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Just five years ago, nobody had ever heard of an ICO. Today ICOs are a very popular way to raise money, with one popular site listing nearly 3000 active ICOs. Popular ICOs can raise nine-digit sums for the ventures behind them. Hereâs a quick look at where the ICO model came from, some ground-breaking ICOs at different stages of their development, and a guide to what separates an ICO from an IPO.
In the beginningâŠ
ICO stands for âinitial coin offeringâ, a term derived from âinitial public offeringâ, which many will recognise from more traditional stock markets. In an ICO, a venture issues blockchain-based tokens in exchange for capital in the form of fiat currency or established cryptocurrency, like Bitcoin.
In other words, an ICO is a way to bypass (or supplement) boutique finance, like venture capitalists and investment banks, by crowdsourcing capitalisation to many smaller contributors.
The earliest ICOs struggled for a number of reasons. One important reason was that the model had never been tried, so potential contributors didnât trust it. Perhaps the most important reason, though, is that they were still based on Bitcoin.
As a currency, Bitcoin is fine, but itâs not necessarily versatile enough as a token for many businesses. Many ventures have specific protocols that they build into their tokens, which give the tokens utility-based value on the platform. For ICOs to be successful, a new, more versatile kind of blockchain protocol had to be invented.
Ethereum is exactly that kind of protocol. It allows new ventures to customise tokens with their own algorithms, making the tokens more than just coins. These custom features turn the tokens into useful tools on the various platforms.
It is no surprise that Ethereumâs own ICO was so successful, despite still being a very early attemptâââEthereum generated the equivalent of $2.3 million in its first twelve hours. And Ethereum accomplished this at a time when the total cryptocurrency market capitalisation was only about 5% of what it is today.
Pre-sale, public sale, success?
ICOs go through stages. The most common are the pre-sale and the public sale, after which the new business succeeds ⊠or not.
After a ventureâs team has completed most of the work to get the token working on a largely functional platform, they will test the marketâs waters with a pre-sale. During the pre-sale stage, the venture will sell tokens to a select group of contributors at a discount before opening the sale process to the public.
Pre-sales serve a number of purposes for the early contributors and the ventures themselves. The contributors have the benefit of acquiring tokens at a discount. Holding the tokens gives them benefits on the platform and, of course, they can resell the tokens.
From the issuersâ perspective, pre-sales let them gauge the interest in their token early. Pre-sales also provide vital capital at a crucial timeâââjust before the token goes public. In addition, let ventures tune the economics of their sale process. By stratifying the pre-sale into tiers with discounts that decrease as the end of the pre-sale period approaches, a young enterprise can tweak the ratio of value it has to trade for capital.
The public sale follows the pre-sale. This is when the general public can contribute to the venture and buy its tokens. Public sales can end in one of three basic ways:
- The venture fails to meet its soft cap, which is the amount of capital it needs to raise to continue developing the business. If this happens, itâs the end of the road. Most ventures will close up shop and return the funds they received at this point.
- The venture exceeds its hard cap, which is the maximum amount of capital the venture seeks to acquire (and the maximum amount of value itâs willing to trade for it). This usually means the ICO was a resounding success. Most ventures will declare an end to the sale and return any funds received in excess of the hard cap. If they donât, it might be a reason for contributors to proceed with extreme caution.
- The sale ends with a figure somewhere between the two caps. While not necessarily a runaway success, this result also usually means that the ICO was planned carefully, executed competently and not over-hyped. With this kind of result, itâs time for the venture to get down to business.
To make this process a little more concrete, letâs look at a few prominent examples:
1. Zeex: primed and ready
Zeex might just manage the greatest trick in the cryptocurrency world: letting consumers spend cryptocurrency on retail purchases. Zeex is rapidly reaching the end of its pre-sale process, and the public sale is ready for a successful start in Q2Â 2018.
Zeex has all the ingredients of a successful Token sales, even at an early stage. Zeex has a clear, simple concept with a token whose value is immediately clear; it has attracted the attention of some valuable and experienced partners; its reviews are impeccable; and the hype is just rightââânot too big and not too small.
Though itâs still early in the game, Zeex has a winning strategy, a strong line-up and plenty of fans.
2. Bancor: a success story
Bancor is effectively a decentralised exchange mechanism for cryptocurrency, especially small-market altcoins. Its ICO took place in June 2017.
