If you’ve not encountered an ‘Initial Coin Offering’ before, commonly abbreviated to an ICO, it can be a difficult concept to get your head around. To act as an introduction, we’re here with a simple background explanation of ICOs that you don’t have to be familiar with the world of cryptocurrencies and blockchain to understand.
So, what is an ICO?
An initial coin offering is an alternative funding mechanism for startup businesses that offer products or services that are in some way based on the technology we know as blockchain. In an initial coin offering, cryptocurrency is typically bought in the form of ‘tokens’ by investors similar to the way an investor would buy shares in a business. The more money invested in the business, the more tokens the investor receives. Once the company starts trading, those tokens can then be sold on exchanges for the market price of the token, or the tokens can be used to buy services from the company.
Why are businesses choosing to use ICOs?
Initial coin offerings are a new way for startups to raise the capital they need to pay for new projects and development of their products and services. Over the last couple of years, ICOs have exploded in popularity with some $4 billion worth of funds raised around the world. Some of the most notable ICOs over the last year include the $100 million raised by Status, the $237 million accumulated by Tezos and the $257 million brought in by Filecoin.
The reason ICOs are proving so attractive to many projects is their ability to raise huge sums of money in an extremely short period of time. As an example, a blockchain-based digital advertising initiative raised $35 million in just 30 seconds. ICOs also allow startup businesses to raise seed funds while avoiding venture capital firms that often demand significant equity in return for an investment.
The role of smart contracts
Given the explanation thus far, you might wonder why an individual or investor would hand over money to become a token holder if they do not own a stake in the business. That’s where smart contracts come in.
A smart contract is a formal agreement between the business issuing the ICO and the token holder. It is simply a piece of computer code that contains a number of rules under which the parties to that smart contract agree. For example, the smart contract could dictate that all individuals who buy a token before May 2019 can sell the token for a fixed price in May 2020.
The real advantage of smart contracts over conventional paper contracts is that smart contracts enforce themselves without the requirement for a third party. They self-execute once certain conditions are met. So, in the above example, the value of the investor’s token would automatically shift to the predetermined fixed price in May 2020.
Considerations for prosecutive token holders
Initial coin offerings can be particularly attractive to those with an interest in tech and a business or product they want to back. The fact that ICOs have already given birth to innovative technologies such as Ethereum shows the potential for this type of capital generating tool. However, it’s important not to be blinded by the tech. Fraud, theft and volatile speculation are a few of the dangers that can lurk for investors. As with any investment, prospective token holders would be wise to do their homework and research the ICO project thoroughly before handing over their hard-earned cash.
ICO legal advice from a specialist cryptocurrency firm
At ICO Law Group, we are one of very few specialized legal firms in the United States providing services to new ICOs. We offer a variety of ICO legal services such as compliance, SEC filings, and offering documentation to help you every step of the way. Get a free consultation today.