What is an ICO?
ICOs are a new way for companies to raise money. Instead of going to a bank for a loan which they will have to repay, or giving up partial ownership to a Venture Capital firm for money, startups can create their own cryptocurrency token, which they sell either to the general public or to accredited investors. Users who purchase ICO tokens do not get ownership of the company like with stocks. Instead, they hope that the value of the token will go up as more people start using it.
How it Works
For an example, let’s look at Filecoin.
Filecoin is a new platform for data sharing built on blockchain. People who need more storage space can pay a small fee to have their files safely stored on another user’s network.
When Filecoin wanted to raise money they decided on an ICO. Because they were concerned about potentially breaking the law if they opened their ICO to American public, they only allowed accredited investors (income > $200k / net worth > $1 mil) to take part.
The Filecoin ICO occurred before Filecoin actually launched their network (expected to occur sometime this year) because Filecoin wanted to use the money they made from the ICO to build their product. This is similar to how startups will raise money from venture capitalists before they have built their product.
To raise interest in their ICO, Filecoin released a white paper — a detailed report on their product. This is customary in the ICO world and similar to a prospectus for IPOs (stocks).
Accredited investors were able to invest in Filecoin by purchasing Filecoin tokens. Unlike stocks, these tokens do not represent ownership in the company. The reason that Filecoins are potentially valuable, is that the Filecoin platform will run on them. Users who store people’s files will be paid in Filecoin by the people who are having their files stored. There is a limited amount of Filecoins that will be in the network, which means that if more people start using the network, individual Filecoins will become more valuable.
Problems with ICOs
The problem with ICOs is that anyone can create them, and it is hard to tell if they are real of not. In 2017, when cryptocurrency prices were soaring, there were thousands of ICOs. However, it is now believed that nearly 80% of ICOs in 2017 were scams. The creators of these ICOs created worthless tokens and sold them to investors as if they had real value. They then took the money they made and ran of with it. While the US government is now enforcing more regulation on ICOs and beginning to prosecute previous schemes, many investors will never get their money back. Additionally, many real ICOs ended up losing all their money because, like most startups, they failed.
The Future of ICOs
While ICOs were all the hype in the crypto world in 2017 and 2018, there have been far fewer ICOs in 2019. This is mainly because investors have become more aware of the potential for scams and because government regulation and the potential for punishment has scared many people away. It is not yet clear which direction governments will take with regards to ICOs. Currently, the US is one of the stricter countries — most ICOs are not open to US citizens unless they are accredited investors. If the US and other major countries eventually create a clear legal framework for ICOs, we may see a return to the heights of 2017. Otherwise, ICOs will end up being just a being a quick flash in the pan.
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