TLDR: Initial Coin Offerings provide a way for blockchain companies to raise money by selling newly minted crypto coins. ICOs to date have offered some extraordinary returns, but have also led to some dramatic failures.

Taking off or getting burnt? (Photo by Dan Carlson)

---

What is an ICO?

ICO stands for Initial Coin Offering and is a method used to raise money for new blockchain projects. It usually takes place before the launch of a coin’s blockchain and involves the public sale of a percentage of the coin’s initial supply. ICOs are sometimes referred to as ICPOs (Initial Public Coin Offerings) or ITOs (Initial Token Offerings).

ICOs work in the following way:

• A new company/organisation/collective of developers announces that it will be selling the initial coin supply of their new cryptocurrency
• Early supporters of the project pay money (normally in the form of bitcoin) in return for these new coins
• The company then has money to spend on building out the technology to the point of release and beyond
• The new project launches and if it gains traction, then the value of the new currency rises and investors of the ICO make a profit

An ICO sits somewhere between an IPO and a crowdfunding campaign. On the one hand it is an offering of shares in a currency. On the other hand it enables the purchaser to use a new product in the form of the blockchain technology being provided. In this way, Ethereum classified their ICO as ‘Software Pre-sales’, where payments are received not for an equitable share in the enterprise but for a license to run the Ethereum software.

---

Benefits of an ICO

There are three key benefits of an ICO:

1. Ease/speed. There is a lack of regulation in the space, making it administratively straightforward and a relatively fast way to crowdfund a project
2. Reach. ICO crowdfunding enjoys global participation due to the borderless nature of cryptocurrencies
3. Distribution. ICOs solve the problem of initial coin distribution. Supply of the new currency goes to whoever has paid money for the project’s development

Many successful blockchain technologies have been funded through ICOs, including Ethereum, Bitshares, NXT, Lisk and Factom, and many investors in ICOs have made significant returns. The price of Factom hit 7 times it’s ICO price in March 2016 and Ether is currently trading at around 40 times what is was sold for during it’s ICO.

Annual growth in the price of Ether

---

Problems with ICOs

ICOs are controversial, mainly due to a number of scams and failures that have occurred. There are two problems inherent to ICOs:

1. The need for trust. Blockchains remove the need for trust in transactions, and yet investors need to trust that the creators of blockchains are not scammers. A new company can announce that it is running an ICO and can make grand claims about its vision and technology. The company can then raise money and disappear into the night. A recent example of this was Edon.
2. Unknown technological flaws. The most high profile failure to date (by a country mile) was the DAO. After raising the equivalent of $150m USD in its ICO, a flaw in the contract allowed a hacker to withdraw a third of the value of the company, leading to a month of turmoil and eventually the Ethereum hard-fork.

---

Alternative ICO structures

Proof-of-burn

One of the craziest ICOs to date was done by CounterParty. In order to get XCP (their currency), people had to “burn” Bitcoins — send them to an address that could never be accessed meaning that those coins were destroyed forever. This meant that money was spent to access the new tokens, but no money was received by the development team. While this was pretty drastic, it was in line with the project ethos and meant that:

• Developers of the platform did not enjoy special privileges
• Developers did not “make a killing” from the ICO
  In the eyes of Counterparty, this gave the project maximum legitimacy right from the start.

DAO ICOs

A DAO (Decentralized Autonomous Organization) crowdsale differs from other cryptocurrency ICOs, as the money raised is not directly accessible to the founding team. Instead, funds can only be spent when a majority of DAO holders agree to use it in order to improve the economic situation of the DAO. Digix was the first DAO ICO, reaching its crowdsale goal of $5.5 million in under 12 hours.

While this system gives investors confidence that their money is not being flushed away or stolen by scammers, it also leads to the problem of having to mobilise investors before money can be spent on important projects. Future instances of DAO crowdsales are likely to have features that allow investors to allocate their voting power to trusted individuals to speed up the decision making process.

---

The future of ICOs

ICOs are not going away any time soon. They have become a central financing mechanism in the blockchain ecosystem. However, I would expect a number of trends to permeate through into future ICOs:

1. Increased accountability. Going forward, it is unlikely that investors will be comfortable giving developers “carte blanche” to spend the money raised from ICOs. Blockchain companies will become increasingly transparent and accountable as to how ICO funds are being spent.
2. Simplicity over complexity. While DAO models of fundraising will become more popular, aiding accountability, the failure of “the DAO” will mean that companies favour simplicity over complexity in the structuring of DAOs and smart contracts. The Digix ICO is a good example of this.
3. Fixed funding targets. Open-ended funding campaigns can get out of hand, as shown by the DAO. Owing to increased accountability, it is reasonable to expect future projects to have more concrete development targets, and as a result, fixed budgets in mind.
4. Government regulation. It’s just bound to happen… and for good reason. Without the Ethereum hard fork, a lot of people would have lost a lot of money in the DAO hack. There would have been a hoard of angry people and nobody would have been accountable. We’re living in the wild west of blockchain fundraising and it’s only a matter of time until another hack takes place or something else untoward happens. As ICOs become more frequent, it’s only a matter of time until the government gets involved.

Charlie is a developer at Mind Fund Studio and focuses on iOS and blockchain applications. His latest app, Ether Tracker, is on the App Store now.
You can follow him on Twitter and Steemit @chtmorris