Initial coin offering (ICO)
An Initial Coin Offering (ICO) is a fundraising method used by startups to generate capital for new cryptocurrency projects. Unlike traditional Initial Public Offerings (IPOs), ICOs allow investors to purchase cryptocurrency tokens without acquiring an equity stake in the company. These tokens are typically intended for use in a future product or service developed by the startup, offering potential for value appreciation. However, ICOs carry significant risks, as they are not heavily regulated like IPOs, making them susceptible to fraud.
Investors may be drawn to ICOs either to use the future services linked to the tokens or to seek profit from potential appreciation in value once the tokens are traded on exchanges. The cryptocurrency market's volatility can lead to profit or loss, depending on the success or failure of the associated projects. Additionally, regulatory scrutiny varies globally, with some countries banning ICOs altogether. Despite the risks, some experts believe ICOs could be instrumental in funding innovative open-source projects that might struggle to gain traditional investment support.
On this Page
Subject Terms
Initial coin offering (ICO)
An initial coin offering (ICO) is a fundraising tool that many start-up companies seeking to launch a new cryptocurrency use to generate capital. A public ICO affords retail investors the chance to purchase the company’s new cryptocurrency tokens. As opposed to a traditional initial public offering (IPO), however, this transaction does not give the investor an equity stake in the company. Instead, the reward for investors is the promise that they will be able to use their coins on a product that will be created later. This provides those who buy into an ICO the opportunity to potentially profit from their investment in the future. While ICOs have become an attractive crowdfunding option for start-up companies, such offerings can be especially risky for investors. In significant part, this is because ICOs are not subject to the same strict federal regulations as normal IPOs and are much more likely to be fraudulent.
Background
To fully understand ICOs, it is first necessary to understand the concept of cryptocurrency. Cryptocurrency is an alternative to traditional currency that exists in the online world and uses encryption to ensure that transactions are secure. In effect, cryptocurrencies are systems that make it possible to carry out secure online financial transactions using virtual tokens. Cryptocurrency systems allow users to send payments to one another without relying on a bank or some other third-party institution. As a result, cryptocurrencies eliminate the need to use one’s social security or credit score as collateral. In addition, they allow for a level of anonymity in financial transactions that is impossible with a bank account or credit card.
Cryptocurrencies have many potential uses. Users living abroad can send money to their friends and family without having to pay various international fees. Business owners who use cryptocurrency enjoy an added level of security from bad checks or financial fraud because their customers can only spend the tokens they already have. On both sides of the business equation, cryptocurrencies have clear advantages over normal financial transactions.
There are a wide variety of cryptocurrencies available for use. The first and most famous is Bitcoin. First created by an unknown person or group referred to as Satoshi Nakamoto, Bitcoin became enormously popular when it was initially released in 2009. The company continued its success through the 2010s as the most used cryptocurrency, even as other cryptocurrencies emerged in the market. By the 2020s, there were more than 19.9 million bitcoins in circulation, with a total estimated value of about $1.39 trillion. Bitcoin’s overwhelming success led to the creation of numerous other cryptocurrencies, including Litecoin, Ethereum, EOS, and Cardano.
New forms of cryptocurrency are constantly being developed. The creation of a new cryptocurrency, application, or virtual service can be an expensive endeavor. As a result, the companies and individuals behind such endeavors often have to find creative ways of raising the capital necessary to fund their work. Although there are many more traditional approaches to fundraising, ICOs are an effective alternative that allow entrepreneurs to avoid the strict regulations required by banks and other similar institutions.
Overview
On the most basic level, ICOs are a way for start-ups to raise funds without selling stock or seeking capital from other traditional outlets. Instead, developers crowdfund their projects by making and selling their own cryptocurrencies that work much like Bitcoin and other established cryptocurrencies. In most cases, the cryptocurrency tokens that a start-up sells as part of an ICO are specifically designed to be used only in connection with some sort of computing service that the developers are creating. This represents the central tenet of most ICOs: investors purchase tokens on the premise that they will become valuable once the system in which they will be used is built. In most cases, the tokens sold in ICOs are based on and purchased with existing cryptocurrencies like Bitcoin. The new tokens are ultimately meant to exist outside of other cryptocurrencies and eventually have their own independent value.
