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What is an ICO – Meaning of Initial Coin Offering and How it Works

Blog • 5min read
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Inna

Writen by Inna Chernikova

@Innach974
Published on 22 May 2018

What is an ICO - Meaning and How It Works

Initial Coin Offerings have been big news for the last year or more. Filecoin, Tezos and EOS are just a few of the most successful ICOs in 2017 alone.

There are now hundreds of cryptocurrencies, most of which started through some form of Initial Coin Offering. But what is an ICO and why should you consider it for your business?

ICO Meaning

Simply defined, an Initial Coin Offering (ICO) is the first step in creating and distributing a new cryptocurrency to the public. The issuing company receives currency (it can be fiat, Bitcoin, or Ether depending on what they need) that it can use to fund its growth. Participants receive tokens that will rise in value if and when the company is successful. We will have an entire article about the difference between tokens and coins, but at the risk of over-simplifying, tokens carry currency value only within an ecosystem, such as a company. Coins carry value across a wider, more public space.

Ethereum physical coin with physical Bitcoins at background

This description sounds a lot like what happens in an Initial Public Offering in that it enables people to invest in a project and share in its future success. It also sounds a lot like crowdfunding, but instead of just committing to being a customer, supporters will be able to both use the product and potentially make a profit. Unlike an IPO where a lot of documentation and auditing are required before the issuing of any shares, an ICO is a lot more accessible. Crowdfunding can even be achieved without a running product or proof of profits.

Initial Coin Offerings have several advantages over traditional funding methods, especially for start-up companies. These advantages are accessibility, affordability, speed, and an instant user base.

ICOs are more efficient than traditional finance

Traditional financial markets rely on a centralised authority to decide who is allowed to conduct business and to process transactions. This authority acts as a gatekeeper, requiring companies to jump through all manner of legal and procedural hoops before they are granted access to the market. The business plan has to be reviewed by an expert, the accounts have to be audited, and someone must maintain the official list of investors. Centralized monitoring and validation is required in the traditional system to ensure participants can trust each other but it is time-consuming.

Listing a company on a stock exchange often takes over a year of work before any money is raised. However, Initial Coin Offerings take place on a blockchain (a distributed decentralized ledger) which removes the requirement for a central authority. All of the necessary record keeping is handled by a global network of computers, which ensures trust and eliminates hacker access. A company that raises money using an ICO could have launched their product before their traditionally-financed rivals have even raised their first dollar.

Raising money through the traditional financial markets is a costly business. A company looking for finance needs to hire lawyers, accountants, compliance experts, salespeople, and other expensive middlemen. On top of all of those expenses there will be payment processing fees. An Initial Coin Offering does away with many of these costs so the company gets to keep more of the money they raise and the investors get a larger slice of the pie. This makes it viable to raise smaller amounts of funding because it will not be swallowed by fees.

ICOs create an instant user base

One of the main problems that new companies face is building their user base. ICOs make it easy for people to support a project which means they tend to attract more users than traditional funding. Participants in an Initial Coin Offering also tend to be interested in the project for its own sake rather than just its potential to make them money. This means that the company has a ready-made population of potential users, all of whom want to see it succeed. Indeed, some developers who could easily self-fund a project still do an ICO because they understand the value of building a community – even Kik decided to go down this route to help create their “ecosystem of digital services” despite there being no shortage of willing equity investors.

The Bitcoin physical coin in the center of a computer printed circuit board.

What happens during an ICO?

Once a company has an idea and a plan, they should start arranging the funding that will be required as well as when they will need it, and how they are going to get it.

Companies will often conduct a token pre-sale to raise some initial money and test the market's appetite for their product. These can be either private or public, depending on how much funding the company needs, how much it needs users, and how much publicity it wants (or wants to avoid). It is entirely possible to have a private pre-sale and then a public one once the product is at a more advanced stage and requires more funding. These could be compared to the incubator and private equity rounds of traditional finance.

The actual ICO itself is a combination of fundraising and product launch. It needs to attract and convince people who are interested in using the product, people who believe in the potential of the business, and people willing to provide liquidity (having a coin is no use if nobody is using it).

After the ICO, the coin needs to be listed on cryptocurrency exchanges to encourage new users and allow supporters to realise their profit more easily. However, this is also something of a balancing act as many people judge the quality of a company by the price of their coin.

This is a very brief overview of what happens during an ICO. It is not quite as simple as “invent a coin, raise millions” but is still a lot smoother than using old-fashioned methods to fund a company.

Rounding up — what is an ICO?

So, to round up, what is an ICO? The short answer is that it is a revolutionary way of funding a business that is affordable and more efficient than traditional finance. ICOs also give companies a head-start on growing their user-base which makes their product launch more likely to succeed. ICOs are better for supporters because they can get involved at an earlier stage of a company's growth with a smaller commitment than traditional methods of financing a project.

Published on 22 May 2018
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