An Initial Coin Offering (ICO) is a hybrid-product which sits between a crowdfunding round and an IPO. As such, companies raise capital through the pre-sale of ‘tokens’, a platform of specific cryptocurrencies which can be used on the platform in some capacity.
Funding from the token sale provides capital for the development of the project and should the project then be successful, there will be increased demand for tokens, and thus the price of pre-sale tokens will appreciate. As such, users have the opportunity for financial reward on early adoption.
There are no current specific regulations for ICOs, and as such projects can define the parameters of their token sale, including the quantity and distribution model. This is often referred to as a wild west scenario and there have been a number of fraudulent, nefarious or ill-researched ICOs which support this description.
Exhibit 1: Bancor
Bancor is a market-making startup that failed to properly make its own market. It managed to raise an astounding $153m in just three hours, overshooting the initial target by $51m! Shortly after the ICO, a paper entitled ‘Bancor is Flawed’ was published which brought the project’s viability into question. It resulted in hundreds of naïve investors losing money because they did not conduct the necessary due diligence.
Exhibit 2: OneCoin
This April, blockchain technology company OneCoin were in the midst of a sales pitch when financial law enforcement agents raided the meeting and later jailed 18 OneCoin employees and representatives.
They seized more than $2m and found that over $350m of scammed fundraising had already been moved through payment processors in Germany. Officials claimed that OneCoin was little more than a Ponzi scheme and the underlying technology was found to consist less of blockchain technology and more of an excel spreadsheet with fake transaction animations.
Despite these examples, interest in this fundraising method is growing, with $180m raised in 2017 already. This compares favourably with a 2016 total of $101m and is drawn from both new and existing companies being attracted to the model. Notably, messenger app Kik recently announced an upcoming ICOs in a quest to raise additional funding and “combat the monopolisation” of digital services.
One should, however, note that as well as being a disruptive business model to traditional VC and angel investing, it is also being embraced by the incumbents. Firms such as Union Square Ventures and Andreessen Horowitz have backed crypto-token investment funds such as Polychain Capital, who exclusively invest in token offerings. Two notable 2017 ICOs are Gnosis who raised $12m in less than 15 minutes, with the only accompanying document supplied to investors – a PDF. And Brave, a bitcoin browser who raised $35m in 30 seconds.
With both new and existing companies looking into the option of an ICO rather than traditional financing, this could look to pull revenue from banks and VCs. However, this nascent funding option has been left untouched by regulators so far.