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What Are ICOs?

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Initial Coin Offerings (ICOs), sometimes called ‘token sales’ or ‘token
generation events,’ are a new way for companies to raise money without
diluting ownership of the company or having to pay investors back. ICOs
are a combination of existing forms of fundraising with a few twists, and
the phrase ‘ICO’ seems to have been coined (ha) to evoke connotations
with IPOs or Initial Public Offerings of equities. According to icodata.io,220
over 11 billion US dollars was raised between 2014 and mid-2018 using
some form of ICO. Early ICOs were Mastercoin (July 2013) and Maidsafe
(July 2014) though they used the term ‘crowd sale’. ICOs became popular
in 2017.
Traditionally, a company can raise money in any of three ways: equity,
debt, or through the pre-ordering of specific products. They can raise
money from a small group of investors as is typical in early venture
funding, or from a large number, a style of raising money typically called
‘crowdfunding’ that has become increasingly popular.
In an equity raise, investors pay money to the company in return for a
share of ownership of the company. Investors receive a share of company
profits in the form of dividends and may get voting rights at shareholder
meetings, among other privileges. In a debt raise, investors loan money to
the company and may get periodic interest payments in the form of
coupons. Debt holders expect to get their capital back at the end of the
lifetime of the loan. In a pre-fund or pre-order, customers (note, they are
customers, not investors) pay money for a product that they will receive
later. Often the product isn’t yet ready for distribution. Sometimes there
are discounts for ordering early.
Crowdfunding is a recent phenomenon using the power of the internet
where a project or company can be funded by raising small amounts of
where a project or company can be funded by raising small amounts of
money from large numbers of people, often through a web or app-based
platform that brings together the projects and the investors, or
customers. All types of funding can be raised from the ‘crowd’. Examples
of equity crowdfunding platforms are Seedrs, AngelList, CircleUp, and
Fundable. Debt crowdfunding platforms include Prosper, Lending Club,
and Funding Circle. Sometimes these are called ‘peer to peer lending’
platforms. Pre-funding platforms include Kickstarter and Indegogo, and
work on pledge basis, where a project only goes ahead if a certain target
amount of money is pledged. This is popular for products that appeal to a
niche. Pre-ordering is popular for book and computer game sales.

Different ICOs have different characteristics, and the generalisations I
make in this chapter serve to provide a broad overview, but there will be
exceptions. The industry is moving quickly, and regulators are starting to
clarify their views on this new form of fundraising.

How Do ICOs work?
Companies221 describe a particular product or service in a document
called a whitepaper and announce their ICO. Investors222 send funds,
usually cryptocurrencies, to the company in return for tokens or a
promise of tokens in the future. The tokens can represent anything, but
usually represent either financial securities linked to the success of the
project (and described as security tokens) or access to a product or
service created by the venture (and described as utility tokens). At some
stage, tokens may become listed on one or more cryptoasset exchanges.
Eventually, a product or service is created, and in the case of utility
tokens, holders may redeem their tokens for the product or service.

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