We all know the magic behind the revolutionary Bitcoin is the blockchain technology. But there are scores of other benefits that this disruptive technology offers. Blockchain enables transaction of cryptocurrencies through a decentralized environment. As there are no governing body or third parties involved, the technology is highly transparent and trustworthy. In the past couple of years, the technology has evolved significantly and today, blockchain is much more than just cryptocurrencies.
In this post, we are going to discuss perhaps the most persuasive offering of the blockchain platform, which is ICO. If you are a fan of blockchain technology and following the industry trends, you must have heard about ICO. Before we dig into it for details, let’s first tell you about ICO.
What is ICO?
“It’s like penny stocks but with less regulation.” — Jeff Garzik
Companies raise funds for various business purposes like acquisitions, expansion, resource hiring, etc. This is usually done via Initial Public Offering (IPO), where a company offer its shares for the public to purchase. This was an expensive affair as you have to utilize capital markets, which small and medium scale companies couldn’t afford. Powered by blockchain technology, ICO (Initial Coin Offering) was introduced as a fund-raising mechanism in which new projects offer their underlying crypto tokens in exchange for Bitcoin and Ether. ICO promise quick liquidity, immutable contract guarantees and most of all — they democratize access to investment capital.
After getting a lot of success, ICO witnessed increasing adoption among various companies who started developing ICO and use it instead of utilizing their capital markets. Notable companies like Telegram and Kakao have raised funds offering ICO instead of IPO. With a substantial piece of their cumulative money being raised in 2017 alone, ICOs have been able to raise more than $2.3 billion in funds since their inception. Rather than offering shares to the market, ICOs offer ‘tokens’ for the public to buy. Few of these tokens can be bought using fiat, while others accept payment via cryptocurrency. Before learning more about tokens, let’s first discuss the characteristics of ICO and how it is different from IPO.
Strategy
The strategy behind developing ICO is to raise funds for a project to enter the market. ICO is usually performed by start-ups. On the other side, IPO is performed at a bigger scale when a firm is finally stable and wants to expand with the help of the public.
Legal Aspect
ICOs are not limited to any legal document. They have a resource paper (usually white paper) where all the project information, it’s purpose, execution plan and possible results are explained. However, ICOs are not bound to create a white paper. On the other hand, IPOs are heavily legal bound. They must create a legal document called a prospectus. This is kind of a legal declaration which has to include various key information regarding the company.
Eligibility
To offer an IPO, a company require certain eligibility criteria which involve highly stable financial track records. But in the case of ICO, companies do not require any regulatory framework.
Duration
IPOs need to undergo a long legal process before being offered (usually take up to 6 months time). But the ICO process is much shorter and less complicated. A company can start with the crowdsale after issuing white paper and a smart contract. (take up to 1 month). The length of the crowdsale can be dependent on reaching the maximum hard cap, or a fixed sale duration, which usually lasts a month.
Target
IPOs usually target institutional investors such as banks. There is a small part of the entire process which is for retail investors. But ICOs are open for anyone. All you need is a currency in the form of Bitcoin or Ether which you can convert into a token of the particular ICO.
Purpose
IPOs purpose is to collect dividends while ICO’s promote adoption of the company and its associated services/platform, meaning the investors will receive the project’s utility token, stored in their personal crypto-wallet to avail the products or services of the company.
Ownership
IPO holders have a decent volume of ownership and control over the company. While owning ICO tokens does not mean you have ownership or control over the project or the company. However, it offers owners governing rights on the platform as well as access to that token’s utility. An ICO investor can reap future benefits in a number of ways. This depends on the design and utility strategy of the coin with a blend of the project goal.
ICO and IPO sound similar, but they are completely different in nature. Both have their own set of pros and cons, but in the modern business era where companies want to keep more control on their business while attracting more investors, they are more inclined towards ICOs because of it’s significant benefits.
Let’s run through the key advantages of ICO for which it is attracting many potential investors.
