What do you do when you have a winning idea for a project but not enough money to execute it? You raise the needed funds by pitching your idea to investors. Various projects already do that in real life and Web3 is no different. In this space, this process is called initial coin offering or ICO.
What is an Initial Coin Offering (ICO)?
An initial coin offering (ICO) is a way that projects adopt to raise funds through cryptocurrency. The project’s team creates its own token and holds the ICO promising interested investors the newly created token.
ICO vs IPO
You might have heard of initial public offerings (IPO) instead. An initial public offering is a traditional way of raising capital for companies. In this case, the company raises money from investors and, in return, distributes shares of the company’s stocks to these investors. Considering that IPOs offer stocks to investors, they require stricter rules.
So, the main difference between ICOs and IPOs is that in ICOs you sell crypto instead of shares. And, that IPOs are subject to stricter regulations.
How Do Initial Coin Offerings Work?
Initial coin offerings are fairly simple. The process is the following:
- Project. A company, or a team, decides on an idea for a new product or service that they believe is valuable and profitable.
- Whitepaper. They prepare the project’s whitepaper containing all required information regarding their project.
- Token creation. They create the token on their desired blockchain, like Ethereum. This token will be what investors receive as a result of their investment.
- ICO. At this point, the company shares the whitepaper and holds an ICO. Those who invest receive the newly created tokens.
- Execution. If the company raises enough funds, they start working on their project distributing the money as mentioned in their whitepaper. If they don’t meet their capital goal, they may choose to refund investors.
- Trading. If the company goes through with the project, the new tokens can be traded on cryptocurrency exchanges. The value of these tokens will fluctuate based on supply and demand as well as the success of the project.
The team has decided that they will hold an initial coin offering to raise funds. Alright. But, before going through with it, they have to also decide on the ICO’s structure. There are three main ICO structures:
- Static supply and static price: Both the supply and token price are pre-determined.
->For example, 1 million tokens at a price of 1$ each.
- Static supply and dynamic price: The token supply is pre-determined. But, the amount of funds received determines the token price.
->In this case, we know that the supply is, for example, 1 million. Once the ICO ends, the company decides the price per token based on how much money it got.
- Dynamic supply and static price: The token price is pre-determined. But, the amount of funds received determines the token supply.
->In this case, we know that the tokens are set to be, for example, 1$ each. Once the ICO ends, the company decides the total supply.
An initial coin offering’s whitepaper is the document containing all the necessary information regarding the project. This is the first thing that investors check when they’re researching the project.
The whitepaper outlines the project’s vision, team, roadmap, fund needed, ICO’s structure, how will the funds be used, etc. Basically the team includes everything there is to know about the project in this document.
Pros and Cons of Initial Coin Offerings
Initial coin offerings sure provide a lot of positives to both the company and investors but they also have major negatives.
- Provides easy access to funds. ICOs are an easy, fast and efficient way for companies to raise money for the project they want to build.
- Removes intermediaries. Besides it offering an easy access to funds, it also removes intermediaries to reach these funds. Companies don’t have to rely on a third party. Through ICOs, they are in direct contact with the public making investing accessible to everyone.
- Increases community reach. ICOs attract investors, with no limits, prior to the launch. This helps the team build a community very early on in the project which is crucial to be able to succeed in this space. We’ve seen major names fail solely because they didn’t build a community or they disappointed theirs.
- Expands token liquidity. ICOs offer the newly created token as a result for investment. Therefore, now there’s a fairly large group of people who own these tokens and will trade them and use them to their full utility.
- High potential profit. Investors join the project before it even launches so they’re very early. This is a great opportunity to buy at cheap, and then profit when the token’s price increases after adoption.
However, if the project doesn’t get picked up, it’s a recipe for disaster which brings us to initial coin offerings’ disadvantages.
- Lack of regulation. ICOs offer cryptocurrency, and not shares, so they’re not well regulated. There aren’t any clear laws regarding these offerings which makes it the perfect stage for scams and frauds.
- No Investor protection. Given that there are no regulations, you can’t ensure that you’re protected as an investor. If the team ends up being fraudulent, takes your money and disappears, there’s nothing you can do about it. You’d just have to accept that you lost the money.
- High volatility. Investors might want to immediately start trading their newly acquired tokens. However, the tokens’ prices might fluctuate immensely due to multiple factors: supply and demand, project adoption, project longevity, community support, etc. If the project fails, the tokens will lose value which will lead to drastic losses for investors.
- Project viability and execution. There are two scenarios that might take place when the ICO ends. One, the team follows up with their word and starts with their execution plan. That’s good for investors, sure. But, the project simply might not be viable and ends up failing despite the team’s effort. So, investors’ money are now down the drain.
Two, the team gathers enough money and runs for the hill. They don’t bother to do anything, and investors would lose their money.
Should You Organize Your Own ICO?
Alright an initial coin offering, despite its negatives, is a great way to raise money for a project. So, should you organize your own ICO? Well, just because it’s an efficient way to raise funds doesn’t mean you have to adopt it. Face your truth. Sometimes, you don’t need an offering to raise money and there are easier routes for you.
Also, don’t fall into the trap of “we have money, we can do whatever”. So you end up coming up with any project. Don’t ever start a project, or a business, without doin an in-depth research and seeing if your project provides actual value and if it stands a chance on the long run. Now if you want to get free digital currencies with minimal effort, you might want to check out some crypto faucets. Good luck!