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Initial Coin Offering (ICO)

An initial public offering that uses cryptocurrencies

What is an Initial Coin Offering (ICO)?

An initial coin offering (ICO) is a type of capital-raising activity in the cryptocurrency and blockchain environment. The ICO can be viewed as an initial public offering (IPO) that uses cryptocurrencies. However, it is not the most precise comparison, as there are some crucial differences between the two fundraising activities. Startups primarily use an ICO is to raise capital.

 

Initial Coin Offering

 

The main advantage of ICOs is that they remove intermediaries from the capital-raising process and create direct connections between the company and investors. In addition, the interests of both parties are aligned.

 

Types of Initial Coin Offerings

The two types of initial coin offerings are listed below:

 

1. Private ICO

In private initial coin offerings, only a limited number of investors can participate in the process. Generally, only accredited investors (financial institutions and high net-worth individuals) can participate in private ICOs, and a company can choose to set a minimum investment amount.

 

2. Public ICOs

Public initial coin offerings are a form of crowdfunding that targets the general public. The public offering is a democratized form of investing because almost anyone can become an investor. However, due to regulatory concerns, private ICOs are becoming a more viable option relative to public offerings.

The rise of cryptocurrencies and blockchain technology is helping boost the popularity of ICOs. In 2017, more than $7 billion was raised using ICOs. In 2018, the figure almost doubled. The largest ICO to date was executed by Telegram, an instant messaging services provider. During a private ICO, the UK-registered company raised over $1.7 billion.

 

How Does an ICO Work?

An initial coin offering is a sophisticated process that requires a deep knowledge of technology, finance, and the law. The main idea of ICOs is leveraging the decentralized systems of blockchain technology in capital-raising activities that will align the interests of various stakeholders. The steps in an ICO are listed below:

 

1. Identification of investment targets

Every ICO starts with the company’s intention to raise capital. The company identifies the targets for its fundraising campaign and creates the relevant materials about the company or project for potential investors.

 

2. Creation of tokens

The next step in the initial coin offering is the creation of tokens. Essentially, the tokens are representations of an asset or utility in the blockchain. The tokens are fungible and tradeable. They should not be confused with cryptocurrencies because the tokens are just modifications of existing cryptocurrencies. Unlike stocks, the tokens generally do not provide an equity stake in a company. Instead, most of the tokens deliver their owners some stake in a product or service created by the company.

The tokens are created using specified blockchain platforms. The process of the creation of tokens is relatively simple because a company is not required to write the code from scratch as in the creation of new cryptocurrency. Instead, existing blockchain platforms that run existing cryptocurrencies such as Ethereum allow the creation of the tokens with minor modifications of the code.

 

3. Promotion campaign

At the same time, a company usually runs a promotion campaign to attract potential investors. Note that the campaigns are commonly executed online to achieve the widest investor reach. However, currently, several large online platforms such as Facebook and Google ban the advertising of ICOs.

 

4. Initial offering

After the creation of the tokens, they are offered to the investors. The offering may be structured in several rounds. The company can then use the proceeds from the ICO to launch a new product or service while the investors can expect to use the acquired tokens to benefit from this product/service or wait for the appreciation of the tokens’ value.

 

ICO Regulations

The initial coin offering is a completely new phenomenon in the world of finance and technology. The introduction of ICO’s made a significant impact on capital-raising processes in recent years. However, regulatory authorities around the world were not prepared for the introduction of the new fundraising model in finance.

Approaches to the regulation of initial coin offerings vary among different countries. For example, the governments of China and South Korea prohibit ICOs. Many European countries, as well as the United States and Canada, are working on the development of specific regulations to govern the conduct of ICOs.

At the same time, there are already published guidelines governing ICOs in a number of countries, including Australia, New Zealand, Hong Kong, and the United Arab Emirates (UAE).

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep learning and advancing your career, the additional resources below will be useful:

  • Bitcoin
  • Investing: A Beginner’s Guide
  • Private Equity Funds
  • Speculation

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