Initial Coin Offering: Why the IPO of cryptocurrencies is suddenly popular
Finance

Initial Coin Offering: Why the IPO of cryptocurrencies is suddenly popular

It is the buzz phrase of the decade and holds all the heady promise of those early dot-com boom days of the 1990s. Initial Coin Offerings (ICO) are in some ways the cryptocurrency alternative to an Initial Public Offering and they are gaining ground as blockchain startups turn to cryptocurrencies to capitalise their business.

Essentially, any blockchain startup wanting to do an ICO needs to create and issue their own digital currency that can be used within the company’s own ecosystem to buy products or services on offer or as an investment that can be sold once the token achieve higher values. Smart contracts platform Ethereum is a good example. Its 2014 ICO raised over $18 million in Bitcoins, making its tokens – called ethers – worth $0.40 at the time. By 2016, ether value had skyrocketed to $14, with a market capitalisation of over $1 billion.

Eric Ross, Director of Technology at Loci, which is pursuing its own ICO, says that ICOs or token sales, have become the new gold rush within technology, but they are fairly limited to the blockchain technology space. “Blockchain has tremendous potential to revolutionise many technology spaces, but it has always been difficult to get funding through traditional routes,” he says.

Read an interview with the author of ‘Blockchain For Dummies’ and download the first chapter as a PDF - Blockchain For Dummies: What you really need to know

 

What are the benefits of an ICO?

Ross believes that ICOs offer several benefits to purchasers, people who would like to have access to a particular product or service the company selling the tokens offers. In the case of Loci, groups such as inventors and researchers will be purchasing tokens for the same reasons. As Loci’s portfolio of products and services grows, holders of tokens will have access to InnVenn, Loci’s patent searching tool product, and other products. The company is creating tokens that can be redeemed for the use of InnVenn.

“To my knowledge, we are the only company to date to offer a token sale with a product already on the market. The paradigm we are operating under is that these tokens are pre-sales for our existing tool, and it is up to us to build more uses for those tokens and release more uses for them in the future,” Ross says.

He explains that purchasers of ICO tokens also have the added benefit of diversification of their crypto assets. “By spreading out assets, they can hedge against any particular cryptocurrency running into an issue,” he says. For example, if Bitcoin has a hard fork, it could be worth drastically less at that point and if you are only holding Bitcoin at that point, you will lose value. 

“It is identical to the stock market now, being over leveraged in a single asset pool, like tech stocks or retail. Diversification always works to protect portfolio value and the crypto markets behave the same way in this sense.”

Dylan Dewdney, co-founder and CSO of Harbour DAO, agrees. “We're building Harbour to allow people to hold a broad array of tokens, without having to pick and choose and research each one. That's the safest strategy when you're acting without any definite knowledge.”

Harbour describes itself as a community-governed, Ethereum-based DAO (Decentralized Autonomous Organisation) for managing and holding tokens by harnessing the wisdom of the crowd. “All decisions are taken by the users for the users. Each HRB token you hold gives you one vote in Harbour. Token holders vote on what tokens Harbour should acquire, and how many of each. Token holders also have the power to create and vote on proposals that change the way Harbour itself works.”

Dewdney says one of the core benefits of ICOs is the democratisation of capital. “Digital technology has already changed just about everything, and with ICOs, it is starting to change how capitalism itself works, how companies are run and owned,” he says.

Dewdney says that it enables equity crowdfunding, where instead of just being a consumer of a company's product, you are part-owner. “It was surprisingly hard to have that sort of ownership structure before, which is why all the companies that dominate the world have centralised ownership; they're in the hands of a small number of rich people,” he says.

“ICOs are decentralising that ownership. Don't underestimate what a big shift that is in the way society is run. It aligns everyone's interests; it means the company won't act against the interests of the consumers, because the company is the consumers.”

Jessica VerSteeg, CEO of Paragon, says that ICOs are quicker to start up and the line of paperwork is fractional in comparison to an IPO. “This allows for ideas to be realised much sooner in addition to early offerings being accessible to the general public before tokens hit exchanges,” she says.

For Dewdney, though, this lower barrier to entry and lack of regulation is both an advantage and a risk. “It means more people can own a piece of the pie, but it also means it's a lot easier for a huckster to set up a scam ICO than a scam IPO. There is a lot of risk for anyone looking to acquire tokens. We're trying to mitigate some of that risk; we're crowdsourcing the decisions about what's a scam, and what's a worthwhile token.”

 

What are the problems with an ICO?

