The low down on ICOs: the best form of crowdfunding?

12. April 2018 | Drooms Global

In 2017 alone, initial coin offerings (ICOs) raised $5.6 billion worth of capital compared to just $1 billion for traditional venture capital. While several companies are opting for the new fundraising option however, just as many are warning against it.

How does ICO fundraising work?

Start-ups and businesses looking at more traditional capital-raising options tend to either opt for an initial public offering (IPO) or for crowdfunding platforms.

Central to the business models of companies who are looking to launch ICO campaigns however is the issue of crypto-tokens on a blockchain. Investors will acquire tokens, on the Ethereum platform these are referred to as ‘Ethers’ for example, in exchange for cryptocurrency. The investors can then use the tokens for the product or the service the company is offering. Cryptocoins, also known as cryptos, include the likes of Bitcoin the first cryptocurrency made possible by blockchain technology whose founder/co-founders are still unknown and altcoins such as Ripple and Litecoin.

The so-called original option sees the organisation launch its own token, but this has become less common. Another option is the second-layer token whereby the company launches a custom token on top of an existing one. The route many are opting for today involves using a custom build ICO platform similar to the likes of Kickstarter.

In terms of time limitations and market caps on the amount of money raised, ICOs have certain restrictions. The value or the number of tokens released by the company can be calculated based on how much the company has raised or it can remain static.

Becoming a simple and highly popular form of fundraising

Since the fundraising is mainly performed at an early stage, often without a clear product or service yet launched, for many companies ICOs offer an easy solution providing access to capital quickly and helping them to develop their own offering faster.

It’s not just an attractive option for businesses but also for investors whose success is built on the speculation that the value of the coin will increase. Ethereum at one point increased in value by 4,000%.

Easy access to high rewards and liquidity as well as fast turnaround times are just some of the reasons why ICOs are becoming so popular.

Legal issues forming big clouds over the investment option

Despite certain advantages, when it comes to the law, ICOs remain unchartered waters. Their legal classification is a point of contention. These exchanges are not donations, as they give the investor a stake in the company, but they are not the equivalent of stocks either.

So far, there have been no clear regulations or assessments made by national governments. However, there have been many warnings. Just last December, the US Securities and Exchange Commission (SEC) warned investors about putting their money into cryptocurrencies, stating that it might be in violation of federal securities law. The threat of regulation has led many cryptocurrencies to decrease in value, including Ethereum.

In addition, the lack of regulation can pose enormous risks for both companies and investors. If issues do arise, it can be hard to determine who is at fault. Both parties are vulnerable to the interpretations of local courts. Without clear rules and regulations, both sides can lose. Unfortunately, the same levels of protection don’t apply as they would for traditional crowdfunding opportunities.

Risk assessment is difficult but necessary

Ultimately, investors must understand that ICOs are at their core like any other investment opportunity and are not risk averse. It’s crucial to follow a proper assessment procedure and to understand the legalities of the specific offering. This legal assessment is also important for companies considering venturing down this route. The prospect of hitting the jack pot overnight or following an easier fundraising process should not cloud one’s judgement – a good business and a savvy investor always analyse the dangers involved.

The risky and speculative nature of ICOs distinguish them from the traditional crowdfunding process. During a given investment round financiers can estimate the value of a business by comparing it to similar companies out there, the market value is visible. With ICOs, investors often proceed more blindly because there is no clear way of analysing the worth of each token.

The future of ICOs in terms of replacing traditional crowdfunding options is hard to assess. Although there is potential long-term for the latest investment option, it does not come without its fair share of issues that still need ironing out.