There are two main reasons why people typically choose to invest in ICOs. Some choose to purchase tokens sold through an ICO because they want to use the services to which they will one day be attached. Others instead purchase such tokens simply because they hope the value will eventually increase. This is possible because of what happens after an ICO. During an ICO, tokens are sold at a set price. Afterward, tokens are traded through open-market bidding on third-party exchanges similar to traditional stock markets. As a result, the value of a given cryptocurrency can fluctuate over time and lead to profits or losses for those who purchase them. People who choose to invest in an ICO typically do so with the belief that the developers will complete the services the tokens will be used for, which will lead to greater demand and an increase in the value of the tokens themselves.
Investing in an ICO does not always lead to profit. If the developer fails to complete the service its tokens are meant for, investors will most likely lose the money they put into the project. Some ICOs may even be outright fraud. Because there is little regulation of cryptocurrency markets, it is relatively easy for scammers to defraud potential investors by offering an ICO with the promise of a forthcoming service and never actually building that service. This has led to many questions about the legalities surrounding cryptocurrencies and ICOs. In the United States, federal regulations have suggested that at least some cryptocurrency tokens should be categorized as securities like stocks and bonds. Tokens categorized as securities would be subject to standard securities law and would, therefore, be less of a risk for investors. In other countries, such as China and South Korea, ICOs were deemed illegal in the late 2010s.
While many investors may be wary of cryptocurrencies and ICOs, some tech experts believe that ICOs could provide critical funding for open-source projects that would otherwise be unlikely to receive adequate support. Open source refers to software for which the original source code is made freely available for redistribution and modification. Crowdfunding achieved through ICOs could aid in the creation of a new generation of open-source Internet protocols that might be crucial to the next evolution of the Internet itself.
Bibliography
Brown, Aaron. “Initial Coin Offerings Are Getting a Bad Rap.” Bloomberg, 29 July 2018, www.bloomberg.com/opinion/articles/2018-07-29/initial-coin-offerings-are-getting-a-bad-rap. Accessed 27 Dec. 2024.
“Crypto Assets.” US Securities and Exchange Commission, www.sec.gov/securities-topics/crypto-assets. Accessed 27 Dec. 2024.
Daily, Lyle. "What Is an Initial Coin Offering (ICO)?" Motley Fool, 27 Feb. 2024, www.fool.com/terms/i/initial-coin-offering. Accessed 27 Dec. 2024.
“Initial Coin Offering (ICO): Coin Launch Defined, with Examples.” Investopedia, 2 June 2024, www.investopedia.com/terms/i/initial-coin-offering-ico.asp. Accessed 27 Dec. 2024.
"Initial Coin Offering (ICO)." Corporate Finance Institute, corporatefinanceinstitute.com/resources/cryptocurrency/initial-coin-offering-ico. Accessed 27 Dec. 2024.
Kharpal, Arjun. “Tokenization: The World of ICOs.” CNBC, 12 Apr. 2019, www.cnbc.com/2018/07/13/initial-coin-offering-ico-what-are-they-how-do-they-work.html. Accessed 27 Dec. 2024.
"Understanding Initial Coin Offerings." European Parliament, 2021, www.europarl.europa.eu/RegData/etudes/BRIE/2021/696167/EPRS‗BRI(2021)696167‗EN.pdf. Accessed 27 Dec. 2024.
"What Are Initial Coin Offerings (ICOs) and How Do They Work?" Coinbase, www.coinbase.com/learn/tips-and-tutorials/what-are-initial-coin-offerings-and-how-do-they-work. Accessed 27 Dec. 2024.