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What is an ICO? Everything you need to know

cryptocurrency
(Image credit: Shutterstock / robuart)

The first thing anyone needs to know about ICOs is that they're no longer called ICOs.  You may remember the mania-fueled days of 2017 when projects with little more than a whitepaper raised over a million dollars in less than a day with an initial coin offering, an ICO. Some of these ICOs proved to be outright scams, whereas others were legitimate and the funds garnered helped to launch some of the most successful blockchain projects.

Today blockchain technology is safely facilitating investing outside of traditional capital markets. Crypto tokens facilitate capital formation and provide incentives within blockchain networks.  Token sales have become an essential part of the crypto economic ecosystem and how projects rise to prominence.

About the author

Ray Mayo is Tokenization Lead at Republic

History of the ICO

Bitcoin was the world’s first cryptocurrency, arriving in 2010 via a shadowy figure, Satoshi Nakamoto. As the whitepaper circled throughout crowds of technocrats and entrepreneurs, the world understood that this novel use of decentralized technology could unlock countless innovations that could serve as a new foundation for the world’s financial infrastructure. The most standout functionality at that time was Bitcoin’s ability to create a natively digital currency that operated outside of the bounds of sovereign reach. If Bitcoin could be used to incentivize activity on the network and therefore hold intrinsic value, then this model could be replicated.

As early as 2012 people realized they could mint new cryptocurrencies that could be sold to raise money for their projects, no VC backing needed. The most famous early example of a cryptocurrency sale was Ethereum’s public token offering. Ethereum raised about $2.3 million in the first 12 hours. Participants paid through Bitcoin, which was the only way to access Ethereum at the time.

Since then, token offerings have exploded in popularity. 2017 was the year of ICO mania that marked the definitive arrival of token sales.  Over the course of that year, there were over 400 sales that rose an average of  $12.7 million. These token sales were extremely lucrative for early purchasers— it was common for investors to see 10X returns. Moreover, they helped cryptocurrency projects secure the funding needed to expand their operations. As of June 2018, more than 15 projects had taken in over $100 million. The total amount invested in 2017 was $5.6 billion. The easy money backing token offerings resulted in a frothy token market and generated extraordinary wealth and opportunity for those who were able to cash in at the right time.

As an unregulated market, thousands of investors were swindled during the ICO mania of 2017.  These scams drew the ire of companies and regulators alike. The People’s Bank of China completely banned token sales and prohibited banks from offering services to projects using token sales to raise capital. Facebook, Google, and Twitter meanwhile blocked ICO advertisements on their platform. Within the United States, token sales occupied a legal grey area. The SEC implemented the Howey test to determine whether a token had been launched simply to raise capital without providing any actual utility within a blockchain network. People today don’t like the term ICO because it indicates an association with an IPO, the sale of a security, and is triggering from a regulatory perspective. We’re still seeing the lingering effects of these early token launches and the harsh legal implications for projects who were accused of violating securities laws. Ripple, the organization that launched the XRP token in 2021, is in ongoing litigation after allegedly selling $1.3 billion through an unregistered, ongoing digital asset securities offering. The business of token sales at that time was high risk, high reward, in more ways than one.

How token sales work

In theory, you can tokenize anything of value— stocks, bonds, art, gold. Launching a token and the idea of ‘tokenizing’ something can be done in many different ways.

Utility tokens are created to serve a specific function or provide some sort of capability. For example, within the Ethereum network, Ether is used as the gas to pay for transactions and computational power to power programs that utilize the Ethereum blockchain. Consider these utility tokens as crypto commodities. One thing must be understood when launching a utility token, in order to not trigger securities laws: the token does not represent a share in a project.  As a result, they do not have any actual intrinsic value and they don’t come with any legal protections. They have value when used in association with a specific technology.

Whereas security tokens on the other hand are meant to be digital representations of actual financial instruments. They can represent fractions of assets like real estate or stock and must be traded in compliance with local securities laws. Financial services institutions are adopting the use of security tokens to bring efficiency and transparency to markets.

A newer token model is the profit sharing token, which aligns the incentives of the community with activity on the associated platform.

Key takeaways

Token sales have been one of the cryptocurrency sector’s most important innovations. The ease with which entrepreneurs can launch tokens to receive funding via the internet is greatly lowering the barriers to accessing capital.

In recent years token sales, combined with regulatory changes, have lowered the barriers to invest in start-ups and we’re seeing non-blockchain native projects use token models to bring innovation to their industry. Token sales are making our financial system global, open and more liquid. 

To summarize, token sales…

  • Are a new method for start-ups to raise money
  • Leverage new technologies to facilitate capital formation
  • Are mostly built using the Ethereum ERC20 standard
  • Are very risky, so an investor should never invest more than they can afford to lose

Ray Mayo is Tokenization Lead at Republic