What Is An ICO? Initial Coin Offerings Defined, & How Tokens Work

what is an ico
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Have you ever asked this generic question, what is an ICO, an Initial Coin Offering? A lot of people continually ask this question, despite the ICO boom of 2017/2018 taking the financial world by storm. This piece takes a closer look at what ICOs are, the types there are, and other key considerations for investors amongst others. 

In this article, we will have a look at the ICO meaning and explain to you, how an ICO works. Furthermore, we will give you the insides of ICO tokens available today. Are you ready? Then let’s begin with our ICO definition!

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What is an ICO? Our definition

ICO means “Initial Coin offering” which of course begs the question “what is an initial coin offering?”. Well, an initial coin offering is a means by which blockchain projects raise funds from the public through the issuance of tokens. 

This ICO definition may be an oversimplification of what this fundraising model entails. ICO can be noted as a crowdfunding option and an alternative to the traditional Initial Public Offerings (IPO) through which regulated firms raise capital.

In an ICO, the fundraiser is usually opened to the public, subject to the attainment of some criteria issued by the organizing platform. The tokens issued are often a depiction of a stake in the company, which qualifies the investor as a stakeholder in the startup. ICOs may either be highly regulated or not, depending on the types of tokens issued. The potential for these regulations is based on the applicable laws under which the issuing startup operates.

In the past couple of years, ICOs have grown to become a common route to secure funding by blockchain-based startups. ICOs take place on a dedicated platform which may also be a cryptocurrency exchange. These types of platforms like CoinList are advantageous as the issued tokens can be traded there. With many iterations of ICOs common today, scams are rising. This situation is continually drawing the attention of regulators like the Securities and Exchange Commission (SEC).

More will be discussed about ICOs but first, let us consider the major types of Initial Coin Offerings there are.

2 Types of Initial Coin Offerings

There are two major types or forms in which ICOs are conducted including the Private and Public fundraising events respectively. Typically, both options are complementary and are often embraced by the startup following a time-bound succession.

1. Private ICOs

Private ICOs are public sale events in which coin issuers sell the tokens directly to private investors. The sale is often conducted with huge venture capitalists and high net worth investors. This class of investors often backs the project by issuing the tokens at a very early stage, and the funds raised help in powering the project development.

Investors who back a startup at the private ICO stage are often in it for the long term. The project defines the tenor in which they can hold the coins even after it has started trading on an exchange.

2. Public ICOs

This is the ICO that is typically opened to the members of the public. The basic goal of every crypto project is to create a product that can be adopted by the public. The extension of a new cryptocurrency or token offering to the public is to get an initial crop of mass supporters for the project. People that invest their money in a project are likely to test out whatever product will be introduced later on.

Ethereum (ETH) is one of the biggest blockchain and crypto today. The firm conducted its ICO in 2014 for the eventual launch of its open-source blockchain in 2015. With an ICO price of US$0.3 according to ICO Rating, the growth of Ethereum to a price over $2,500 today showcases the massive returns on investment to investors.

Ethereum, as well as the majority of the genuine ICOs in the past years, comes with a usable product helping to advance the adoption of blockchain technology. While many investors focus on the rate of return, the utility tokens and the technology behind the startups are the selling points for both private and public ICOs respectively.

How does an ICO work? 

The question, of how do ICOs work is a broad inquiry that may be sought by many, especially those new to the space. While the concept and the various elements of ICOs will be explored in this section, let us look at a general overview of how ICOs work.

Process of Initial Coin Offering (ICO)

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ICOs typically involve a mutually beneficial relationship in which token issuers get funds in exchange for a promised value. With different blockchain startups redesigning different models, all have a corresponding value or promise attached to the tokens they issue.

The plans, aspirations, and business models of almost all projects seeking to offer an ICO are often detailed in a White Paper for investors to read. The format for the Whitepaper may differ, however, they all represent the primary way to sell the project to investors. A partnership with a crypto launchpad is also necessary as this will serve as the brokerage for the transaction. Purchased tokens are often distributed to investors following a successful ICO under predefined terms and agreements.

What is an ICO company?

An ICO company is the firm backing the development of a particular project. The ICO company is the outfit that develops the project per its core aims, visions, and target market. Take the case of Ethereum for example. The ICO company is the Ethereum Foundation and it is not uncommon to find firms with varied names for their projects.

Cardano is one of the most iconic smart contract-based decentralized platforms of our time. While everyone knows Cardano, a good number of people are not aware of the company behind the project, Input-Output (IOHK). While the growing number of blockchain startups employs the decentralized model of governance, the ICO company is often inseparable from probable advances in the ecosystem.

What are ICO tokens?

