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How ICOs Are Changing Startups and Investing

 5 min read / 

On July 1, Tezos, a startup building a blockchain with a self-governance mechanism included in its protocol, raised $222m in 14 days through an initial coin offering (ICO).

Venture advisor, entrepreneur, and author William Mougayar, who organised the 25 May Token Summit in New York City, said of ICOs and the opportunities they provide to start-ups:

“What has become easier is raising money. What has not become easier is the difficulty level of developing a company. Just because [a startup] can raise a lot of money doesn’t mean that [its] chances of success are going to be greater. If anything, it is the opposite.”

Tezos is just one more name on a growing list of startups that have recently raised astronomical funds from the public through blockchain technology. In June, Bancor, a startup building a decentralised exchange for digital tokens, raised $153m. Weeks later, enterprise blockchain solution startup raised $183m through its EOS tokens.

As the amounts raised grow, so does the list of startups and entrepreneurs planning new ICOs. In June, more than 20 major ICOs took place on the Ethereum blockchain, compared to 9 in May.

The trend is catching on with non-blockchain companies. For instance, mobile messaging app Kik is preparing its own ICO. It will issue tokens known as “Kin” on the Ethereum blockchain. In addition to helping the company raise capital, the tokens will serve as an in-app currency and fuel an economy among users.

What is an ICO?

Also known as a crowdsale, an initial coin offering, or ICO, is the process by which a company, institution or even an individual creates tokens on a blockchain and then sells them to the public. Tokens represent shares in the issuer’s project.

Tokens also serve other roles. For instance, blockchain start-ups Storj, Sia and Filecoin provide cloud storage solutions in the sharing economy. Their tokens act as the currency used to pay for their services, as well as the value received by those who rent out storage space.

Using tokens as the medium of exchange on these platforms helps users overcome payment restrictions that exist across international borders.

In the example of prediction market platform Augur, tokens serve as bonds placed by users when giving answers to prediction questions. Submitting misleading answers makes the user lose the value in the bond. This creates an economic incentive for users to be honest and truthful on the platform.

The Ethereum blockchain is popular with startups who run ICOs because it supports diverse applications. In particular, it can host smart contracts, which are critical for token creation.

The platform also provides infrastructure, such as wallets for holding, selling and spending tokens. Any token that meets ERC20 standards interoperates with other decentralised applications and their corresponding tokens.

Ethereum itself came into existence through an ICO in July 2014, when investors bought pre-mined ethers with Bitcoin. Other earlier successful ICOs include Omni in 2013, which raised over 5,000 BTC, and Factom in early 2015, which raised $1.1m.

Types of ICOs

Initial coin offerings result in either new cryptocurrencies or non-currency digital assets. If an ICO comes from a project that has its own blockchain, then it falls into the category of those launching a new cryptocurrency. Tezos and EOS belong in this category.

If a project is building a solution that doesn’t include building a new blockchain, then the coins it generates are simply digital assets that reside forever on the Ethereum blockchain. Most ICOs belong in the second category and include those by Storj, Sia, Kik and Filecoin.

What Makes ICOs Popular with Startups?

The process of creating an ICO is less rigid than that of seeking venture or angel capital. For example, startups that choose to go the ICO route don’t have to prove their idea in the marketplace before receiving funds. A detailed white paper is often enough for investors, even though less proof means they take on more risk.

Raising capital through the blockchain also fits the special needs of open-source and decentralised projects that are common in the blockchain space. Traditional sources of capital undermine the decentralised nature of blockchain projects.

High Risk

Because ICOs are largely unregulated, they are a risky investment option.  It is upon the investor to do due diligence before participating. Mougayar reminds investors that “the laws of startup evolution” remain the same, regardless of the methods used to raise capital.

“The tradition of VC wisdom is that if you have less money to start with, you will be more careful with how you use it and you will make better decisions. I am a bit worried now when two or twelve people have in front of them $15, $20 or $150m.”

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