The Initial Coin Offering is a new method of funding for startups and growth companies. Instead of raising funding for a project, you can now raise money for a token or coin which gives the purchaser the future right to use your product. An ICO is the cryptocurrency version of crowdfunding. ICOs are not equity fund raises despite the similar of the name to IPO. ICOs follow the Kickstarter funding model in which backers support a project. Backers get to have a direct say in the project development. Blockchains use this level of interest to raise funding for the project.
It usually runs for a week to one month and lets the user purchase a token in exchange for cryptocurrencies such as like Bitcoin (BTC) or Ether (ETH). There is a specific goal for the funding such that each token will have a set price that will not change during the ICO offering period. Some ICOs have a dynamic funding goal which means the more tokens that are sold the higher the token price will be.
The ICO is not an equity raise and does not fall under the SEC securities law although the SEC and the IRS are currently reviewing ICOs for securities implications. They apply the Howey Test to determine if the ICO falls under the securities regulations.
The four tests are:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
The ICO creates a plan for the fundraise called a White Paper that states the project’s function and purpose and how much funding is needed to undertake the venture. It also states how much of the funds the developers of the project will take, what type of currency is accepted, and how long the ICO will run.
During the ICO campaign, backers and supporters will buy some of the distributed tokens with either fiat (i.e. US dollars, etc) or virtual currency (i.e. Bitcoin, or Ether).