What do you know about ICO vs. traditional financings for crypto startups?
The cryptocurrency market is getting bigger every day. Have you already heard about Ethereum – Bitcoin’s biggest recent competitor?
Unlike Bitcoin, Ethereum was created as a result of an ICO (Initial Coin Offering).
On the one hand, a process similar to a classic IPO (Initial Public Offering), and on the other, also with features of crowdfunding.
The ICO is a small revolution in the world of fundraising. It offers startups the potential to raise astronomical sums very quickly.
In December 2017, the startup SingularityNet raised $36M in the space of a minute.
In this article, we will share with you the main differences between ICOs and Traditional Financings for Crypto Startups.
The Ultimate Guide To Pitch Decks
Here is the content that we will cover in this post. Let’s get started.
- 1. What is an ICO?
- 2. How do ICO’s work? A windfall for blockchain startups
- 3. Ethereum – a perfect example of a successful ICO
- 4. 4 Advantages of raising funds through ICO for startups
- 5. Speed and ease of an ICO fundraising
- 6. Borderless and low cost
- 7. No dilution
- 8. Liquidity, profits, and openness
- 9. Disadvantages and Risks of ICO Financing
- 10. Risks of scams and token theft
- 11. Fraud, money laundering, and business disruptions
- 12. 5 Differences Between ICOs and IPOs
- 13. Project-based
- 14. Faster
- 15. Associated rights
- 16. Requirements
- 17. Accepted currency and pricing decision
- 18. 7 Essential Steps for a Successful ICO
- 19. Have a Clearly Defined Product
- 20. Put in place a team
- 21. Writing a white paper
- 22. Translate the operation into legal, fiscal, and accounting terms
- 23. Drawing up a smart contract and putting it online
- 24. Connecting the smart contract to a purchase funnel
- 25. Promote your ICO
- 26. The Conclusion on ICOs
What is an ICO?
An ICO is a method of raising funds, which works via the issuance of digital assets called tokens (digital tokens), for cryptocurrencies during the startup phase of a project.
Tokens are issued and exchanged using a cryptocurrency. The ICO is, therefore, a mixture of crowdfunding and IPO.
The difference is, however, with ICO, there is a potential for an enormous profit.
However, with crowdfunding, there is a desire to support the development of the project.
The funding is often, in principle, given as a donation. Though there are also debt and equity crowdfunding platforms.
We will dive deeper into the difference in the section below.
Moreover, in crowdfunding, the contributors are protected to some extent.
If the campaign fails or does not reach an appropriate level, then, sometimes, the money is returned.
Of course, there are exceptions here, too. In the case of ICO, the raiser typically keeps however much they raise.
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How do ICO’s work? A windfall for blockchain startups
Previously, a crypto startup wishing to find financing had to identify and convince investors to fund their project or product.
This was an arduous and time-consuming task that required a solid business plan, a reliable network, and a detailed project.
The ICO greatly simplifies their task. It is a participative financing method.
And, often open to the public, which allows crypto startups to raise funds in a much simpler way than before.
Often much earlier. Sometimes even when the project is only at the idea stage.
During the ICO, the startup offers investors to buy digital assets, most often in cryptocurrencies.
These digital assets are called tokens, and the most popular tokens are utility tokens and security tokens.
A security token gives the right to participate in future revenues or to increase the value of the issuing entity.
However, a utility token grants the right to access services or blockchain, thus ensuring the digitization of rights.
The number of tokens put into circulation, and their value is left to the discretion of the startup.
A great example of timely ICO fundraising was achieved by one of the founders of the Mozilla internet browser.
Brendan Eich, thanks to his brave ICO, achieved funding of $35M dollars in May 2017.
In this case, it is not so much the amount of fundraising that is impressive, but the time.
He got that $35M in just thirty seconds. The record amount raised is held by the platform EOS, which raised more than $4.2B.
With numbers like that, it’s easy to see why ICO has become the star of startups.
Ethereum – a perfect example of a successful ICO
Ethereum, like Bitcoin, is based on blockchain technology. However, it is not just a cryptocurrency.
Its founder, Vitalik Buterin, publicly presented Ethereum’s white paper for the first time in January 2014 at the North American Bitcoin Conference.
Funds were raised during the Ethereum ICO conducted in 2014.
In 42 days, $18,439,086 was raised in exchange for 60,102,216 tokens of Ethereum, the new cryptocurrency.
The money raised was first used to pay off debts, among other things, and then to further develop the project.
4 Advantages of raising funds through ICO for startups
Financing through ICO brings several advantages to a crypto startup compared to conventional financing methods.
The following are the advantages of raising funds through ICO.
#1. Speed and ease of an ICO fundraising
When a startup launches its ICO, it can set a “goal, i.e., a maximum amount to be reached (for example, $10M dollars) and/or a deadline (for example, 3 months).
Thus, the implementation of an ICO and the arrival of funds can be much faster than financing by venture capital.
Or by IPO, for which several intermediaries may analyze the project, the business plan, the market, or the financial strength and negotiate many terms.
If the project appeals more than expected to the community, it is possible that the ICO can sometimes raise astronomical amounts in a very short time.
The ICO thus has the advantage of speed and ease.
This was the case with the ICO of Filecoin in August 2017, a crypto storage network, which raised as much as $200M in just one hour.
#2. Borderless and low cost
ICOs also have the advantage of being able to reach an international audience beyond a country’s borders.
It is thus possible to raise funds in the four corners of the world.
The launch cost is often lower since the ICO makes it possible to bypass the lengthy and expensive processes of conventional fundraising.
It’s an excellent solution for financings for crypto startups.
#3. No dilution
The ICO brings a remarkable advantage since it avoids the phenomenon of dilution of the company’s capital to the benefit of external investors.