1.Lesser transaction costs
As transactions in an ICO happens in cryptocurrencies, the cost is always lesser. While trading directly in between individuals it is free, and when trading on a centralized crypto exchange, the cost will be merely around 0.1 to 0.3%. Smart contracts eliminate intermediaries, which in turn cuts down costs of service delivery. And the administrative costs of buying and selling are zero. On the other hand, transacting in stocks are highly expensive including a hefty intermediary charges.
2.[24/7] trading options
Cryptocurrency trading exchanges operate 24*7. This means you can purchase ICOs whenever you want. While stock exchanges opened for a limited period of time.
3.Transparency
The transaction in cryptocurrency is highly transparent and can be seen by anyone. This reduces the error percentage and eliminates any kind of dispute. Transparency is one of the most compelling benefits of an ICO.
4.Easy to kick-start funding
A small company or a start-up firm can use ICO to kick-start funding quickly without much hassle. As the process is less complicated and doesn’t require any legal document, this is easier for small companies. Anyone can get funding using ICOs.
5.Fungible
ICOs are highly fungible, movable and sellable assets. You can sell your ICO to whomsoever you want.
6.Quicker settlement:
Cryptocurrency transfers settle in minutes. In contrast, stock exchanges typically settle in a few days. This allows both ICO issuers and investors quickly settle their transactions.
7.Zero regulation
As cryptocurrencies don’t have any regulatory bodies, ICO transactions and exchange process is not bound by any governing body. This drives more empowerment and accessibility.
8.Cross-border transactions
ICOs are cross-border transactions — subject to local regulatory restrictions. Blockchain technologies can be accessed by any investor irrespective of their geographical presence. This doesn’t include any additional cost. However, in the case of a stock exchange an overseas exchange costs higher.
9.Flexibility
ICO tokens like Ethereum ERC-20 are based on standard protocols and can be listed on a number of crypto exchanges seamlessly. This can be transferred between different exchanges and personal crypto wallets without any additional costs.
Earlier in this post, we mentioned that ICOs offer tokens instead of shares to the market. Now let’s learn little more about token and how it is being used in ICO.
What is a Token?
A token is an asset (unit of value) issued by a company after launching an ICO. An investor gets tokens in exchange for his investment in an ICO, just like we get stocks in exchange in IPO. There are usually two types of tokens in ICO;
Utility Tokens
Utility tokens are basically user tokens or app coins. We can use utility tokens to avail the products or services of the company. So, utility tokens are not built to be an investment. Any start-up can create utility tokens and sell digital coupons for their services or products. Utility tokens are not intended to give their holders the ability to control how decisions are made in a company. They merely enable users to interact with a company’s services.
A perfect example of a utility token would be the underlying POE token. Po.et is a platform that aims to decentralize the creative sector by providing a way for content creators to maintain ownership of their content (through Ethereum-based smart contracts) throughout the duration of its digital life and monetizing content in a safe, controlled way. This Ethereum ERC-20 token, aims to bootstrap the network by attracting early users and contributors of content to the platform, to raise funds for the continued scaling and development of the platform, as well as to provide a mechanism that incentives and rewards early adopters of the platform. Other examples for popular utility tokens are Sia token which enables trust-less decentralized storage, Status Network Token (SNT), etc.
Security Tokens (STO)
On the other hand, security tokens offering (STO) are like shares, selling participation in the fund through a liquid digital currency offering. The value of a security token can be derived from an external asset which can be traded. These tokens are subject to federal laws that govern securities. If you fail to comply with these regulations, this could result in unwanted consequences including financial penalties and also derailment of the development of a project. However, if a startup abides all the regulatory requirements, security tokens can offer a huge array of advantages. You can offer tokens as a digital representation of shares and provide investors with an array of financial rights, which include; equity, voting rights, dividends, buy-back rights and many others that utility tokens could not offer.
As above stated, companies issuing securities have to abide by essential anti-money laundering (AML) and know-your-customer (KYC) requirements, which are not only costly but also time-consuming. Most upcoming blockchain startups have now realized the importance of complying with the regulations, and several SEC (U.S. Securities and Exchange Commission-compliant) security tokens have been issued. Examples of such tokens include; Polymath, Corl, and tZERO.
