Faster, more efficient and without banks: ICOs as decentralized corporate finance?

How do you raise about 153 million US dollars in less than 3 hours without a venture capitalist or a bank, without handing over shares and without even having a product, but just a vision? It sounds absurd, but it is possible, and not just in theory. ICO is the magic word. In 2017 alone, 1.2 billion US dollars are said to have been raised in this way. But what does that mean and how does an ICO work?

An Initial Coin Offering (ICO) is a “new” (since July 2013 but currently very popular), decentralized way of corporate financing for blockchain startups. Like crowdfunding, it is intended to finance projects or companies. The term ICO is based on the English term for initial public offering (IPO), but has little to do with it. So far, there is neither a uniform legal framework for ICOs nor trading on regulated stock exchanges.

The process is usually as follows:

1. Publication of a white paper

Blockchain-based projects publish a white paper, which resembles a scientific article, before the ICO. There, technical information about the blockchain platform is published to show developers and potential supporters how the platform is supposed to work. Likewise, white papers contain information about the business model and the like. The young startup generates interest in their project in advance and builds a community of supporters who, unlike with original types of financing, can do their own due diligence by contacting the startup directly. So, the startup has not yet made any profit, let alone implemented a product or prototype. In most cases, only a vision of the project exists.

2. ICO and tokens

This is followed by the actual ICO, which stretches over a period of at least one week. During this period, “investors” can acquire so-called tokens. Unlike an IPO, therefore, one does not acquire shares in the company and therefore does not have the rights that, for example, a shareholder has. A token is needed to be able to use the respective blockchain platform. Tokens can be understood as digital shares in a project or the products and services from a project. A token can thus represent, for example, a kind of “voucher” for a service on the new Blockchain platform. For example, “investors” in, a provider of decentralized cloud storage, can use the tokens they buy to purchase storage space after the product launch. In many cases, the tokens evolve into a new cryptocurrency. This was the case with Ether, for example. Ether is the token of the Ethereum blockchain platform and is also traded on cryptocurrency trading venues. But again, Ether is and will remain the means of payment for transaction costs on the Ethereum platform and is needed by all developers and operators who want to build an application on the Ethereum platform.

3. the actual product development

After the ICO, only the actual development of the blockchain platform begins. The startup now has seed capital, without having given up its own shares, for example to motivate talented people to work on the project.

So, in summary, blockchain startups finance themselves in an ICO by selling their tokens in advance. The concept is compared by some to the crowdfunding platform Kickstarter. However, ICOs are more likely to be classified as a mixture of crowdfunding and crowd investing, as investors hope to make a higher profit when the tokens become established as a cryptocurrency and are traded on marketplaces.

The following chart illustrates the impressive development. One of the first and best-known ICOs was Ethereum’s ICO with the concept of “smart contracts” in July 2014, where interested parties bought tokens (Ether) worth a total of 14 million US dollars for 30 US cents. Currently, Ether is traded on trading venues above 200 US dollars (current prices and total values of cryptocurrencies and ICO e.g. here at coinmarketcap). Here you can see an overview of current ICOs with the corresponding white papers.

However, an ICO also has many disadvantages, as it doesn’t always go as positively as Ethereum and the money disappears because there is never a product launch. Likewise, Charles Hoskinson (one of the founders of Ethereum) warns against the current hype. According to him, new startups are issuing tokens for new blockchain platforms “even though the same task could be done with existing buckchains.” Likewise, no regulations exist yet and thus little protection for the investor.


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