To gain a broad over of ICO tokens explained, we would need to explore the tokens by the classification per regulatory provisions. Based on these, ICO tokens are primarily divided into two: utility tokens, and security tokens. But creative people came up with some “sub-category” tokens as well. Let’s have a look at what exists so far.

What are the types of ICO tokens?

Utility Tokens

Utility tokens are often sold out to investors in exchange to gain access to a project’s platform and offerings upon Mainnet launch. Ether and Gas coins are top tokens. As in the case of Filecoin (FIL) in which a total of $257 million tokens were sold to give FIL holders access to the network’s data storage infrastructure. 

Utility Tokens

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Issuers of utility tokens are often less burdened by regulatory issues for their crowd-sale or token sale programs as these are not considered investment security. The bulk of the tokens issued, be it an ERC-20 or much recently a BEP-20 token is often sold as a utility token. Typically, these tokens grant incentives to decentralized exchanges, exclusive access to token launchpads, and a host of other use cases.

Security Tokens

Security tokens on the other hand are classified by monetary authorities as investment securities issued by a company. Per this classification, security tokens conform with securities laws and they represent a share in the issuing company. In reality, the issuance of a security token takes the tag of a Security Token Offering (STO). Holders of these tokens may be entitled to sharing profits alongside the firm. 

Security Tokens

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To issue Security tokens, the ICO company must receive authorization from such market regulators as the US SEC. Startups must do their due diligence before venturing to issue tokens which are known as high-risk assets. The improper classification of a token can attract regulatory clampdown, heavy fines, and eventual derailment of the crypto project.

Asset Tokens

Asset Tokens are similar to Utility tokens but it represents an asset. It can be a debt or equity claim on the issuer. These tokens are analogous to equities, bonds, or derivates. Most regulators don’t consider an asset token as a security token. They usually only require a Code of Obligations (OC).

Reward Tokens

Reward Tokens can be described as loyalty points. This type of token is BSV-based and distributed to users of a platform or service. There are many Reward Tokens out there. The SurfMoon token, for example, is a travel-based coin. BODA Token is a DeFi token that automatically rewards investors on Binance. Rewards (RWD) is the first reward token that is interoperable and works across multiple blockchains.

Equity Tokens

Equity Tokens are a form of security tokens. Normally, it represents the equity in an underlying asset, typically the stock of a company. Similar to shares, an equity token entitles its holders to voting rights and or dividends.

Payment Tokens

Payment Tokens do replace sensitive debit or credit card payments. A unique identification code (called a token) is used during the payment transaction. Payment Tokens make online transactions more secure.

Non-Fungible Tokens (NFTs)

Non-Fungible Tokens can represent any asset in the digital world. NFTs became very popular lately in the form of digital artwork and digital real estate. Such a digital asset is not a copy or a scan of an artwork. It is a unique, non-interchangeable unit of data stored on a blockchain.

How ICOs work with an ICO wallet

The central focus of an ICO which is the digital currency being issued is typically custodied in a digital wallet. As designed in collaboration with the platform or exchange issuing handling the digital assets offering, ICO wallets are often created to receive the tokens upon distribution. 

The fintech firm and its partners develop the processor model of distribution and depending on the nature of the blockchain upon which the token is built, a compatible wallet must be created. The ICO wallet requirements for Ethereum blockchain wallets may be different from a Binance Smart Chain (BSC) wallet. These differences are often communicated in the project Whitepaper for potential investors to note.

In today’s ICO programs, the ICO wallet creation is done automatically by the mediating platform. However, some ICOs may require investors to generate the wallets following a few simple steps.

ICO fundraising: How do ICOs make money?

ICOs raise money in one prominent way; the sale of the new token. Potential ICO investors back the project of their choice in a diverse ICO market and contribute or make their purchases through Bitcoin (BTC), Ethereum (ETH), or Stablecoins like Tether (USDT). Some regulated platforms may permit investors to pay through fiat currency like the US Dollar.

Besides the direct receipt of investors’ funds, ICO fundraising becomes quite profitable for the project incubators with the growth of the token. As mentioned earlier, the growth in Ethereum has made a number of early investors rich. ICOs backers and developers can also make a lot of money through similar growth.

The fees generated from the platform being marketed may also add a source of revenue to ICO builders upon launch. Typically, with advances in social media marketing, platforms like Telegram, LinkedIn, Reddit, and Twitter can be used to promote the general acceptance of the project toward productivity. In the long run, productivity benefits both the investors and the company behind the ICO.

How to setup an initial coin offering

Setting up an Initial Coin Offering may take a lot of time on the part of the project owners. ICO development requires a unique use case. To launch an ICO successfully you should consider hiring experts to broaden your views. The logistics of selling and distributing the created tokens are usually assumed by third-party launchpads or exchanges. As a result, this burden is taken away from project teams.

