How can this possibly be a legitimate way to raise money?
Justin JaffeManaging editor
Justin Jaffe is the Managing Editor for CNET Money. He has more than 20 years of experience publishing books, articles and research on finance and technology for Wired, IDC and others. He is the coauthor of Uninvested (Random House, 2015), which reveals how financial services companies take advantage of customers -- and how to protect yourself. He graduated from Skidmore College with a B.A. in English Literature, spent 10 years in San Francisco and now lives in Portland, Maine.
Before you jump into the ICO stuff, get to know the fundamentals by reading our first article in this series, Bitcoin, explained.
Bitcoin and its legions of cryptospawn and blockchain babies are rewriting the rulebook. Actually, lots of rulebooks.
Blockchaintechnology is changing the face of everything from banking, to payments, to security. But it's the way these crypto projects, currencies and companies raise money that's attracting the most attention from startups and established companies alike. The "initial coin offering," or ICO, is rapidly reshaping the conventions, boundaries and timelines for how entrepreneurs, startups and corporations finance their endeavors.
Let's get into it.
Going public, streamlined
Like an initial public offering (IPO) of stock, from which its name is derived, an ICO is a way that cryptocurrency startups -- and even established manufacturing companies -- can raise money. With a somewhat circular approach to economics, crypto companies fund their enterprises by selling their own cryptocurrency, often accepting payment in other forms of cryptocurrency (most often bitcoin or Ethereum).
This is radically different from the highly standardized, lawyer-heavy orchestrations of a traditional corporate IPO. With an IPO of company stock, investors exchange money for equity and voting rights in an established corporation. In the US, the process is underwritten by an investment bank and tightly regulated by the Securities and Exchange Commission.
In the freewheeling world of crypto, however, there's none of this. No investment bank. Rarely equity or voting rights. Very minimal regulatory oversight (though the SEC's new task force will likely change that). And, in many cases, no corporate track record or even product. What's not to like?
Proponents argue that ICOs accelerate and democratize the venture capital process. Skeptics point out that the whole thing is crazy. Depending on your opinion of cryptocurrency, and whether it's a viable form of payment or investment, ICOs may look like an ingenious tool or transparent scam. Either way, they're a thing; according to Forbes, these types of offerings raised more than $4 billion in 2017.
A novel idea
Mastercoin, now known as Omni Layer, was the first to hold an ICO. In 2012, J.R. Willet, the creator of Mastercoin, published an influential whitepaper suggesting the blockchain could serve as the foundation for other applications, currencies and "smart contracts." (He tells the story well.) To fund the development of his project, Willet promised to give 100 Mastercoins to anyone who sent him a bitcoin during the month of August 2013.
It worked. In the end, Willet received roughly 5,000 bitcoins -- valued at approximately $500,000 at the time and more than $50 million today -- and released about 500,000 Mastercoins. But, more significantly, he validated a new financing template for a succession of coins that would follow.
The typical ICO begins with a statement of some kind, often a white paper, that outlines the technical details, project plan, goals and budget for a project, as well as some discussion of how the coins or tokens will be distributed. (Generally, tokens are issued to represent an ownership stake in a project or decentralized autonomous organization, whereas coins usually represent ownership of a currency.)
Most ICOs fix the number of tokens or coins on offer before the sale. Investors who buy in earlier may be given preferential terms, paying a lower price per coin. But prices can fluctuate, and if more folks buy in, you could end up with fewer tokens. Some offerings have a specific fundraising goal, and may keep the price fixed throughout the offering period. Others may keep the supply fixed and adjust the price based on demand, raising as much as possible. And there are those that allow for a dynamic supply, with a new coin created whenever someone buys one.
Many ICOs have been executed independently, managed by the issuing entity on its own website or platform. That noted, the more credible offerings are now usually facilitated by an exchange or an escrow service that can afford investors some modicum of security against scammers.
Speaking of which, there are plenty of reasons to be skeptical of cryptocurrencies. But you may need to engage in some wholesale suspension of disbelief to participate in an ICO.
Exhibit A: In 2013, Jackson Palmer created Dogecoin -- the name is a reference to a meme involving an internet-famous Shiba Inu -- in an effort to highlight the excesses of the burgeoning cryptocurrency craze. It didn't work out the way Palmer planned: Today Dogecoin has a market cap of more than half a billion dollars.
Since then, amid the explosion of ICOs -- with more than 100 in 2017 alone -- there has emerged a comical arms race of sorts, featuring increasingly absurd coin offerings with stridently satirical names. There's Useless Ethereum Token -- tagline: "Seriously, don't buy these tokens" -- and the religiously oriented Order of Ethereum, which accepts donations of Ether tokens as atonement for sins or to purchase a station as "saynt," "prophyt," or "savyor." (The group's ICO has raised just shy of $62 to date.)
Dubious coins and outright scams have fueled widespread distrust of cryptocurrencies and ICOs. And yet, a steady torrent of startups and companies continue to plan and launch their own currencies using the mechanism.
In September 2017, social network Kik raised nearly $100 million through an ICO on the Ethereum platform. And in January of this year, Kodak -- yes, Kodak -- announced its own cryptocurrency and a blockchain service designed to help compensate photographers for unlicensed uses of their photos.
Given that the company's stock price doubled after the announcement, we're certain to see more ICOs -- not only from crypto startups but big companies trying to act cool or put a modern veneer on an antiquated brand.
Ethereum: The ICO platform of choice?
Kik's choice to launch an ICO on Ethereum wasn't arbitrary. In addition to serving as a tradable cryptocurrency in its own right, the Ethereum platform has made it relatively simple to create tokens and have an ICO. (Ethereum's own ICO, or "presale," in July 2014, raised more than 31,000 bitcoin, now worth more than $250 million.
That it's been embraced by a number of large corporations and academic institutions hasn't hurt. But it's the Ethereum platform, with its "smart contract" protocol and extensible blockchain, that has made it the ICO launching pad of choice for dozens of cryptocurrencies, startups and projects.
There have been misfires, however. In 2015, the DAO, a "decentralized autonomous organization," raised $150 million worth of Ether -- a world record for crowdfunding. It was almost immediately hacked, losing control of more than $50 million of the proceeds. Though Ethereum administrators helped recover a portion of the money, the DAO remains a cautionary tale for both investors and startups.
Still, since then, dozens of other coins have launched successfully on Ethereum including Golem, Augur and Iconomi -- each an interesting project on its own merit -- without drama. A TechCrunch analysis shows that the platform is gaining momentum: The majority of ICOs in 2017 were launched on Ethereum, and Ether-based cryptocurrencies accounted for two-thirds of all cryptocurrency assets as of July 2017. (You can see which platforms have spawned which cryptocurrencies at mapofcoins.com.)
As with any investment -- particularly one in a nascent, evolving and unregulated marketplace -- due diligence and extreme caution should be exercised when considering participation in any ICO or purchase of cryptocurrency. Do your research, HODL and caveat emptor.