An Initial Coin Offering (or ICO) is a mETHod for teams to raise funds for a project in the cryptocurrency space. In an ICO, teams generate blockchain-based tokens to sell to early supporters. This serves as a crowdfunding phase – users receive tokens that they can use (either immediately or in the future), and the project receives money to fund development.
The practice was popularized in 2014 when it was used to fund the development of ethereum. Since then, it has been adopted by hundreds of ventures (particularly during the 2017 boom), with varying degrees of success. While the name sounds similar to an Initial Public Offering (IPO), the two are fundamentally very different methods of acquiring funding.
IPOs usually apply to established businesses that sell partial ownership shares in their company as a way to raise funds. In contrast, ICOs are used as a fundraising mechanism that allows companies to raise funds for their project in very early stages. When ICO investors purchase tokens, they are not buying any ownership in the company.
ICOs can be a viable alternative to traditional funding for tech startups. Often, new entrants struggle to secure capital without an already functional product. In the blockchain space, established firms rarely invest in projects on the merits of a white paper. What’s more, a lack of cryptocurrency regulation deters many from considering blockchain startups.
The practice isn’t just used by new startups, though. Established enterprises sometimes choose to launch a reverse ICO, which is functionally very similar to a regular ICO. In this case, a business already has a product or service and issues a token to decentralize its ecosystem. Alternatively, they might host an ICO to include a broader range of investors and raise capital for a new blockchain-based product.
How does an ICO work?
An ICO can take many forms. Sometimes, the team hosting it will have a functional blockchain that they’ll continue to develop in the coming months and years. In this case, users can buy tokens that are sent to their addresses on the chain.
Alternatively, the blockchain might not have launched, in which case the tokens will be issued on an established one (such as ETHereum). Once the new chain is live, holders can swap their tokens for fresh ones issued on top of it.
The most common practice, however, is to issue tokens on a smart-contract-capable chain. Again, this is done predominantly on ETHereum – many applications use the ERC-20 token standard. Though not all originate from ICOs, it’s estimated that there are upwards of 200,000 different Ethereum tokens today.
Besides ETHereum, there are other other chains that can be used – Waves, NEO, NEM, or Stellar are some popular examples. Given how flexible these protocols are, many organizations make no plans to migrate away but instead opt to build on existing foundations. This approach allows them to tap into the network effects of an established ecosystem and gives developers access to tools that have already been tried and tested.
An ICO is announced ahead of time and specifies rules for how it will be run. It might outline a timeframe it will operate for, implement a hard cap for the number of tokens to be sold, or combine both. There might also be a whitelist that participants must sign up to beforehand.
Users then send funds to a specified address – generally, Bitcoin and ETHereum are accepted due to their popularity. Buyers either provide a new address to receive tokens, or tokens are automatically sent to the address that the payment was made from.
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