What is an ICO?

To start any business or enterprise, capital is needed. Traditionally, there are several ways to acquire this capital. For example:

1.    You can invest your savings (if you have any)

2.    You can sell some of your assets such as jewelry or vehicle, etc.

3.    You can borrow money from family or friends

4.    You can borrow money on interest from a bank

5.    You can borrow money from institutions against shares in the company or as convertible notes (amount needs to be paid back within a prescribed time with agreed-upon interest, or it will be automatically converted to the company’s shares at a discounted price). Each shareholder is now entitled to part-ownership of your company to the extent of his shares. The majority shareholders can even determine your salary. If more than 50% of the shareholders decide to remove you from the company ownership, they are very capable of doing even that. Moreover, you have to register all these concerns with the Security Exchange Commission (SEC) and you are liable to abide by your country’s laws and rules of various government institutions. All this naturally makes the process somewhat cumbersome.

6.    You can get funds from the public by carrying out an IPO. IPOs need an underwriter (investment bank) to facilitate the process and to meet the statuary requirements by the Security and Exchange Commission (SEC).

All these tasks require a lot of time for thinking, planning, taking care of regulatory affairs, satisfying government requirements and proving that you are, indeed, a trustworthy person spearheading a venture that deserves to be funded.

In recent years, crowd funding has challenged these age-old practices by creating a way to ask for funds directly from common people all over the world. By proving the details of your company or venture, the credentials of your team and further technical details on websites such as KickStarter or GoFundMe, you can appeal for funds from people all over the world.

Most of these funds are in the form of donations; the donor gets nothing out of it and supports your work by way of charity. In some cases, at the completion of project, the donor can either claim benefits such as samples of your product, or their funds back, according to pre-decided agreements. The company usually deducts a commission of between 10-15% of these funds before returning them. If you are unable to interest a significant number of people to fund you, or the funding target fails to be achieved, then all the funds will be returned to the respective donors and you will gain nothing.

Sites like GoFundMe, KickStarter and LaunchGood have raised over 5 billion dollars for various campaigns and projects that users have posted on their sites. Even charity organizations like Kiva are following trend and opening up funding avenues for individual needs.

Initial Coin Offering (ICO) is actually a modern take on the above-mentioned crowd funding practice – it is a method of raising funds used by cryptocurrency and blockchain based startups. The entire process is the same, with the difference that all of it is done on blockchain and the funds received are in cryptocurrency. In return, you give the donor some tokens of your project or company. The new native currency created by the startup is sold to investors against Bitcoin or Ethereum.

In contrast to traditional crowd funding, ICOs offer donors the prospect of increase in value of the tokens so that they can earn a profit solely by virtue of donating. Investors buy the coins or tokens of a new company in the hope that its price will increase following the launch. For example, the price of Ethereum at ICO was 40 cents, and it is now running at around $200 per coin. The world has never before seen profit margins such as these. Most of the startups in ICOs sell their coins as pre-sale tokens or donations to avoid legal and regulatory authorities. The native tokens are then listed on private crypto exchanges like Binance, etc. for further trading after the successful ICO.

Contrary to regular funding methods with financial and audit reports, ICOs start with a simple ‘whitepaper’ explaining the technology, total number of tokens, percentage of tokens being offered on sale, the percentage that founders and developers will get, and the funds that will be kept separate for further extension of the platform or technology. It also details the goals, mission and timelines of the project, in addition to how long the ICO will run and what kinds of cryptocurrencies will be accepted. If the funds raised do not meet the minimum criteria for ICO funding, all funds will be returned to investors and the ICO will be deemed unsuccessful. If the funds raised are above the required maximum limit, the extra funds will also be returned.

There are 3 basic types of tokens issued by the company:

1.    Coins

Each project has its own native currency. For example, when Ethereum ran its ICO, Ethereum was valued at 40 cents. From USD 0.4, it reached a value of USD 1,300 in due course – about a 4,000 times profit!