Artia Moghbel, head of operations and director of communications at DFINITY Networks, explains that it is currently very easy for a company to have an ICO, as the process is currently unregulated. “Companies don’t have to show any information about their technology or financials, and yet can still create very successful ICOs with savvy marketing,” he says.

“With an ICO there is also no requirement to deliver products, remain transparent or even provide any fiduciary responsibility to the public. It is highly risky, as it is essentially an unregulated sale of securities, which is why the SEC is starting to make motions toward regulating the industry. That said, there are a handful of companies that do offer legitimate technology and are using the ICO process ethically.”

In contrast, IPOs are highly regulated and tend to come later in the lifecycle of a company, rather than right at the start. Moghbel says that the SEC has very specific requirements for companies that go public, including quiet periods, reporting on financials, and restrictions on how and what a company can say about the future of their stocks. “Because they are more regulated, they are generally regarded to be less risky than unregulated markets, however, markets can be volatile and even public companies are susceptible to changes in market conditions, competitive landscape, and current events that may have an impact on the company’s stock prices,” he says.

VerSteeg adds that the lack of regulation is a disadvantage that may cause mainstream investors to be more reluctant. “Moreover, most tokens do not have any underlying value and are solely speculative,” she says, adding that crypto assets are inherently more volatile than traditional assets. But, she says, notwithstanding the risk factors, ICOs have realised perhaps the most impressive returns ever seen.

Moghbel says that while ICOs are a great way to raise funds for companies, due to the recent ICOs in which companies have raised millions in a matter of minutes, some companies are abusing the system and seeing it as an easy way to raise funds quickly with limited regulation. Moghbel believes this is having a negative effect on the overall blockchain industry and cheapens what is being done. “Fortunately, the US government has already signalled that it will start regulating the sale of digital assets as securities sales,” he says.

Regulation is likely to impact on the way that ICOs are approached. As Corporate attorney Will Turner of law firm Barnes & Thornburg points out, while it is too early to know for certain, the United States Security and Exchange Commission’s issuance of new guidance may dampen enthusiasm for ICOs. According to Turner, the principal points of this guidance are:

  • Initial coin offerings (ICOs) are required to be registered with the SEC if the coins are securities and offered and sold in the U.S.
  • Coins can be evaluated for securities status using traditional criteria
  • The issued guidance is the most comprehensive public guidance to date from the SEC on cryptocurrencies and tokens
  • Companies dealing in coins should consider whether these coins are securities
  • Companies dealing in coins may need to register as broker-dealers, investment advisers, securities exchanges or alternative trading systems

Using an ICO as a means to fund a startup is not as simple as it first appears. Ross says: “If a company needs capital and has a story that can captivate the crypto community, then an ICO might be a good idea. The missing link, however, is in the blockchain implementation, but if that falls into place, then it could be a good fit.”

He adds that ICOs are basically crowdfunding events and just like a successful Kickstarter the story must be told to get people to buy into the sale. “The reason why there is so much money in ICOs is because they are global in appeal. Cryptocurrencies transcend borders and the market is huge globally.”

 

Are ICOs just another tech bubble?

This demand has raised concerns in some quarters that blockchain and ICOs could be the next tech bubble to burst. VerSteeg points out that, like many traditional assets, Bitcoin supply is finite, and will reach its maximum amount of 21 million in a relatively short time. “Demand doesn't seem to be slowing down, applications are growing and legislation is becoming more progressive -- leading to more adoption,” she says. “Still, many economists will argue that Bitcoin is inherently worth nothing. This is true, but this is also its strongest element: a pure market of supply and demand.”

VerSteeg adds: “Some ICOs have terrible business concepts and will ultimately fail, bringing plenty down with them. However, this form of capital is not going away and the long term future looks rather well secured.”

Ross says that any time a lot of money is sloshing around, “analysts” who did not understand the concept or technology are likely to call it a bubble. He cites Bitcoin as an example, pointing out that when it “skyrocketed” from $100 to $300, market observers were quick to call it a bubble. Bitcoin hit almost $3000 in June 2017.

“The most fascinating aspect of this ICO phenomena is the fact that a very small percentage of crypto asset holders were participating early on, but that has grown substantially in the past few months. This is a new marketplace opening up, not just a bubble with limited resources that will run out and cause a crash,” he says. Ross believes that as more quality opportunities arise for token purchasers to diversify and become part of new communities, more participation will occur and it should continue to grow as the crypto markets continue to grow.

 

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Bianca Wright

Bianca Wright is a UK-based freelance business and technology writer, who has written for publications in the UK, the US, Australia and South Africa. She holds an MPhil in science and technology journalism and a DPhil in Media Studies.

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