While regulation on these types of securities remains beneficial for participants, but on the other hand more such regulations could limit the capabilities of these projects. It removes decentralization — when you file paperwork with any authority, you are removing your decentralization. The authority has control over everything you do, as a company, as an individual and as a project. It has to be done in line with the laws and rules of that country.
This eventually breaks the spirit of DAO (Decentralized Autonomous Organization) and token economics. Thus, readers must understand that there is difference between tokenized assets of a decentralized application and STO. The merge between the IPO and the ICO is the birth of STO.
Security tokens bridge the gap between the traditional financial sector and the blockchain framework; it’s one of the reasons banks have initiated the integrated Blockchain frameworks in their system. Issuing security tokens allows investors to raise funds through a thoroughly regulated digital share of its equity, asset or part of the revenue. This way STO targets the institutional investors as well such as banks, venture capital firms, etc. If you are creating a security token, you must know the importance of the Howey Test. The Howey Test was a precedent from a 1946 Supreme Court case. The ruling gave the SEC guidelines as to what could be considered a security. So, make sure your coin resemble one.
Security tokens also represent shares in physical assets such as gold or oil. In these situations, the purpose of the blockchain platform is to provide simple trading environment for all participants. For example, Dubai based OneGram uses blockchain technology to create ICO, where each coin is backed by one gram of gold at launch.
To bring all under the roof of cryptocurrencies and token world, it’s not bad to add the below classifications too to educate the readers.
Equity Token
The key difference between Security Token and Equity Token is that in the security token, an asset like real estate, gold, etc. are used as collateral. However, in the case of Equity tokens, the shares of the company are diluted into tokens.
Consensus Token
The first type to appear, and used by Bitcoin and Ethereum is the “consensus token”. This token is given out as a reward for ensuring the network consensus either via PoW (Cryptomining) or PoS voting. But, we refer to these types of tokens as cryptocurrencies in general. Also every other cryptocurrency that followed the first cryptocurrency Bitcoin is called an altcoin (alternative coin). Thus altcoins refers to all the tokens and all cryptocurrencies other than Bitcoin.
Stablecoins
Stablecoins are cryptocurrencies designed to minimize the effects of price volatility, thus they seek to function as a store of value and a unit of account. To minimize volatility the value of a stablecoin can be pegged to a currency, or to exchange traded commodities. There are Fiat backed stablecoins and Cryptocurrency backed stablecoins. Cryptocurrency backed stablecoins are issued with cryptocurrencies as collateral, which is conceptually similar to fiat backed stablecoins. However, the significant difference between the two designs is that while fiat collateralization typically happens off the blockchain, the cryptocurrency or crypto asset used to back this type of stablecoins is done on the blockchain, using smart contracts in a more decentralized fashion. MakerDAO is the first fully-decentralized stablecoin on Ethereum.
How to create an ICO?
“We need tokens to use, not just to keep in wallets. If we do not dive fully into Crypto and use the Blockchain as a way to enhance our lives and the world around us, instead of just collecting coins hoping for a Bull market, then our greed will have killed the greatest opportunity yet offered to mankind.” — John McAfee
As you now know what an ICO is and the types of ICO tokens, you need to check if this is applicable to your startup. You must be able to answer these questions before creating your ICO;
1.Why do you need blockchain tokens in your startup?
2.What advantages does blockchain technology give your project?
3.What is the link your product with the blockchain technology?
Once you have figured out how to bring a token / blockchain system into your start-up and able to present your product with a white paper and a website, you can start looking at creating your ICO, the wallet and launching into the cryptocurrency exchanges. Let’s look into the various ICO platforms that helps creating your ICO tokens.
We will look into the ICO Development Platforms, ICO/STO Creation, Launch etc., in details on the next the post ICO vs IPO? How ICO and STO powered by Blockchain platform is transforming modern day start-ups for crowdfunding — A Very Extensive Look (Part 2). Stay tuned!