Initial Coin Offerings Explained
Over the past couple of weeks, we’ve covered the past, present and future of cryptocurrencies. Today we’re taking a deep dive into the world of token and Initial Coin Offerings (ICOs).
ICOs can be understood as a revolutionary new breed of primary markets, a process by which tokens of value are originated and distributed. Since its birth in 2014, this new issue market has become a thriving space that, curiously, has not received much attention in the mainstream financial press. So, we decided to tease out the key facts and explain the significance of the movement.
The invention of Bitcoin in 2009 provided tools to transact digital tokens of value via the web without trusted intermediaries. With a market capitalization of $40 billion, Bitcoin remains the most ubiquitous cryptocurrency. But it was the creation of Ethereum in 2015 that ushered in the era of decentralized smart contracts, giving developers the ability to manage digital tokens over the Internet without intermediaries. Adoption by developers and institutions has been impressive, with some of the largest enterprise level organizations in the world, including BP, Toyota, Intel and UBS, coming on board.
Smart contracts – once referred to as “the technology that will replace lawyers” – are applications running on a decentralized network that allow tradable tokens to be created and allocated to users. An Initial Coin Offering is the process by which tokens are originated and distributed to users.
In other words, ICOs allow investors to receive tokens in exchange for established digital currency like Ether or Bitcoin. ICOs are the technological equivalent of the traditional Initial Public Offering (IPO), but instead of shares being offered to investors, digital tokens are issued. Issuance, allocation, transferability and contractual triggers are programmed into the smart contract.
So, whilst ICOs can be used in a number of ways, the most popular use case is transactions that enable people to invest in companies offering new digital tokens. ICOs provide an innovative way to raise capital in support of entrepreneurial projects, whilst creating new tradable digital currencies.
Perhaps the most prominent ICO model is the issuance of “Appcoins”, digital tokens that give access to products or services. Participants in the ICO are early adopters who benefit from capital gains of the tokens as the underlying product or service increases in popularity. These are easily transferable, either over the counter or through a cryptocurrency exchange.
One of the first ICOs – and perhaps the most high profile to date – took place in in 2014, with the Ethereum project raised over $18 million dollars. During pre-sale, the token on sale, Ether, was worth between around $3. It recently traded at over $200. Another high profile ICO was that of Gnosis, which raised $12million in Ether currency in 12 minutes, issuing only 5% of its total supply of tokens and implying a post-issuance market cap of circa $300million – before a product had been built! Then there’s Bancor, who raised an almost unbelievable $140million in just a few hours. These are just a handful of examples – new ICOs are taking place all the time.
The appeal of ICOs is obvious. The borderless, decentralized nature of public blockchains makes it easy to transfer wealth across borders. They also lower the barrier to entry for start-ups and investors alike. And they’re cool, existing on the fringes of culture where visionary early adopters and risk-takers hang out.
Clearly, ICOs are a risky business. Besides the obvious concerns regarding cybercrime and a string of unsavoury incidents, ICOs are not regulated. These transactions can provide start-ups with a quick way to raise capital, but investors might struggle to understand the complex nature of how smart contracts and tokens function and hence, fail to accurately compute risk/reward.
As the market for cryptocurrencies and ICOs continues to grow, they are bound to come under scrutiny from regulators, particularly when an established brand name (inevitably) brings an ICO to market in order to benefit from advantageous pricing and exposure. Right now, it’s still early days for ICOs. Opportunity knocks for those with the right mix of expertise and risk-appetite.