What is an ICO?
An Initial Coin Offer, also commonly called an ICO, is a fundraising mechanism in which new projects sell their underlying cryptocurrency tokens in exchange for Bitcoin and Ether. It's a bit like an Initial Public Offering (IPO) in which investors buy shares in a company.
ICOs are a relatively new phenomenon, but they have quickly become a dominant topic of discussion in the blockchain community. Many see ICO's projects as unregulated bonds that allow founders to raise an unwarranted amount of capital, while others argue that they are an innovation in the traditional venture capital financing model.
The US Securities and Exchange Commission (Securities and Exchange Commission – SEC) recently reached a decision on the status of tokens issued in the DAO ICO that forced many projects and investors to re-examine the funding models of many ICOs. The most important criterion to consider is whether or not the token passes the Howey test. If so, it must be treated as a guarantee and is subject to certain restrictions imposed by the SEC.
ICOs are easy to structure due to technologies like the ERC20 Token Standard, which abstract much of the development process required to create a cryptographic asset. Most ICOs work by having investors send funds (usually Bitcoin or Ether) to a smart contract that stores the funds and distributes an equivalent amount into the new token at a later time.
There are few, if any, restrictions on who can participate in an ICO, assuming the token is not, in fact, a guarantee. And since you're getting money from a global group of investors, the sums raised in ICOs can be astronomical. A key issue for ICOs is the fact that most raise money from a pre-product. This makes the investment extremely speculative and risky. The counterargument is that this style of fundraising is particularly useful (even necessary) to encourage protocol development.
Before we get into a discussion of the merits of ICOs, it's important to have some historical context about how the trend started.
History of ICOs
Several projects used a crowdsale model (token sale)to try to fund its development work in 2013. Ripple pre-mined 1 billion XRP tokens and sold them to investors willing to trade fiat currencies or bitcoin. Ethereum raised just over $18 million in early 2014 – the largest ICO ever completed at the time.
DAO (Decentralized Autonomous Organization) was the first fundraising attempt for a new token on Ethereum. It promised to create a decentralized organization that would fund other blockchain projects, but it was unique in that governance decisions would be made by the token holders themselves.
Although the first attempt to securely fund a token on the Ethereum platform failed, blockchain developers realized that using Ethereum to release a token was still much easier than traversing “seed” rounds through the usual VC model. . Specifically, the ERC20 standard makes it easy to create your own cryptographic tokens in the Ethereum blockchain.
Some argue that crowdfunding projects could be Ethereum's “killer app” given the size and frequency of ICOs. Never before have startups managed to raise so much money in such a short time.
Aragon raised about $25 million in just 15 minutes, the Basic Attention Token raised $35 million in just 30 seconds, and Status.im raised $270 million in a few hours. With few regulations and ease of use, this ICO climate is being scrutinized by many members of the community, as well as various regulatory bodies around the world.
Is ICO Legal?
The short answer is maybe. Legally, ICOs exist in an extremely obscure area, because arguments can be made for and against the fact that they are just new, unregulated financial assets. The SEC's recent decision, however, managed to clear up part of this murky area.
In some cases, the token is simply a utility token, meaning that it gives the owner access to a specific protocol or network; therefore, it cannot be classified as a financial guarantee. On the other hand, if the token is an equity token, which means your only goal is to value, then it looks more secure.
Although many individuals buy tokens to access the underlying platform at some point in the future, it is hard to refute the idea that most token purchases are for speculative investment purposes. This is easy to determine given the valuation values of many projects that have not yet launched a commercial product.
The SEC decision may have provided some clarity on the status of utility tokens versus security tokens; however, there is still plenty of room to test the limits of legalities. For now, and until more regulatory limits are imposed, entrepreneurs will continue to take advantage of this new phenomenon.
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