses can withdraw this value in full without the intervention of traditional financial institutions like finance ministries and banks. The downside is the amount of risk involved. The value is purely speculative, so there’s a lot of risk involved.
Though ICOs are relatively new as compared to IPOs, it has become one of the most prominent topics in the digital currency and startup industries. And because ICOs are conducted on various blockchains and use digital currency tokens, they’re largely unregulated. This sparks concern among more conservative investors, business owners, and financial institutions. Their worry stems from the fact that ICOs allow entrepreneurs unfettered capital raising and criminals to commit fraud. Then there’s the risk factor. Aggressive and forward-thinking individuals debate that this is a great innovation that democratizes and decentralizes the traditional fundraising process.
How do you create an ICO?
ICOs are relatively easy to create and structure thanks to frameworks that regulate the ICO process. It starts with a white paper. In these white papers, entrepreneurs explain the value of their business, the token they’re creating, their blockchain, operating system and other things that investors might be interested in. Then, entrepreneurs upload these white papers online and invite investors to read them and fund their business venture. Investors then provide funding in the form of Bitcoin or Ether. Afterward, entrepreneurs send them back tokens equivalent to the value of their funding. Investors hold on to these tokens in the hope that they will increase in value once the entrepreneur’s business venture takes off.
The ERC20 Token Standard provides an API blueprint for startups and entrepreneurs to follow when creating their own tokens within Smart Contracts. These tokens are not just used for crowdfunding but also provide digital money for digital wallets. Additionally, digital tokens have to pass the Howey Test under the securities laws of the United States of America before entrepreneurs use them.
Have there been any successful ICOs?
Ethereum, QTUM, and Storj are just some ICOs which found success, particularly in the skyrocketing values of their respective digital currency tokens. In fact, Ethereum has become so successful that it is currently the second top cryptocurrency by market capitalisation, after Bitcoin.