The latest fundraising technique for businesses in the crypto space is the Initial Coin Offering. Before now, companies looking to raise capital to start or expand a business venture were limited to a little and highly regulated set of options, which led to adopting the crowdfunding method via public platforms.
An initial Coin Offering, just like Initial Public Offering (IPO), is a primary means of raising funds by a startup or an already existing business in cryptocurrency. Instead of acquiring debt, the company creates a new coin, app, or service, sells them, and uses the capital to fund their business projects.
Investors can also buy into an ICO and receive a new token from the company. These tokens or coins derive value by providing utility, attaching their worth to the growth of the company, etc. Initial Coin Offerings and stocks have some similarities, but they sometimes have utility for a product offered.
How an Initial Coin Offering Works
When a crypto-based company wants to start a fundraising scheme through an initial coin offering, it creates a whitepaper. This whitepaper explains the nature of the project, the solution the project offers, how much is required, how many tokens will be stored, and how long the initial coin offering will last.
During the fundraising campaign, crypto enthusiasts and supporters of the project get to purchase some of the project’s tokens with fiat or digital currency. These coins are also tokens and are similar to shares sold to investors in an IPO. However, if the fund raised is less than the actual amount required for the project, the money may be returned to the backers, and the initial coin offering is deemed unsuccessful.
Initial coin offerings and Regulations
The original motive of cryptocurrencies is to avoid government regulations and adopt a global decentralized free trade. And to consider ICOs as being regulated will be a stretch, but the regulatory environment is evolving as businesses adopt cryptocurrencies.
Meanwhile, ICO is under no regulations, but the Securities and Exchange Commission (SEC) can intervene if they suspect ongoing fraudulent activities. For example, Telegram raised $1.7 billion in an initial coin offering last year, but the SEC is attempting to pause the project due to illegal activities linked to the development team.
Some countries, like China, have banned initial coin offerings. They believe that ICOs promote illegal activities. In the U.S., cryptocurrencies are subject to capital gains taxation. Treatment of the issuance of a new coin depends on its worth or value. If the value of the token depends on the growth of the company, then the initial coin offering is subject to government regulations. But If the value lies on some future utility on a platform or service, the initial coin offerings will undergo little or no perusal from regulatory bodies. Also, in early 2018, Facebook, Twitter, and Google banned all initial coin offering advertisements.
Since ICOs are unregulated, investors must apply extra caution when researching and investing in coin offerings. As an investor, you must know the basics of cryptocurrency. You should also have a crypto wallet for Bitcoin or Ethereum, and a wallet that can hold every other currency of choice before considering initial coin offerings.
To know about the latest ICOs that are legit, read up about new projects online. You can also visit sites that discuss ICOs and allow investors to discover new and already existing offerings.
However, there is still no guarantee that investors won’t be on the losing end despite reading about new projects online. To avoid being a victim of initial coin offering scams, investors should:
- Engage developers and make sure they can clearly define their goals without shuttering. Legit ICOs must be straightforward, with easy-to-understand whitepapers. These whitepapers must also explain, concisely, the aims of the company.
- Demand 100% transparency from developers or the company launching an initial coin offering.
- Lookout for legal terms and conditions for the initial coin offering. Because regulators do not entirely oversee ICOs. It is up to the investor to secure a legitimate ICO.
- Also, make sure that funds raised from initial coin offerings are stored in an escrow wallet. This wallet requires multiple keys to guarantee access. And keeping the funds there will prevent scams, especially when a neutral third-party holds one of the keys.
Examples of an Initial Coin Offering
When evaluating initial coin offerings, we should consider Ethereum; it has proven to be crucial for the ICO space in general. Ethereum’s ICO in 2014 was also an early pioneer of the fundraising method, with over $18 million raised within 42 days.
In 2015, there was a two-phase initial coin offering for a company called Antshares (NEO). The first phase ended in Oct. 2015, and the second ended in Sept. 2016. Within this period, the company earned $4.5 million, with early investors receiving substantial ROI.
Based on the highest amount of money raised, a decentralized cloud storage project (Filecoin) was able to raise $257 million after a one-month initial coin offering, which ended in Sept. 2017. However, the company responsible for the EOS platform broke Filecoin’s record by raising $4 billion.
Fred Wilson, a cryptocurrency advocate, also suggests that investors should be diplomatic and careful about initial coin offerings. And when in doubt, do not hesitate to make enquiries from reliable sources in the field. Evaluate projects, and seek guidance when necessary.