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ICO is short for Initial Coin Offering. ICOs are the crypto counterparts to IPOs (Initial Public Offerings). Anyone starting a company, blockchain platform, or token can sell the rights to a portion of their newly minted tokens before the platform even launches. These rights can be bought in exchange for crypto or fiat usually, bitcoins or ether.
You and I decide to start a company that we think will reinvent the blender. We call the company Blendify. We spend hours and hours developing rotor technology and building prototypes. We realize that in order to fund production of our first line of blenders, the Blendify 1.0 Series, we need $150,000. No problem. We create a token, called BlendifyCoin.
We decide BlendifyCoin will be an equity token, entitling owners to a portion of our company. We create 1,000,000 tokens, of which we keep 70%, and sell the other 30% for 50 cents each. People can trade us ether for our tokens. Then, we sell the ether we receive from our ICO and use the money to produce our first blenders. Investors receive equity in our company, and we receive the funds we need to thrive.
ICOs are poised to (and already are, in some ways) change the nature of venture capital. Traditionally, raising money for a new company is a very expensive, legally complicated process. As a result, companies looking to IPO generally need to raise money from a small number of wealthy investors.
Because ICOs are far less regulated, and because a large number of tokens can be created, companies can effectively crowdfund their projects, even if they need many millions of dollars to launch their first product.
For example: let’s say we need a million dollars for our company. Instead of needing to find 10 investors, each to putting in $100,000 to reach a one million dollar goal, we can now find 10,000 people to each give $100, or 100,000 people to each give $10. This may be far easier to do.
And here’s the thing–our tokens don’t necessarily have to be representative of equity. They could, instead, be redeemable for a product or service in the future at a discounted price. This allows founders to raise money for their companies without having to give away ownership.
Or, the token could have no definable value at all, and instead be an abstract representation of how much the public believes the company to be worth, without any associated equity or redeemable service. If this seems ludicrous to you, you aren’t alone. But if a single token costs only a few dollars and people believe in the company, an astounding amount of money can be raised this way. Investors profit as the company thrives, and the company gets the capital it needs to grow.
This also comes with certain risks.
Any venture capitalist will do extensive research before putting potentially hundreds of thousands, or millions, of dollars into a project. Using an ICO to raise money allows many people to invest very small amounts of money. This lowers the incentive to perform extensive research before investing, because it’s only 10 bucks, right?
This lack of due diligence has allowed ICOs to raise enormous amounts of money, sometimes without having a project deserving of the money. Some ICOs have been complete scams, the founders never even intending to launch a product. They simply take the crowdfunded money and run.
Scams have drawn lots of attention from regulatory bodies like the United States Securities and Exchange Comission (SEC). They are likely to begin regulating ICOs in the near future.
The ICO can be a powerful tool. It allows founders to raise money from the general public instead of just wealthy investors, giving everyday people the ability to get in early on projects and potentially see massive returns on their investments. This a privilege traditionally reserved only for the very wealthy.
But be careful out there. ICOs are not always a safe bet, and if it sounds too good to be true, well, it might not be true.