However, distinguishing a project from fraudulent ICOs designed by scammers may require more effort on the part of developers. Building a functional and responsive community on social media handles is a key prerequisite. Putting up the public profile of key leaders or vision bearers of the project is also a good way to earn trust.

Setting up an Initial Coin Offering entails much more than can be covered in this subsection. However, whatever option is being sought, adherence to local regulations should be taken into key consideration.

Investing in ICO coin offerings

It is a key requirement for investors to understand how to buy initial coin offerings. Later we will show you how to participate in ICO. The distributed ledger economy has a vibrant ascension of new projects that may be too numerous to follow. Unsuspecting investors may lose their funds easily to ICO fraud. Therefore, we must warn you of the great risks and immediately turn to the scam.

How to identify ICO Scams

Fraudulent ICOs are everywhere. We saw classic exit scams, dead/fake scams, compound scams, and even exchange scams in the last few years. But there are good ways to ensure that you don’t fall into potential scams. To invest in any ICO, take note of these key considerations:

Addressable market/use case

The project’s key use case must be known and carefully analyzed. Successful ICOs are those who have a unique product or service to offer. If you are promised to get returns at a later stage it might be a Ponzi scheme, a well-known scam in the financial sector.

Backing investors/launchpad

Who are the investors that invested in the project’s private sale, if any? The credibility of top venture capitals in the crypto ecosystem can be used as a viable yardstick to profile a good project. 

Also, the partnering launchpad where the token will be sold and distributed is also a core consideration to note. Top launchpads like CoinList and Binance Launchpad amongst others hardly back fraudulent projects.

In the well-regulated financial sector, you can relate to the Howey Test. It’s a qualification of an investment contract and a subject to U.S. securities laws. Most ICOs are not regulated. Hence, you must choose a known and trustworthy launchpad before investing in ICOs.

Community responsiveness

Social media is increasingly becoming a tool to perpetrate scams. Good use of these messaging platforms can significantly showcase how credible an ICO project is.

A serious ICO is available on all platforms. Still, you have to ensure somehow that you don’t all into market manipulation or pre-mines.

Team profile

Backing a project whose team profile is hidden may be a sign of fraud. While many project developers choose to stay anonymous like Bitcoin creator, Satoshi Nakamoto, investors must beware as today’s faceless inventors are scammers.

ICO structure: How this whole ICO crypto puzzle fits together

The ICO structure or process is quite similar across the various launchpads or ecosystems that sell out tokens. In ICO crypto on a platform like CoinList for instance, a registration or opening of an account is required. This account opening grants access to new token sales, provided you do not reside in prohibited regions.

There are various models for allocating ICOs to eligible investors. But this may largely depend on a random allocation to guarantee equitable distribution. Other launchpads employ the Whitelist option. 

Depending on the project, some ICO tokens may be locked for some months before being released while others are made available to dedicated wallets immediately after the sale. Though timelines may vary, distributed tokens can then be traded on exchanges that list them for trading. Beyond this, investors can deploy the tokens for the exact utility they have been designed for.

ICO meaning and key takeaways 

The digital currency ecosystem has developed a fundraising model that mimics what is obtainable in the broader financial market. ICOs and their many alterations are ways in which startups raise funds to finance unique project developments in the crypto ecosystem. The ICO process may or may not be regulated depending on the type of token (utility or security) being issued.

ICOs may be replete with fraud, however, key indicators like the real-world use case and the team behind a project can give investors the confidence they need to invest in a new token.

If you are planning an ICO, be sure to seek advice from an expert. Get to know the comprehensive iMi Blockchain services during a 30-minute, free initial consultation. In case you are an investor, then you should book our advanced cryptocurrency seminar. We will show you how to profitably maximize your crypto portfolio.

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FAQs

Are ICOs legal?

Yes, ICOs are legal, however, there may be some prohibitions on participation in some countries due to local laws. Provided the nature of the ICOs is well defined as either a utility or security token, regulators may have no issue with the offering.

Is an ICO currency, or something else?

ICOs are not currencies, rather they are tokens that have inherent usage or value to the issuing project’s ecosystem. Digital currencies as a whole may serve as a means of value transfer, they are not classified as fiat currencies in today’s monetary system.

Are ICOs dead?

ICOs are not dead in 2022. There is a growing alteration of the name to public sales, token sales, or IDOs amongst others. The central idea remains the same, raise funds through token issuance. A number of projects still explore this fundraising path to date.

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Marcel Isler

Marcel Isler

Marcel is a Business Economist and founder of iMi Blockchain. A Consultant and international Keynote Speaker. He studied at the University of Oxford. He helps enterprises to implement Blockchain applications. On our blog, he writes about distributed ledger technology, smart contracts, cryptocurrencies, industry news, and future trends.

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