A brief on ICOs

Written by Thomas Yan || July 03 2017

Over the past few weeks, little-known ICOs have grabbed the media's attention. ICOs, or 'Initial Coin Offerings', have become a new way for individuals and start-ups to obtain funding. A significant number of these ICOs are originating from China, so we decided to take a look at the dynamics behind these new funding vehicles. 

What is an ICO?

Firstly, it makes sense to take a look at what ICOs actually are and what they accomplish.

Similar to an initial public offering (IPO) for the stock of a company, an initial coin offering (ICO) is a way for a company to raise funds by offering digital tokens or digital currency to the public for purchase, creating assets that can then be exchanged or traded by investors. The proceeds from the ICOs are (in theory at least) used by the company as working capital to help the company grow.

ICO tokens are typically initially tied to another cryptocurrency such as Ethereum and appear as tokens on the Ethereum ledger. Initially the tokens are typically not tradable, but are often listed on crypto-currency exchanges to facilitate their distribution and spread. 

There is no one standard use of ICO tokens at the moment. Some of the tokens are actually used as the currency of the underlying platform, which is the case with Storj coin, which powers the Storj distributed storage platforms. In many cases though, the ICO tokens are not even used by the platform and typically do not represent ownership in the company like would be the case with an IPO. 

Driven by speculation, these coins and tokens typically increase in value rapidly, so there is a lot of 'pumping' pre-ICO to drive interest. This can both affect the initial ICO price, if it is not fixed, and then subsequent demand post-ICO. 

The most famous example of a ICO is Ethereum, which uses Ether has its cryptocurrency. The Ethereum platform raised $18 million in Bitcoins at its ICO, and has gone on to become successful in its own right, with a current market capitalization of around $30 billion. Asia has become a hotspot for ICOs in recent months, with China and Singapore leading the way.

Why Regulate ICOs?

While often compared to IPOs in nature, ICOs lack much of the regulatory scrutiny that surrounds IPOs. IPOs are often the final stage in a startup’s development, transitioning it from an investor-backed venture to an established, publicity-traded company. On the other hand, one of the reasons that governments are seeking to regulate ICOs is the lack of information that digital platforms offer at ICOs.

Typically, these companies are not required to disclose much information, with their releases generally consisting of a white paper, and perhaps a technical supplement or two detailing the platform and tokens being offered. In some cases, companies that have offered ICOs do not even have a viable, working product at the time, resulting in investors pouring millions into a concept, with no guaranteed returns. In fact, ICOs have been compared to the dot com bubble in the early 2000s, with a focus on speculative investing in products that may never generate any meaningful revenue or profits.   

Additionally, Blockchain products are also at risk of cyberattacks or external hacking. In the most severe case, The DAO, was one of the largest ICOs to date at the time. However, out of $150 million that was raised through the ICO, hackers were able to steal $50 million. This led to a “hard-fork” in the Ethereum platform, resulting in two separate cryptocurrencies to maintain the integrity of the ICO. If this were to happen on a larger scale, it could singlehandedly cripple a cryptocurrency, and by extension, its investors.

The Future of ICOs

While the growth of ICOs represents a step forward in the growth of digital currencies, they also come with significant risks. As with other developments in fintech, regulators must seek to protect consumer interests while encouraging the industry growth simultaneously. ICOs can be seen as a form of speculative investing and may be even more risky than other fintech developments that have seen regulatory crackdowns in the past, such as P2P lending, and should be viewed with caution. Particularly in China, given the large-scale fintech scandals of the last couple of years such as Ezubao’s collapse, regulators would be wise to ensure that ICOs within China follow some sort of regulatory framework and increase transparency in order to protect overeager investors.