Funding a brilliant idea and turning it into a viable start-up isn’t an easy task. Some people ask friends and family for a contribution, while others might initiate a crowdfunding campaign or look for angel investors or VC’s to inject some much-needed capital into their business. Over the past three years however a new method of funding has emerged and various entities have successfully raised funds, sometimes even only based on a whitepaper. What did they do? The answer is: they launched an ICO.
To this day, the money raised through ICO’s in just over three years has totaled over 13,000,000,000 USD, with over half of the total amount being raised in 2018 alone. Compared to the traditional stock markets, cryptocurrencies only account for a small piece of the pie, but the industry has been growing really fast over the last few years.
Just look at this animated overview of the ICO bubble that was created.
What is an ICO?
Launching an Initial Coin Offering (ICO) or Token Generation Event (TGE) is a way to raise funds for a blockchain based start-up in exchange for supplying tokens to investors. ICOs are mainly launched on a blockchain platform like Ethereum, NEO or EOS. One of the main benefits of launching on a blockchain platform is the possibility of adding a smart contract that will execute terms and conditions associated with the ICO.
Participating in an ICO that issues utility tokens as an investor does not mean you generate equity or any other kind of asset from the company. Tokens issued are intended as an IOU or coupons which allows owners to exchange for future products or services.
ICO’s are mostly unregulated and specific countries (e.g. Malta, Switzerland and the Republic of Singapore) are favored to launch an ICO because of its favorable conditions. To avoid issues with authorities afterwards, ICO projects usually prohibit citizens of certain countries to participate and they will require token sale participants to be verified through providing Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) information.
Tokens issued after an ICO are mainly utility or dApp tokens. These tokens function as a future IOU to attain access to a project’s service or product in the future. Besides utility tokens there are also security tokens. A token is called a security token when it offers governance voting rights or when token holders will gain profit sharing rights. A security token gives the owner special rights in regards to the company that issued the token.
Current issues with ICOs
After the ICO gold rush late last year and during the beginning of this year, a lot of people, especially individual investors, got burned and saw massive losses on their investment. ICO projects performed really bad under the recent bearish market conditions, with some even reporting a 99% loss from their all-time-high prices.
“After a lot of consideration, weighing the different options against each other and looking at it from different perspectives, we have decided that the second option is the most responsible way to go — we wind Cofound.it down and distribute the assets to token holders. The purpose of Cofound.it was to build a platform and protocol to enable an alternative VC ecosystem; to continue with this purpose for a market that does not exist is not responsible.”
Over the course of the last few months a decrease is detected in ICOs raising their desired funds, with a few minor exceptions, like entertainment platform TaTaTu (TTU) that raised 575,000,000 USD. It is currently listed on coinmarketcap at number 111 at a valuation of 43,000,000 USD. Hedera Hashgraph raising 100,000,000 USD to build and launch a platform that supports the Hashgraph protocol. They have yet to issue their tokens and launch on an exchange.
Participating in an ICO is in essence not the best position for individual investors. Individual investors are usually the last people to invest with the least amount of insider project knowledge and the highest amount of token price. Because of the lack of transparency, they are often unaware of the token purchase price of seed investors, friends, and family plans or VC rates. Getting dumped upon by earlier investors is a regular occurrence.
ICO Terms state that the project is a high-risk investment and it might fail and there is nothing you can do about it. Yes, it actually says that in the ICO terms.
What is an STO?
A Security Token Offering (STO) is a relatively new way of raising funds for a start-up. It has some similarities to a traditional business that is going public through an Initial Public Offering (IPO). In an STO a company issues security tokens to investors. Security tokens can be described as asset-backed IOUs and they can be considered legally binding investment contracts that give investors access to a share of the company, a monthly dividend or a voice in the business decision-making process.
Is launching an STO a sustainable solution for blockchain companies to raise capital?
While ICO investors at utility token offerings do not acquire any rights or shares from the company they invest in, STO investors have more rights and can own shares similar to a regular business initiating an IPO. Benefits of launching an STO compared to an ICO are: Investors receive an asset-backed token because it basically is a share in the company. The business is more sustainable as it is scalable. It eliminates scam projects because it requires government compliance. A downside to STOs is that it takes away from the decentralized nature of cryptocurrency as government entities are involved in the approval to launch an STO. Given the fact that financial products are involved it seems fair that a reputable source is overseeing its legitimacy.
Lately, more and more companies are leaning towards launching an STO. News surrounding STOs has seen a large increase in the past months:
- Digital asset exchange Binance announced it is partnering with Malta in opening a specific digital exchange that offers the trading of security tokens.
Growing the cryptocurrency industry to a new and fully compliant asset class
Blockchain project The Abyss was the first to take on a new approach in launching an ICO and implemented Ethereum co-founder Vitalik Buterin’s idea of a more suitable ICO scheme, called a DAICO. A DAICO is an abbreviation of Decentralized Autonomous Initial Coin Offering and aims to implement the main benefits of a Decentralized Autonomous Organisation (DAO) into an ICO in a way that minimizes the risk and complexity.
Nebulas announced it will be postponing the teams' payment by at least 1 year with some specific funds being locked for up to 10 years. This gives them an additional incentive into committing themselves long-term and building the project they intended to build.
One of the key issues that need a solution is the fact that an ICO isn’t scalable. After a team runs out of funds there is no way to pay for staff and other business expenses. Money burns really fast when traveling all over the world to visit conferences, sponsor booths and pay a premium to hire blockchain developers, who are a scarcity. Some projects are now initiating second ICOs to fund a new business feature. Recently word got out that Dash might be running out of money. Verge is asking for donations to be able to keep working on the project.
In my opinion, we will see a big surge in the tokenization of securities starting in the coming months. Startups that enter the blockchain and cryptocurrency industry probably notice that the new trend will be to conduct a legit and compliant form of fundraising.
Disclaimer: This article is not intended as investment advice. It is just my personal opinion. You should always do your own research, before investing in a project and never invest more than you are willing to lose.
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