When Bancor released the news just before the public sale that Tim Draper, a prominent venture capitalist, had committed to Bancor, interest reached a fever pitch. As a result, the Bancor ICO raised $142 million in three hours.
However, the Bancor ICO caused a furore during the public sale with its âhidden capâ: only once 80% of the hidden cap had been reached would Bancor reveal how high it really was. Many interpreted this move as Bancor setting two hard caps, which disadvantaged the early contributors as the value of their tokens was then âdilutedâ with later contributors joining in the later, higher cap.
Nonetheless, Bancor is a success by any measure. After three quarters in operationâââwith some market-tracking ups and downsâââthe venture has a market cap of at least $220 million and good prospects.
3. Cartel: up in the air
Cartel starts with what sounds like a great, immediately intuitive idea: using blockchain to connect consumers directly with manufacturers, allowing both to save money by eliminating intermediaries. Cartelâs public sale began on 10 March and is set to continue until 10Â May.
As promising as Cartel sounds, its future is uncertain. The ICOâs ratings on expert sites are mixed, it hasnât been generating much buzz, and its name seems to be inviting regulatorsâ attention.
Cartel has another two weeks before the end of their public sale, and anything is possible.
IPOs in disguise or the model of the future?
Since ICOs are modelled after IPOsâââeven down to the nameâââand IPOs are a tried and tested way to raise money, the obvious question is: why not just launch an IPO? Why do ICOs exist at all?
The short answer is speed and regulation.
Google waited six years after registering before its IPO. Facebook waited eight years. Spotify waited ten. Preparing an IPO requires a small army of lawyers, investment bankers and brokers. It is a very expensive process that requires a huge amount of very costly preparation.
Especially since the advent of Ethereum, which lets blockchain startups develop custom tokens fairly easily, a dedicated team can go from idea to ICO in 6â12 months, depending on the complexity of the project. Just as the digital world moves faster than the analogue world itâs replacing, the crypto world moves faster than the fiat world. A year for an IPO is like a month for an ICO.
As for regulation, American IPOs are covered by US securities law, some of which goes back almost a century. The main EU directive on securities is 148 pages long, covering 97 articles and 4 annexes, not to mention the national laws.
ICOs, on the other hand, are barely regulated. The good news is that the light regulation allows ICOs to be much faster and cheaper than IPOs. The bad news is that traditional IPOs would serve many firms and potential contributors better, but many opt for ICOs just to bypass important rules.
So whatâs the difference between a genuine ICO and an IPO in disguise?
Probably the best clue as to the natureâââand, in some jurisdictions, the legalityâââof an ICO is how the token fits into the platform and the business. Basically, there are two kinds of token available in ICOs:
1. Utility tokens
These are tokens that provide their holders with some kind of utility on the platform. Since their value derives from the platformsâ functions, holders donât need to worry too much about the issuersâ balance sheets. Even if the issuing venture loses money one quarter, the tokens will continue to work on the platform.
For example, the ZIX token lets Zeex users log in to the service, gives them access rights to the Zeex catalogue and even grants them discounts on the gift cards they want. These are all valuable functions regardless of the companyâs value.
Using blockchain technology is important for utility tokens because their functions depend on the smart contract protocols written into the tokens. They could never be replaced by a piece of paper.
2. Security tokens
Security tokens are the reverse of utility tokens: their value depends on the value of the issuing venture without providing much functionality on the platform, if a platform is even part of the business model at all. These tokens represent a claim to some of the businessâs valueâââjust like traditional shares. Buyers speculate that the business will gain value and their claims to that value will rise.
And since security tokens work like traditional shares, in principle they could be replaced by paper. Using blockchain is, in many cases, simply an attempt to bypass regulation and benefit from the hype around blockchain. Many of these ICOs should really be IPOs, and many have turned out to be scams.
However, itâs also important to point out that some ventures are trying to make ICOs for security tokens safer and more professional with measures like best practices and self-regulation.
For more on security tokens, see this helpful post (including a good breakdown of the âHowey testâ).
The distinction between utility tokens and security tokens also explains the difference between contributors and investors. Contributors pay for the service embedded in the utility tokens by buying them. Investors, on the other hand, notionally buy part of the companyâââand its potential profitsââârepresented by the coin.
Of course, not all ICOs for utility tokens are worthwhile, and not all ICOs for security tokens are scams. The only way to determine which tokens are worth buying is to look at the ventureâs business model, its team and how the tokens work.
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The ABCs of ICOs was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.
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