Initial Coin Offering (ICO) is the new kid on the block financing for new startups, with business concept built upon blockchain technology. Proceeds from the auction of these virtual shares help fund the businesses.
If you want to know the differences between Venture Capital vs IPO and ICO, you can read my recent post using this link.
Around 2013, the sponsors of Mastercoin, a protocol on top the bitcoin blockchain, hosted an ICO and later raised a total sum of $500,000. This was followed by other milestone token sales, such as Ethereum in 2014, then the DAO, or Decentralized Autonomous Organization, which was built on the Ethereum blockchain and that stored and transmitted Ether and Ethereum-based assets.
The fundraising tactic, which is sort of like a crypto-financial twist on a Kickstarter campaign.
- You do the prep-work and get your project to a natural technical milestone.
- You build a website, with focus centering around your project for ICO.
- Then you pre-announce when you’re planning to have a token sale, describing some of the terms, and telling a story of the project and its goals.
- You publish a white paper and disclosures, to allow people a chance to read it and comment on it. The usually threads that develop on Reddit, Bitcointalk, Slack, Telegram and elsewhere, where people actively debate the merits of the product.
- Then, on the landing page of your website on the aforementioned date, there’s typically a tool that enables purchasers to acquire the tokens in exchange for bitcoin or ether. The proposed value of the token lies in its functionality and utility.
- [The issuing company] requests [the investor’s] source wallet and the wallet where the token buyer wants to receive the token.
- On agreed token issued date, the company concludes the sale by exercising the smart contract, with the the purchased tokens delivered to the purchasers’ wallets.
(Extract from an article written by Connie Loizos, TechCrunch on “How to stage an ICO”)
Two Types Of Token Sales
1) Utility tokens
The utility tokens are services or units of services that can be purchased. You can use them in the sponsoring company’s ecosystem. These tokens can be compared to API keys, used to access the service in the sponsoring company. These token sales are a way to fund projects of shared infrastructure that couldn’t be funded before. To enable such ecosystems to be built some tokens can be “pre-mined” in addition to be sold in “crowd-sales” during tokens launches.
Token holders are effectively financing future customers’ purchase of product or service offered by the sponsoring company.
2) Tokenised securities:
Tokens are representing shares of a business. In US, the SEC announced any token that can’t pass the Howey test should be considered as a security and fall under the 1934 Security Exchange Act. The Howey test consists of the following:
- Is it an investment of money or assets?
- Is the investment of money or assets in a common enterprise?
- Is there an expectation of profits from the investment?
- Does any profit come from the efforts of a promoter or third party?
Many countries have similar financial regulations that govern “security” tokens.
Most companies propose Utility Token sales in ICOs. These are usually payable using cryptocurrencies out of an abundance of caution (not wanting to handle fiat currency, which touches the margins of banking and money transmitter regulations).
Points To Note
- Usually, the Utility tokens can be traded in designated cryptocurrency exchange/s for token holders who wish to cash out whenever they like. The actual conversion rate for tokens into Bitcoin, Ether, and fiat currency are subjected to market forces, on supply and demand.
- This whole market is just a couple of years old. Many projects have been out for less than a year, so it’s too soon to tell whether it could be a bubble like the dot.com era.
- ICOs are hot-topics in many countries around the world. It is murkier. In September this year, China has banned ICOs. The U.S. Securities and Exchange Commission and other regulatory agencies are currently investigating the practice. The tokens, proponents say, are not quite like a security, yet not quite like a currency either. They’re something in between.
Investing in ICOs can be profitable but there are risks that you need to be aware of. Prepare to ask probing questions on issues and concerns in ICO meetup. The potential investors should be satisfied with the following:-
- The product or service they offer must address a real need area and use revolutionary solutions. Look for concepts that truly seek to disrupt the status quo of a particular industry by leveraging the strengths of blockchain.
- The company must be familiar with the target market. For example, in banking service, there are licence and regulations that need to be complied with, before it could start operation. Knowing the requirements, in the context of their target market are essential to its long term business success.
- The management team must have relevant business expertise in running technical startup or business. They should be supported by a strong project development team.
- Proofs of concept of the technology used are also critical in showcasing that these ventures know what they are doing. Having a functioning technology stand a better chance to progress towards commercial viability than those that still have yet to start development work.
- The key milestones, as stated in growth map in the white paper, should be realistic and achievable.
- Integral to ICOs are the tokens themselves. To know the various functions and uses of the tokens in the sponsoring company eco-system, including the possibility of the tokens to be traded in cryptocurrency exchange (if the token holder want to cash out).
- ICOs are high-risk, high-reward investments. It’s important to know how much one is willing to invest and possibly lose before participating in one.
The key is to perform due diligence and understand the market, the companies, and their solutions to figure out if they have the potential to succeed and provide ample returns for their investors.
(Extract from an article by Ralph Tkatchuk, CIO DIG contributor on “6 tips to pick the right ICO”
Disclaimer:
You should not rely on this post as legal or financial advice. It is written for general informational purposes only, as a guide to certain of the conceptual considerations associated with the narrow issues it addresses. You should seek advice from your own legal and financial counsel, who is familiar with the particular facts and circumstances of what you intend and can give you tailored advice.
If you have any comment, please drop me a line.
Thank you for dropping by.
Reuben Ong
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