How Initial Coin Offerings (ICOs) and Token Sales Work

How Initial Coin Offerings (ICOs) and Token Sales Work

May 6, 2018.
Learn more about what token sales are, how crowdfunding through ICOs work, and more

With the increasing adoption of cryptocurrencies worldwide, many blockchain-based startup companies have likewise accepted and incorporated cryptocurrencies as a cost-effective fundraiser for various projects and business ventures. Technology enthusiasts have also joined in on the trend, as such crypto-token crowdfunding campaigns can also double as investment opportunities.

Crowdfunding through cryptocurrencies are otherwise called Initial Coin Offerings (ICOs), or token sales. While fiat money is “donated” to the initiator (for example, a small business) through traditional crowdfunding platforms such as Kickstarter, ICOs use cryptocurrencies. Here, we’ll talk about what an ICO/token sale is, how it works, its benefits, and more.


What is an Initial Coin Offering (ICO)?

An Initial Coin Offering (ICO), simply put, is an alternative way to raise funds for a business venture using cryptocurrencies. Early investors in an ICO are allowed to purchase newly issued tokens (or coins) in exchange for more established cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH). Such campaigns are usually initiated by blockchain-based tech startups in an effort to bypass stringent regulations and high fees that come with the traditional financial system.

ICOs share some similar qualities with crowdfunding campaigns and that with Initial Public Offerings (IPOs). In a way, ICOs are similar to a traditional crowdfunding campaign wherein interested parties are persuaded to invest certain amounts of money as some sort of donation. On the other hand, tokens being sold in ICOs function similarly as with shares of a company being sold to investors in an IPO.


How does crowdfunding through token sales work?

In an ICO, the initiating startup firm must create and present a comprehensive whitepaper to the public, detailing what the project is all about, as well as a brief company background.

There is usually a certain amount of cryptocurrency targeted to be raised in token sales. Every token will have a predetermined price, meaning that its value is set during the token sale. This typically also means that the token supply is fixed and that the tokens have already been minted.

In other instances, the price of each token is dependent on the amount of funds the project receives, meaning the more funds raised, the higher the token price will become. In this scenario, the supply of tokens remains fixed, but the funding goal is dynamic and the distribution of tokens will be made after the funds are received.

There are also instances where there is a dynamic supply of tokens, in that the supply amount is determined by the amount of funds received. This follows that the price for each token is fixed, but with each token sold, a new token is created. A limit of the total supply of tokens, however, can be set.

An ICO is considered to be a success if the target amount to be raised is achieved within the specified timeframe. A token sale runs for a certain period, typically four to six weeks, and may be comprised of several subsequent rounds.

The amount raised can then be used by the initiating firm to fund their projects and distribute a portion of it to the early investors as some sort of share. Other benefits can also be offered to early investors, at the discretion of the initiating company.

An unsuccessful token sale means that the money raised didn’t meet the targeted amount. In some cases, the pooled money may be returned to the investors or the unsold coins may be burned.


What are the benefits of ICOs?

Among the main reasons that ICOs are appealing to traders is that such crowdfunding efforts offer high return of investment should the company become successful after launching. Early investors pin their hopes on the possibility that the value of the tokens will increase compared to its value set during the token sale, acting as a security token, which is basically an investment.

Tokens purchased in ICOs may also have some sort of utility feature, where the coins can be used within a platform or as a means of commerce; being accepted as a form of payment to the initiating company should the investor decide to buy their products or services, and more.


Where do ICOs legally stand?

While there are a number of successful token sales to date, such as that of the TenX ICO being able to raise $80 million in just 7 minutes, crowdfunding efforts through token sales are also considerably laden with controversy, particularly on its legal stance.

It should be noted that since cryptocurrencies are decentralized by nature, it’s not essentially regulated by financial entities such as the Securities Exchange Commission (SEC). In which case, funds that are lost due to fraudulent ICOs may not be recovered. There are countries, however, who have safeguarded cryptocurrencies with anti-money laundering regulations. One particular “successful” token sale was Tezos wherein they raised a whopping $230 million but had some internal issues that later led to allegations of fraud.

The success and legitimacy of an ICO, therefore, all boils down to the reliability of the initiating firm to actually deliver on their promise. Investors should, therefore, make it a point to do a thorough background check on the initiating firm and the technology being used behind the project. However, it also follows that investing in token sales is a risk that investors should be ready to make; investors shouldn’t invest more than what they can afford to lose.


Final notes

Initial coin offerings as a means of crowdfunding is still at its early stages therefore it’s too early to tell whether it’s going to be widely accepted in the years to come, especially considering its mixed reception. It is, however, undeniable that should it take off well, token sales are bound to change the landscape of the blockchain community.


– Article written by Tinny

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Categories: Cryptocurrency