Explainer: What is Initial Coin Offering (ICO)? Know its pros and cons

The term initial coin offering refers to the capital raising activity in the cryptocurrency industry, which can be viewed as an equivalent to an initial public offering (IPO) in the share market. A firm selling a new cryptocurrency, new app, or service can raise money by way of ICO.

A major advantage of an Initial Coin Offering is that it removes middlemen and establishes a direct connection between the company and its investors.

Know the types of ICOs

Initial Coin Offerings can broadly be classified into two categories, which are enumerated below.

Private ICO

Here in private ICOs, a limited number of investors can participate in the capital raising process and the firm can fix a minimum investment amount. Usually, only accredited investors, i.e., HNIs (high net-worth individuals) and financial institutions can participate in these private ICOs.

Public ICO

Public ICOs are a type of crowdfunding that invites funds from the general public. In this type of ICO, anyone can become an investor. However, these days private ICOs are becoming a more viable option in comparison to public offerings, owing to regulatory concerns.

 

How ICOs work?

When a company announces to come up with its ICO, it reveals the date, rules, and buying process in advance. Apart from using fiat money, investors can also invest in ICOs by paying through other cryptos like Bitcoin, etc.

Typically, the purchase process consists of sending money to a particular crypto wallet address, while investors can provide their own wallet addresses to receive the crypto they buy.

Here, it must be noted that the number of tokens sold during an ICO and the token price can be variable as well as fixed. The same can be explained as follows:

When both the number of tokens as well as price are fixed: Here the firm fixes both tokens and prices, for instance, offering 2 million tokens at a price of $2 per token.

When only the token number is fixed, while the prices are variable: Here the company sells a limited number of tokens and based on the amount received sets a price. Moreover, greater funding amount results in increased token amount. For instance, if a company sells one million tokens and is able to raise $ 5 million, then each token will be priced at $5.

When the price is fixed and tokens are variable: Here, the company fixes the token price but does not put a limit on the number of tokens it intends to sell. For eg., a firm selling tokens at $1 per token till the ICO ends.
 

Let us look at some of the advantages and disadvantages of ICOs.

Pros of offering ICOs

Anyone can purchase coins

Anyone can buy coins through these ICOs, right from freelance workers to budding investors. Each of them has their own budget when it comes to finding the right investment in expanding their portfolio. This process particularly benefits startup companies, which do not have the requisite funds to kickstart their project but have the potential to raise their value over time.

Reduced paperwork

Traditional regulatory means of raising funds like IPOs, banks, stocks, etc. involve a lot of paperwork as well as take up time and energy. However, these ICOs are more attractive than IPOs as they rely on blockchain technology to keep a ledger of its various transactions.

Increased liquidity

Liquidity refers to an asset’s ability to be quickly bought and sold in the market without having any adverse effect on its prices. Since cryptos do not require any physical form to be exchanged, they’re relatively more liquid in comparison to other assets.

High return on investment

Some of the highly successful ICOs started from a relatively low value, whose market value gradually saw an increase rapidly. Further, some of the ICOs have the backing of big names like Microsoft, Alibaba, etc., thereby lending more reliability to them.

Disadvantages of ICOs:

Risky and volatile

Since crypto projects are volatile and often encounter extreme price speculation, there remains a risk that the token might lose its value entirely or the project may fail.

Absence of regulations

The crypto sector is not regulated or governed by central authorities. As a result, a lot of scams and mediocre projects hover in this space.

Lack of accountability

As most of the ICOs are initiated by start-ups, who do not have sufficient amounts to commence their projects. While investors expect high returns on investment in the future, there is no assurance that companies will be able to deliver what they promise.

Examples of some famous ICOs

Ethereum: Crypto lovers were thrilled about Ethereum and its programmable blockchain when in 2014, its ICO occurred. The crypto project ended up raising $18.4 million and became the second-largest cryptocurrency across the globe.

Cardano: Cardano improvised on Ethereum and had an even more successful ICO. In its 2017 ICO, it raised $62.2 million and is one of the top cryptos in the world today.