Over the last year we may have already heard about some ICOs going on, which by the way have been extremely successful: Filecoin raised more than 250M USD and others like Aragon raised 25M USD in less than an hour. ICOs are something really new so still not everybody know what they are.
Initial Coin Offerings, also called ICOs, are a mean by which crypto-funds are raised in exchange of tokens in order to fund a new blockchain-based venture.
If you are not in the tech world, the above definition may not have any sense, so let us elaborate on it.
What is an ICO?
Underlying technology
When Bitcoin brought Blockchain into our lives, we all thought that it would change the entire payment network. Nevertheless, soon after that Ethereum demonstrated that there was much more potential hidden on the Blockchain. As Ethereum states on their website: “Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.”
At this point you may be wondering what Smart Contracts are. I like to think of Smart Contracts as if they were a vending machine; same as when a coin is put into a vending machine it delivers a can, a smart contract is a software that when a crypto-coin is put in it delivers a token.
A token is a piece of code that can represent anything, ranging from shares in a company to your passport ID.
Tokens & ICOs
When tokens are used for funding purposes, an ICO is in place. In these cases, it is considered that two sort of tokens can be issued; on the one hand, utility tokens would be those that can represent products or services, as Balaji S. Srinivasan explains on his post. On the other hand, security tokens would represent any sort of property over a company.
If it is not clear whether a token is a utility or a security token, the SEC announced that any token that can not pass the Howey Test should be considered as a security. The Howey Test consists on the following questions - you can also make the test here:
- Is it an investment of money or assets?
- Is the investment of money or assets in a common enterprise?
- Is there an expectation of profits from the investment?
- Does any profit come from the efforts of a promoter or third party?
Strategic Use
On the one hand, startups have found much value in selling their tokens on initial sales as this option provides them with much advantages, such as:
- The company does not have to give away stake.
- By allowing anyone to join the ICO, a community can be built.
- As it is not regulated - yet- it can be offered to anywhere in the world as it is not constrained by local regulations.
- When it comes to utility tokes, the ICO may not be considered just a source of funding but also as a way to show interest on the product or service to be offered.
On the other hand, investors have been participating considerably actively on this arena due to the following reasons:
- There is a large community of investors who have made large fortunes and can not convert their cryptos into fiat due to tax reasons.
- As opposed to shares in a company, tokens can be easily traded and hence, they are much more liquid.
- Minimum investments are usually much lower than in a funding round, which makes it easier for an average investor to build a diversified portfolio.
This article was written by Pablo Ruiz, CEO @PayPro.
Twitter: @RealPabloRuiz
LinkedIn: https://www.linkedin.com/in/ruizferrer/