An Initial Coin Offering is a new generation funding instrument that operates without the need of an intermediary. Organisations or individuals can raise funds, by issuing tokens to its investors in exchange for cryptocurrencies without a broker.
As such, ventures now have access to capital at an earlier stage in their product lifecycle, from anywhere in the globe and without any minimum investment ticket size. In exchange for cryptocurrencies, ICO sell digital assets to a wide pool of investors. These digital assets are supposed to give utility to its holders through a wide range of functionalities, as explained in the previous chapter.
This method has recently drawn a lot of attention in mainstream media by 2016, mainly because of its ability to help early-stage ventures raise considerable funds in cryptocurrencies very quickly. Viberate, a decentralised platform for the music industry, raised more than 14 million USD in cryptocurrencies in a record time of 4 minutes and 42 seconds.
Let's compare ICOs and Bitcoin:
The term “ICO” has become the most prevalent terminology in the industry to qualify a decentralised crowd sale - although some introduce “tokens” rather than “coins”.
However, many start-ups have decided to change slightly the language, shifting to Initial Token Offering, Token Generating Event or token sales. One of the main reasons could be the correlation between “ICO” and “investment opportunity” and therefore “regulated security”.
Therefore we have decided to consider them, for now, as interchangeable, until an official legal statement from a major regulator.
Venture capitalists and angel investors purchase company shares at a certain valuation, hoping for long term returns after a new round of investment, an acquisition or an IPO.
In this system, the equity is illiquid until an exit occurs – this makes investment risky compared to other traditional securities, as the asset is locked for a certain amount of time.
Tokens issued through ICOs reduces some risks for investors while introducing new ones.
In conventional investments, assets are illiquid; they are difficult to quickly buy or sell, often because of hefty regulations or scarcity of potential buyers. On the other hand, ICOs release tokens at the end of the crowdfunding period and can be traded on exchanges, making the asset very liquid.
Because tokens are quickly disbursed after an ICO, investors can easily buy or sell ICO tokens with established cryptocurrencies such as Bitcoin or Ether.
Here, liquidity reduces substantially the investment risk from a timeline perspective as an exit is only a few clicks away.
Venture capital investments have now become accessible to any type of investors irrespective of their net worth.
Usually, angel investment and venture capital start at 100,000 USD, leaving no room for non institutional players. With ICOs, investors can chip in as low as 100 USD in a project, reducing drastically market entry barriers.
Tokens represent more than a simple stake in a project, as their value is derived from their utility and functions.
Indeed, tokens are incorporated within a decentralised application to create much more than a venture: it builds an eco-system.
This idea is difficult to grasp, as digital tokens have very few active use-cases and are outside of the realm of today’s regulatory framework.
Imagine you can rent out your free hardware storage space, hire computational power to export a design, trade real estate assets digitally or buy goods on a peer-to-peer marketplace, all of that, without the need of a middle man.
These are exactly the types of projects that ICOs can introduce.
Overall, digital assets offer more than merely proof of company ownership, as depicted in the Venture Capital model.
They can hold a variety of functions such as governance right or claims to physical assets as long as it can be programmed and stored on a digital device.
The golden rule of ICO investing is “Caveat Emptor”. It is the principle that buyers need to make their own research before entering an agreement.
In other words, ICOs set the rules of the game: it’s their way or the highway.
Investors need to do their own analysis and due diligence before taking part in a crowdsale/tokensale as there are no negotiations possible between stakeholders.
Before buying any tokens, one needs to carefully understand its fundamentals and economics – just like when you buy stocks, bonds or chip in any investment.
Next, get to know the team, the project roadmap and how well they communicate, manage and sell their product.
Finally, analyse the market of the product advertised.
We strongly advise you to go through the ICO’s white paper before investing: it is a summary document that explains the business model, ICO fundamentals and the product features.
At tropyc, we try our best to ease up the screening process of ICOs by providing you with the fundamentals of every project we choose to list.
Although there are no formal legal regulatory frameworks for ICO fundraising, tokens are currently differentiated by whether they issue a right, a proof of ownership or both.
If an ICO token only provides a stake or equity into a project, the token is therefore considered as a security and is regulated.
While some countries offer a positive environment for tokensales and cryptocurrencies, especially tax havens (Gibraltar, Island of Jersey), others have openly banned them (China).
Because many tokensales are at the ideation stage, without any MVP and have not reached product market fit, and still manage to raise considerable funds in a matter of days.
Most of them are overvalued by providing misguided token distribution, others offer no tangible value to investors while a few are just blatant scams and Ponzi schemes.
Moreover, there’s one aspect that all ICOs and tokensales have in common: they are vulnerable to hacks and digital attacks.
Initial Coin Offerings and Tokensales are without any doubt a massive innovation for crowd funding and venture capital. Unfortunately, too many of them turned out to be misguided, fraudulent and highly speculative.
When individuals are not protected, it’s maybe time for the regulator to step in the market.