Companies working with blockchain continue to expand our understanding of the possible, forcing us now to rethink the idea of attracting and raising capital.
The concept of Initial Coin Offerings (ICO) was once understood by and available to a small number of blockchain technology enthusiasts. In today’s realm, they are quickly gaining popularity among venture investors, to an extent that there are now official regulations. The most recent news is that Abu Dhabi’s Financial Services Regulatory Authority (FSRA) released guidelines on ICOs and virtual currencies for the first time.
If this new way of investing caught your attention, here's what you need to know about ICO.
ICO: What is it?
A mixture of crowdfunding and capital raise gives birth to an ICO. With its help, developers are raising funds for new blockchain projects.
Now the attraction of capital is often carried out before the launch of the project. The issuing company releases digital tokens and exchanges them for a common digital currency, most often bitcoins (Bitcoin) or ethers (ETH/USD). The token gives access to the project after it is launched. If it is successful, people who have invested in it at an early stage will benefit from the increase in the cost of the token.
How is the ICO technically organized?
In terms of technology, the ICO process looks misleadingly simple. The new token is transferred to the investor with the help of a "smart contract" in an exchange for a certain amount. Typically, the funds are provided by transferring the digital currency to developers.
For ICO, developers prepare an official document, a White Paper, which provides general information about the blockchain project and digital tokens. At times, there is a second document added to it, a Technical White Paper, which details the technological features of the project and the ICO itself. The third document can be an Offering Memorandum, in which various risk factors and the investment processes are described.
Who are the ICO investors?
Here are the main investors who have interests in Asia in particular:
- Pantera Capital, the first US investment company aimed exclusively at investments in blockchain projects. Pantera invested in Z Cash, Ripple Labs and coins.ph.
- Established in 2013, Blockchain Capital, was the first venture company that agreed to consider applications for investments in bitcoins. It invested in Coinbase and Wave.
- Digital Currency Group - an investment company known for supporting such blockchain projects in Asia as Melotic, Luno and BTCC.
- Fenbushi Venture Capital, the first venture company in China, invests exclusively in blockchain projects. It invested in Abra and Symbiont.
Why are ICOs appealing for VCs?
According to some venture capital companies, the main value of the new technology lies in the protocol and not in the applications.
Digital tokens enable the protocol creators to monetize it directly. This is generally done by reserving part of the tokens for developers, early stage investors or first time users. When the project is created and succeeds, this group of investors can launch a chain of positive feedback and give market support to the tokens. Good applications based on the blockchain protocol help to draw interest to the protocol itself, which already has a ready market. With the increase of the price, the market capitalization of the protocol would raise quicker than the capitalization of applications.
ICOs’ major advantage is that the token can be exchanged for a more popular digital currency, and then to the fiat currency on a crypto exchange. This makes tokens liquid.
ICO is in many ways similar to the placement of securities. The documents that are being prepared for the ICO are developed on the basis of a standard package of documents for the issue of securities. The very name of the procedure "Initial Coin Offering" is similar to the "initial public offering (securities)".
Those who claim that ICOs are not securities indicate the following:
- With the ICO, investors are not offered a share in the blockchain project.
- With the ICO you can buy a cryptocurrency. Crypto currency is not a security.
- ICO is an international instrument and is not controlled by any regulator or bank.
- A digital token that is issued as part of the ICO can be used, including for access to the project being developed or the purchase of services in it.
Those who consider ICO as the placement of securities indicate that the procedure and placed tokens fully comply with the criteria for what a security is and its placement. Investors participating in the ICO expect to make a profit. Once something is proposed as a tool for investment or speculation, and not an object for use, it is more likely to be treated as a security. The increased interest of regulators is due to the fact that the offer to buy is made by the general public.
Usually, ICOs are launched at an early stage of development, often immediately after the concept is developed. It’s important to keep in mind that any investment in the project at an early stage is essentially risky.
The blockchain industry does not yet have a quality infrastructure for investors, including analytical support. Therefore, these investments are not suitable for investors who are used to the help of professional intermediaries who track all information about the industry and companies and manage investments in a regulated environment.
The conditions of many ICOs do not meet the standards aimed at combating fraud and money laundering.
The infrastructure of the ICO does not provide for any control over the expenditure of funds or control over the progress of the development of the blockchain project, for which the money was collected. Nothing stops the developer from raising funds and escaping with them.
However, ICO is attracting increasing attention. They will soon be interested in those who want to raise capital in an unregulated setting in fact without reporting to investors and without a deep understanding of the main investment risks. This might be a dangerous mix.
ICO will become a common tool. Many analysts believe that their main value lies in the projects that appear due to this funding. ICO provides an opportunity to receive financing without extra costs and create a network of interested supporters of the project. This allows solving the very acute problem of the financing gap faced by private companies around the world before they find a strategic investor or go on the stock exchange.