Imagine if you could raise capital for your project idea or company without giving up ownership of your company or equity. How? -ICO! The first ICO or first token sale was done by Master coin in July, 2013.
ICO stands for Initial Coin Offering. This is similar to an Initial Public Offering( IPO) i.e.when a company lists out their stocks on a stock exchange for the first time by offering their stock to the public in order to raise capital. This is a traditional and regulated means of raising capital.
An ICO is an innovative and unregulated crowdfunding mechanism used by new cryptocurrency ventures or start-ups in which they sell their underlying digital currencies or tokens in exchange for popular cryptocurrencies like bitcoins and ether, or sometimes a fiat currency e.g. the US dollar. An ICO allows start-ups to bypass the rigorous and regulated capital-raising process required by venture capitalists and investment banks.
There are about five types of tokens in a cryptocurrecy ecosystem; cryptocurrency token – (This is the most popular and is used for peer to peer transactions. e.g the bitcoin.), utility tokens, reward-based tokens, asset-backed tokens and security tokens. When an individual invests in an ICO, they are simply investing in a utility token or a security token. With a security token, an individual invests in the worthless coin or token of the company, with hopes that the demand for these coins may increase, which in turn increases the value of the tokens of the company.
These tokens in most cases are not intended to be security tokens but according to the US Security Exchange Commission(SEC), if they possess the features of a security, they are treated as securities. Utility tokens are used to access the product or services of a company and are not designed as investments.
There was a lot of buzz around ICO’s in 2017 and everyone seems to want in at the moment. Early stage startups who have built models utilising the blockchain technology, see it as an easier way to raise capital without giving up equity.
In a report published by Coindesk, the number of ICO’s carried out in 2017 was estimated to be around US$5.6 billion. This is 118 percent less than the total amount recorded in the first quarter of 2018 which had the highest amount of ICOs recorded. Data from Tokendata also shows that only 48% of the ICO’s done in 2017 were actually successful.
There are a number of problems with using an ICO especially for investors since most ICO’s raise money before an actual product is launched. There have been a number of pump and dump cases, exit scam cases, and ponzi schemes associated with ICO’s. An ICO is known to be speculative and risky.
How does an ICO work?
A quantity of a company’s tokens are offered up for sale to members of the public. These tokens carry a particular utility value and are mostly used in carrying out transactions on the company’s platform- to access the goods and services of a company.
Companies who intend to carry out an ICO are required to publish a white paper that contains the total supply of the tokens they are willing to create, the utility value of the token, a credible list of the members of the team, how much they are looking to raise in an ICO, consensus model, what platform they intend to carry out their operation on, among others.
Most tokens are based on the Ethereum ERC20 standard (Tokens designed and used solely on the ethereum platform) and more than 70% of ICOs are done on the Ethereum blockchain because of its ability to allow for decentralized applications (DaPPs).
ICO’s may have a specific target on the amount they intend to raise in a crowdsale. If this is the case, every token will have an intended price that will not change during the crowd sale. Hence a static token supply. There is also a possibility of having a static token supply with a dynamic funding goal. In this case, the price of a token is determined by the amount of funds received.
Stages of an ICO
There are various stages to launching an ICO. The common stages of an ICO are private sale, pre-sale and public sale. Some ICO’s may carry out more o r less of these token sales to reach a wider audience or because they do not want to hit their hard cap early. A private sale is an unannounced sale of tokens to early investors (institutional investors).
These early investors enjoy greater discount and benefits. It has some disadvantages; institutional investors are more prone to risks caused by an unsuccessful presale or public sale. A pre-sale is an announced sale of tokens promoted through the company’s website and social media- mostly telegram and reddit. It is done before a public sale and after a private sale.
A pre-sale provides investors with a higher discount and bonuses compared to a public sale with lesser risks than a private sale. A public sale is the same thing as a token generation event and an initial token offering. This is the main sale that is opened to the general public and allows them to contribute to the venture and buy its token.Although, some ICOs are limited to geographical areas. A public sale can end if the venture exceeds its hard cap or fails to meets its soft cap.
If an ICO exceeds its hard cap, the excess money recouped are to be given back to investors. If this is not done, there is a need to investigate the ICO. According to a report by Token data, a good percentage of failed ICO’s were linked to Africa – this is an over representation of failed ICO’s in Africa and in the cryptocurrency space. A lot of ICO’s fail at the initial stage because the proposed tokens lack a unique use value and as a result, they are never implemented
Regulation of ICOs
The US Security Exchange Commission regulates securities in the United States and makes use of the Howey test to ascertain whether an investment can be considered a security. A designation as a security means that the investment is subject to certain registration requirements and a number of restrictions. The Howey test is used to characterize tokens as either security or utility tokens. A security token can be compared to equities and bonds and are treated in the same regard. A token is to be treated as a security if it fulfills the Howey test conditions;
- It is an investment of money.
- There is an expectation of profit.
- The investment of money is in a common enterprise.
- The expected profit is to be generated by a third party or promoter.
A number of African countries; Nigeria, South Africa, Kenya, and Zimbabwe are neither here nor there when it comes to ICO’s. There are no regulations for ICO’s in these countries, neither are they banned. They are said to be in a ‘grey area’. -Pratik Makadiya (CryptoGlobe)
Regulators in Ghana, Nigeria, Mauritius, and Botswana have warned citizens to proceed with digital currencies at their own risk. The Intergovernmental Fintech Working Group which comprises of the National Treasury, The South African Reserve Bank, the Financial Sector Conduct Authority and the Financial Intelligence centre released a report of their workshop in April 2018 outlining the need to classify cryptocurrencies into payment or utility tokens and the proliferation of ICOs.
Africa has recorded some successes in ICO such as AFCash by Africunia, Wala, RMT Token, Nurucoin and also ICO failures; Tingo coin.
A good amount of capital can be raised with an ICO, unlike an IPO which involves a higher cost. However, ICO’s are risky and speculative. So do your own research (DYOR)!
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