Why Initial Coin Offerings are the New and Improved Way for Start-ups to Raise Capital

Financing is the primary challenge that new startups face today. Founders are continually looking for ways to fund their dream, but unfortunately, only a few of them end up getting the success they envisioned.

Recently, however, new companies have been increasingly trying their luck with initial coin offerings as opposed to the traditional venture capital route. According to statistics, less than 1% of startups seeking financial support get money from angel investors, and only 0.05% receive venture capital funding. On the other hand, a decent 25% of companies that go the ICO way get the capital they need. ICOs seem to be the golden ticket to getting a blockchain project up and running.

So, if you’ve been wondering what the ICO hype is all about, read on to find out how coin offerings work, and whether they could be the financial solution that gets your business to the next level.

What is an ICO?

An ICO is a crowdfunding event where a blockchain-based company releases a new cryptocurrency with the intention of selling it to get capital for its project. The initial coin offering usually starts with a specific number of "coins" or "tokens" whose price and supply remains constant during the event. However, it's possible to have a dynamic funding scheme, in which the token's price rises as more buyers join the fold, or a dynamic supply, where a new token is created every time an existing one is bought.

  • Buyers get the coins by exchanging them with more established currencies like Bitcoin or Ether, and all the money the ICO generates becomes capital, which the startup can use to develop its project. With the ICO, the company also establishes a community of early supporters that become vested in its project's success.

What Makes ICOs An Appealing Way to Raise Capital?

The ICO concept may have started a mere five years ago, but it’s currently the undisputed darling of the investment world. When the industry exploded in 2017, blockchain-based companies raised more than $5 billion worth of capital with initial coin offerings, an amount that was far more than what was brought in by venture capital and angel investors.

If you’re one of the many prospective startup founders wondering why ICOs are the new number-one strategy for funding blockchain projects, here are five notable advantages of initial coin offerings that will give you some clarity.

1. Tokens Are Global

ICOs differ from equity sales in the sense that the latter is regulated by the host country’s government, while the former is similar to the sale of API keys. Equities can only be sold to the “accredited investors” in the country, who are ideally high net worth individuals. Blockchain tokens, however, can be sold to anyone willing to buy them, locally or internationally.

ICOs also have the edge over typical online crowdfunding campaigns in that, while banks can freeze new accounts that receive thousands of wire transfers from all over the world within minutes, a token sale paid in digital coins is always open for business. An ICO enables a startup to reach a lot more investors and gather more money in a shorter timeframe, without the inhibitions of third-party regulators.

2. Tokens Have A Liquidity Premium

Tokens have definitive prices immediately they go on sale, and that price floats unrestricted in the global market. So, although it can take years for seed investment equity to become liquefiable, investors can sell tokens the moment they buy them.

Of course, any appreciation in value will likely be much larger over a few years than a few minutes, but the fact that investors get the option of liquidity immediately makes ICOs seem like a safer and more attractive investment option. Fast liquidity also allows users to participate in any new coin offerings launched by the same startup for another project.

3. Decentralized Funding

An ICO enables a startup to reach its prospective investors directly, without interference from intermediaries. Because coin buyers only need to hold private keys to guarantee custody, ICOs change the public’s notion of property rights. The final arbiter that manages the transactions is not a slow and rigid legal system but an automated international blockchain

4. Pro-Active Investors

Tokens break down the barrier between investors and startups, allowing anyone to become an investor in the same way that the internet enabled anyone to become an amateur journalist or blogger. Buyers can choose the project that they feel passionate about and contribute to making it a success. As with journalism, some of these amateur investors become exceedingly successful and use their token-buying record to break into professional leagues.

Moreover, just as many traditional journalists are now running their own blogs, institutional investors are gradually getting into token buying. New tools analogous to Wordpress and Blogger are also being developed to make it easier for users to buy, sell and discuss tokens amongst themselves. ICOs create a community of investors that is more active in a project's network, and which helps the startup to succeed in more ways than just by injecting capital.

What Are the Risks?

Political and economic influencers from several countries have made statements regarding their view of initial coin offerings, and understandably, most of them are warning that the highly speculative and unregulated nature of ICOs significantly exposes investors to risk.

In the U.S., for instance, the Securities and Exchange Commission is yet to issue definitive rules on ICO tokens and investments. It is therefore not entirely clear which coin sales are subject to securities regulations, and how the SEC might deal with startups that are discovered to be non-compliant. Consequently, the safest route for investors seems to be buying into startups that involve legal firms when conducting their ICOs or restrict sales to accredited investors.

  • Another risk that investors face is the general volatility of digital currencies. An ICO whitepaper might paint a colorful picture of possible impressive returns, but that is usually a goal and not a guarantee. It's proper practice that a startup gives potential investors enough information about their ICO. Likewise, investors must deal with companies with an experienced team and a solid business model.

Cybercrime is also an undermining factor in ICO funding, mainly because of the lack of concrete regulatory guidelines in the blockchain space. Recent reports indicate that 10% of all ICO-raised funds end up with cybercriminals, and the SEC has warned that investors may have little chance of recovering their money in the event of fraud or theft.

For investors that choose to believe in the project and brace the risks, however, the returns can be bountiful. With an impressive product or service and a concrete plan, there's no reason a startup can't achieve success for itself and its investors through an ICO. In fact, there appears to be a move by projects towards more friendly environments that are flexible on ICOs in terms of regulation such as Singapore, United Kingdom, Switzerland, etc. Data from blockchain analytics firm Elementus indicates that there was a decline in the number of ICO hosted in the United States compared to Singapore in the month of August 2018.

In that month the city-state hosted 17 Initial Coin Offerings while the United States hosted 15. Other countries which also hosted a significant number of Initial Coin Offerings included the United Kingdom which had 9 ICOs while Switzerland boasted of 5 ICOs in the same month. As a matter of fact, Elementus estimates that during this same month of August, ICOs raised approximately $1.466 billion and this was nearly the same amount that was raised last year during the bull in the month of November - $1.429 billion.

  • And besides, most of the funding that has been raised in ICOs was collected this year, when the price of cryptocurrencies had fallen off their record high whereby of the total $28 billion raised to date, $15.9 billion occurred between February, 2018 and August, 2018.

The Future for Initial Coin Offerings

If your startup has a cryptocurrency as part of its business model, an ICO can be a novel way to get the funding you need and reward your investors with your success. ICOs gives new companies a chance to raise capital without the external pressures of shareholders, influencers or the market. For investors, they're more exciting than typical online crowdfunding, which doesn't tie rewards to the success of the venture.

Like the entire blockchain technology, the ICO is a new concept, and it's bound to mature over time. Decentralized access to capital will continue to gain ground as a driving force among startups, and as new platforms emerge and try to earn a piece of the Ethereum market share, the technology will grow and mature. Furthermore, investors are becoming increasingly aware of the risks, and that means number of projects whose ICOs are based on whitepapers with little proof of concept is going to drastically decrease.

For now, there’s no indication whatsoever that ICOs are going anywhere. They may very well be the standard for jumpstarting digital businesses in the coming years.

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