The real role of ICOs & how they compare to traditional fundraising
In mid 2017, a strange shift happened in the startup world: early-stage venture capitalists were being replaced by Initial Coin Offerings (ICO). In fact, at that time, ICOs had already raised over $1.2 billion total and surpassed traditional VCs.
Despite concern over a lack of transparency and regulation, ICOs continue to be the startup fundraising channel of choice.
How it works
For those unfamiliar with the phenomenon, the process typically looks like this: a startup sells its branded cryptocurrency to users, who can then use it to make purchases on its platform. The value of these tokens are independent of other cryptocurrencies. Similar to crowdfunding, the ICO serves as a way for startups to raise funds. In the same way that an IPO sells shares on the stock market, an ICO sells tokens.
The benefits are hard to refute: startups can gain colossal amounts of capital without sacrificing any equity.
In return, users receive various perks or benefits for their early support. On the downside, if a startup does not deliver or never sees the light of day, users have no power. As of today, most of those platforms are not yet up and running, so future users buy in good faith, hoping that the platform will be successful and increase in value.
ICO or IPO?
These “crowdfunding campaigns” get complicated because of the financial element, which leaves the campaign resembling a security. (Again, it’s no coincidence that ICO sounds like IPO.) The difference lies in that buyers hold tokens, not stake in the company — that scenario would require them to adhere to securities law.
Regulators and task forces are working to catch up. Unsurprisingly, fraudsters have taken advantage of the cryptocurrency craze, setting up ICOs without the intention of ever delivering a finished product. In the US, the Securities and Exchange Commission (SEC) launched a cyber unit in late 2017 to tackle such cases. It recommends that buyers only conduct transactions on exchanges that are registered with the SEC.
The Security Token Offerings (STO) is an infant concept that many believe deserves to replace the ICO. The STO offers transparency by embracing the financial essence of an ICO, removing the gray area and giving context to regulators.
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