An Initial Coin Offering (ICO) is a new technique for project financing. Right now it is primarily used for Blockchain related projects but it could be used for any type of projects. It is similar to IPO (Initial Public Offering) in terms of how the company distributes the “shares” to investors. However, these “shares”, also called coins or token, can be attributed any right towards the project, and their uniqueness, value and transferability is guaranteed by a Blockchain (often Ethereum). This allows investors to track the use of the money transferred to the project and to freely and rapidly sell or buy their coins.
What is the main disruptive idea here? In fact, Blockchain enables the project owners to create tokens, that have a unique value linked with the application/product being developed. Hence, people can buy those tokens in advance, knowing that not only the value is guaranteed, but also that they could either sell them right away or sell them later- once the application is available.
Starting a company or a project takes time and money. Entrepreneurs always try to find news ways of financing their project, from personal investment to Venture Capitals, loans and friends and family investments. But recently, thanks to the development of Blockchain technology, a new source of investment has emerged: the so-called ICO (Initial Coin Offering).
In a regular investment round, investor usually receive shares of a company which give them access to some rights regarding that company. For ICOs, investors receive so-called “Tokens” (or “coins”). Unlike shares, tokens don’t have to give any special rights, but they can provide multiple advantages; it is up to the token creators to decide what advantages they want the tokens to provide. As with shares, the creator of the token can decide how many tokens will be issued. All those characteristics are enforced through a “Smart-Contract”.
Smart-Contracts are autonomous programs executed by a blockchain. In this case, the Smart-Contract would state the rules of acquisition, transfer, redemption of tokens, as well as enforcing those rules. Investors can then interact with the smart-contract directly to buy and use tokens, and the owners of the smart-contract can retrieve the funds invested to finance their company.
The rest of this article analyses the various characteristics of ICOs.
What is a Coin?
The coin (or token) represents the unit of value investors get in return of their investment. These tokens can represent anything: shares within the company, access to the application being developed, timeshare of a building, vehicle, etc.
The coin itself is regulated through a Blockchain, where the coin is either the main currency in the Blockchain or it is regulated by a Smart-contract (an autonomous program ran by the computers all around the Blockchain).
The use of Blockchain ensures that:
The rules enforcing the coin are known to everyone
The rules are enforced as intended
Every creation, destruction and exchange of coin is traceable (this also ensures the uniqueness and value of each coin)
It guarantees investors with the free and independent possibility of selling or buying coins either on specialized marketplaces or off those markets.
Value of a Coin
The value of the coin either comes from the usage of it in the application or by its ability to be traded and its fungibility.
There are two possible way of distributing a coin, which one is chosen will influence the value of the coin:
The tokens are in limited quantity, hence the price follows the law of supply and demand.
Example: The case in the Gnosis ICO, where they raised $12m selling all their tokens in 15min.
There is no limit to the amount of tokens, hence they can all be bought directly through the smart-contract at a fixed price.
Example: This was the technique used in the Tezos ICO, with great success as they raised more than $200m over the course of one month.
From a purely technical point of view, the first approach makes sense if the scarcity of the token is linked with an underlying resource. For example, imagine a token giving people access to the computing power of other people. Ideally, the token would represent a unit of available computing power on the network, hence when a user wants to use X units of computing power, he needs to buy X tokens and those tokens will be transferred to the owners of the computer computing the tasks. The owner can then sell those tokens again on a marketplace so that people can reuse them to get more tasks computed. Here the price of the token would be dictated on the marketplace, most likely ending up being sold to the highest bidder.
When a token is not backed up by a limited underlying resource, for example it provides access to a bidding platform, then it's value can only be dictated by the fixed selling price of the token. There is no reason to trade it through marketplace as it is as easy to just get a new one from the platform itself.
What is the investor interest?
There has been over in H1 2017 a rise in popularity and amount of investments in ICOs, from only a dozen in 2016 to a hundred in H1 2017, and for H2 there is 87 announced and many more who have yet to announce it. The amount invested increased too, from a few millions to more than $100 millions in some cases. In H1 2017 more than $700m worth of crypto-currencies have been invested in ICOs.
Reasons for people to invest in ICOs :
It is the First “large” crypto-currency investment opportunity: ICOs only accepts crypto-currencies. The ICO is the first financial tool that allows for the investment of a consequent amount of crypto-currencies into a number a diversified assets..
ICOs promise liquidity: Crypto-currencies have seen a huge increase in valuation over a short amount of time; yet, they are not as liquid as they could be as people are encourage to hold on to their investments in hope of future growth, and people who already believe in crypto-currencies have already invested in it. ICOs and their underlying projects can provide some liquidity as soon as the token becomes tradeable. They also bring a number of new users wanting to join the “crypto-party” and willing to buy crypto-currencies to do so, thus increasing the liquidity of the whole market.
Trustworthiness: There is a clear commitment as to how the money raised will be used, and this is enforced via Smart-Contracts. The Smart-Contracts limit when the money can be used, and how, and the openness of the Blockchains allows for everyone to track the coins and see how they are used. So there are both barriers to prevent the ICO owners to abuse the moneys
Small risk for a sizeable investment: The crypto-currencies have seen a rapid increase in value over the last couple of years (Bitcoin went from $700 to $4000 over H1 2017 and Ethereum went from $12 to $400 over the same period of time). Thus people can invest huge amounts of money into ICOs but their initial investment is actually pretty small, so the real risk is limited to 1/1000th of the amount the company received.
Clear potential that will only grow from now: The Blockchain technology allows for unique use-cases with a huge potential across a lot of industries. The market is huge and the competition is still relatively limited compared with the potential size of the market, hence those projects have a huge potential, similar to the arrival of the Internet and the 2000 dotcom Bubble (not saying there is a bubble, but the promise for investors seems similar).