2.    Utility tokens

These are units of service which can be used at a later date. For example, you participate in a school’s ICO, and then later, in exchange for these tokens, you can get your children schooled at that institution. There are many examples of this in the music and arts industry.

3.    Security tokens

These are exactly like traditional company shares – possession of these makes you a part owner of the company. For these, it is necessary to be registered at the SEC. In order to find out which token comes in the domain of SEC, the United States SEC has laid down the conditions of Howey Test. If any kind of money is used in the purchase of security tokens, the money has been given to some company and the donor stands to claim a profit solely by investing and without any hard work, then this process is known as Security and on this, all the rules of SEC stand to apply.

ICOs do also fail, plummeting the value of its token to zero. It is highly advisable to understand the characteristics of a good ICO before investing in such a venture. The project should be related to cryptocurrency and blockchain, it should have a detailed whitepaper, and the management and technical team should be sound with respect to skills, credentials and past success in the domain or related domain of their intended project. Moreover, the distribution of funds in question should be transparent (coin allocation), and the total ask-for amount should be between 2 million to 10 million dollars. The ICO should also have the direct application of its token soon after the ICO (the use case), and you should be able to talk to and reach the founders with ease.

There have also, unfortunately, been a couple of hacking incidents where hackers were able to steal large amounts of ICO-based money from startups – recently, DAO, Ethereum and a couple of exchanges. More incidents like this are likely to tighten regulations and make them harder to work with for the foreseeable future. We need a technologically superior system that would be compatible with regularity affairs, or create a regulatory sandbox to experiment with new models of funding while protecting the resources and money for entrepreneurs, investors and public at large.

In order not to dampen the spirit around ICOs, it is worth looking at some ICO success stories. In 2013, an ICO by the name of NXT ran from 28 September to 8 November of that year. Twenty-one bitcoins were collected from 73 investors which were collectively worth USD 14,000. In only a few years, the profit gained by these 73 investors was 200,000%. The Ethereum ICO ran from 20 July 2014 to 2 September 2014 (about 42 days) and collected about 21,500 coins which would be valued today at USD 18 million. This ICO earned its investors a 4,000% profit.  The ICO of LISK ran from 22 February to 21 March 2016. USD 5.7 million was collected and the profit was 138%. The ICO of Waves was USD 16 million and that of DAO was USD 160 million. To date, there have been over a thousand ICOs which have done business of over USD 10 billion. In light of the growing popularity of ICOs, you can call them the security shares of the future.

Among prospective tokens, those worthy of mention are Human-IQ (which helps the poor gain inclusion in the international economic system), Eternity (where smart contracts will be able to work with live data), and others such as Internet of Coins, Cosmos, Blue Frontiers, Gnosis, Etherex and Akasha. These ICOs are expected to garner significant profit through business. Within ICOs as well, many further innovation are being introduced. IBO (Initial Bounty Offering) is an example, where initial developers of the project are given IBO tokens when they complete their share of the work. On average, an ICO is able to collect USD 12.7 million and on average, the percentage of profit expected is 12.8 times.

With the help of the Ethereum platform and the ERC20 token standard, anybody can issue their own tokens in a matter of hours. Before getting involved in an ICO, it is advisable to check the local laws, lest in your ignorance you get embroiled in legal complexities. China, for example, has completely banned ICOs and the US has applied many laws. Nowadays, regulations are the biggest threat to ICOs. It is wise to check if the prospective ICO would clear the Howey Test – “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” If the ICO can be classified as a security as per the Howey Test, it clearly means that the investor and the startup both have to follow SEC guidelines and regulations in the process, or risk losing their enterprise and money.

There exist many websites, such as Token Foundry, which can help you in launching your ICO. For further information, explore websites such as Token Market, ICO List, Smith & Crown, ICO Bench, ICO Countdown, ICO Rating and Crypto Compare, to name a few.

I’ve recently published a book — Introduction to Blockchain with Case Studies and it’s available from Amazon worldwide, Gufhtugu Publishers in Pakistan and here is my Urdu Book (بٹ کوائن، بلاک چین اور کرپٹو کرنسی) on the subject as well.