In a way similar to an initial public offering, ICO lets a company raise capital from multiple sources. But rather than issuing shares of ownership, the offering company sells digital tokens, or “coins,” created through blockchain technology.
As the name implies, ICOs are inspired by standard IPOs, although in practice they are very different. The simplest way to understand an ICO is that it consists of crowdfunding on top of a blockchain (the technology behind Bitcoin). Investors buy tokens — units of digital currency — which are typically meant to be an integral part of the application that the startup wants to build. The bet is that the application will be popular and thereby generate demand for the tokens, increasing their value. So far, most ICOs are built on top of Ethereum, which is like a version of Bitcoin that can also host applications called “smart contracts.” Source : https://www.inc.com/sonya-mann/invest-in-ico-pros-cons.html
Vishal Gupta, CEO SearchTrade defined ICO :
Initial Coin Offering (ICO) is the literal equivalent of Initial Public Offering, except the offering, here is not equity; it is cryptocurrency. ICO is an unregulated means of crowd funding via cryptocurrency. The term is often confused with “token sale”, which is a means of obtaining access to a particular project through investment whereas an ICO offers the sale of a right of ownership or royalties of a project.
Case study 1:
Brave, the upstart web browser founded by Mozilla co-founder Brendan Eich, completed an initial coin offering (ICO) in May 2017. The sale for Brave’s ethereum-based Basic Attention Token (BAT) generated about $35m and was sold out within 30 seconds. Instead of following the typical path of an IPO or issuing his company’s shares to funders, Brendan choose to raise fund using blockchain and ICO.
Types of ICO Tokens
One of the most promising applications of Ethereum-based smart contracts is the potential for startups to issue stock–or equity tokens–through initial coin offerings. This will benefit startups since the barrier to entry into the financial markets will be much lower than in the past. It will make stock trading more accessible to the average investor and allow shareholders to take a more active role in corporate governance since voting can be conducted transparently through the blockchain.
Due to the current lack of regulatory guidance, few startups have attempted to conduct equity token sales. However, Delaware recently passed a bill that allows companies to maintain a list of shareholder names on a blockchain rather than conventional methods, which will enable blockchain-based stock trading. Consequently, it is likely only a matter of time before equity tokens take a central role in the crypto finance industry.
A security is a broad classification that refers to any kind of tradable asset. Through ICOs, investors have access to a wide variety of securities tokens, ranging from coins redeemable for precious metals to tokens backed by real estate.
In the United States, these token sales and investments are subject to SEC securities regulations. SEC v. Howey established the guidelines for whether a financial arrangement involved an investment contract and was subject to securities regulations. As described by Cooley LLP Fintech Team Leader Marco Santori, an arrangement is a security if it involves “an investment of money. And a common enterprise. With the expectation of profit, primarily from the efforts of others.”
Presumably, most tokens are securities since the majority of ICO participants view crowdsales as investment opportunities. However, if a token does not meet the three requirements of the Howey test, it may fall under the classification of a “utility token”. Utility tokens, which may also be called app coins or app tokens, provide users with access to a product or service.
For example, Filecoin–which raised an ICO-record $257 million–plans to provide a decentralized cloud storage service that will take advantage of unused computer hard drive space. ICO contributors received tokens that they will be able to use to purchase storage space from Filecoin once the service has launched.
Since total supply is fixed, utility tokens may appreciate over time if demand for the product or service increases. However, investors should be wary of startups that describe their token as a utility or app coin but also market it as an investment because it is likely that regulators will consider the asset a security.
It is important to note that “utility token” is an organizational distinction–not a legal one. The SEC has not given official guidance on utility tokens, so the industry does not with certainty whether they are subject to securities regulations.
How to evaluate ICO?
Google all about the ICO you plan to invest. The most important step is to read the whitepaper and build your own ICO analysis framework.
- a project makes sense as a business
- there is demonstrated demand for it
- the business is something that needs a cryptocurrency token system to work
- you are willing to take the risk and part with your money.