It does not require giving shares of the company to the investors as a stock does.
Nor the power of decision, management, and strategy that the latter brings.
This leaves the decision-making power of the startup’s directors intact.
#4. Liquidity, profits, and openness
On the other side of the coin, investors will get tokens that they can trade or keep, depending on their earnings perspective and time frame.
Gains can also be sizable as cryptocurrency markets are very volatile.
Daily variations are not comparable to stock markets for example, and can often reach tens, even hundreds, of percent in a few days.
Finally, a common advantage for investors and startups is that ICOs can be open to everyone.
Though it depends on the policies in force and the regulations of each country.
Disadvantages and Risks of ICO Financing
ICO-funded projects are often in the development phase and based on business plans that have not been independently evaluated.
There is no guarantee that the projects can be implemented or achieve the expected success.
Here are some other advantages and disadvantages of this form of financings for crypto startups.
#1. Risks of scams and token theft
In general, the world of ICOs is still very poorly regulated and is, therefore, the subject of many controversies because of scams.
The most recent, and one of the most spectacular, happened in April 2018.
That’s when the Vietnamese company Modern Tech disappeared after raising $660M during its ICO for Pincoin Token.
Specialized platforms and token storage systems may have security flaws that can lead to the risk of hacking and theft.
#2. Fraud, money laundering, and business disruptions
The lack of regulation and control attracts criminals who use ICOs to commit fraud.
ICOs can also be a vehicle for money laundering or terrorist financing.
The technologies that enable the creation, transfer, and storage of tokens are particularly innovative.
However, investors are exposed to the risk of permanent or temporary system interruptions.
As well as hacking attempts, problems related to activity peaks, etc., which may result in the unavailability of tokens.
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5 Differences Between ICOs and IPOs
What do ICOs and IPOs have in common? How do financings for crypto startups work?
An initial cryptocurrency offering and an IPO are frequently compared.
They are indeed two forms of public fundraising for a company, but the similarities between the mechanisms often end there.
Keep the following points in mind:
Most of the time, everything is still at the concept stage.
ICOs are conducted by startups that may not have been formally incorporated.
And have not yet launched any commercial activities related to the blockchain(s).
There is, therefore, no financial track record on which to make a valuable judgment.
The investment will be made based on a technology proposal that has everything to prove.
In addition, there are no transparency statements imposed in this still largely deregulated environment.
For an IPO, the team of founders, underwriters, and advisors must carry out the necessary legal, financial, and tax verifications while producing the appropriate documents.
This administrative process usually takes between 12 and 18 months.
On the contrary, an ICO will often be conducted in a much faster way, with execution possible within 2 to 4 months.
Also, the marketing and allocation of crypto tokens are usually shorter for the ICO.
This can range anywhere between 1-2 months.
That’s far less than that needed for investor tours, order book building, pricing, and allocation of an IPO.
#3. Associated rights
Unlike the rights associated with the shares of a listed company (ownership, dividend, governance), the possibilities offered here are the use of a “currency” on a dedicated blockchain platform.
A major difference is that the rights granted in an ICO generally do not confer ownership rights.
This is a strategic advantage for entrepreneurs who do not want to split up the governance of their company.
But this can be a disadvantage for cryptocurrency holders in the absence of voting rights.
The difference is also that IPOs are regulated by the government.
Issuers have high disclosure requirements, and they face severe consequences for their mistakes or negligence.
This can lead to the fact that not every company goes public, but also is a relatively safe investment.
In the case of ICO (which is not regulated in any way), there are no such restrictions. And virtually any project can use this form of financing.
All you need for an ICO is a minimum viable product, an audited public code, and a white paper.
In some circumstances, an ICO can take place even without these.
Just have a great pitch. And, take the time to understand how financings for crypto startups work.
#5. Accepted currency and pricing decision
Securities in IPOs are exchanged for fiat currencies such as the dollar, rupee, etc.
Unlike ICOs, cryptocurrencies are exchanged for other cryptocurrencies such as Bitcoin, Ethereum, Neo, etc.
However, some ICOs even accept fiat currencies apart from other cryptocurrencies.
The company spends a lot of time and involves several third parties to decide the share price at the time of the IPO.
The crypto price is set according to the capital requirements of the project. And the number of tokens that will be issued for mining or distribution.
Before we talk about how to raise a successful ICO, you might need information about how rounds of financing work for startups. Check out this video I have created where I explain in detail how it’s done.
7 Essential Steps for a Successful ICO
It is tempting for entrepreneurs to bite into the apple of the initial coin offering (ICO) in view of the amounts collected via this new financing method.
ICO fundraising must involve several experts specialized in their respective fields (tax, technical, legal & marketing).
Here are seven essential steps startups should take to succeed in an ICO.
#1.Have a Clearly Defined Product
An ICO is about a specific project. The product that will be sold to future customers must be defined in detail.
Whether it is pre-existing or in development, it must be sufficiently stabilized, simple, and explicit to convince users.
#2. Put in place a team
The team must be able to invest in the long term by surrounding its business with consultants and specialists.
Among these experts, we distinguish between service providers (for legal, marketing, accounting, etc.) and those who have more specific knowledge (technical audit, token structuring, etc.) and who are associated with the success of the project by being paid in tokens.
#3. Writing a white paper
The white paper is a marketing document, which is more or less technical depending on the ICO.
It is the cornerstone of virtual currency fundraising.
In order to learn about the project, investors must consult the white paper published by the startup.
An essential document that should not be overlooked.
Project owners can call upon a service provider which provides assistance to its clients throughout their ICO.
From the audit of the project to the communication strategy, including the production of the white paper.
#4.Translate the operation into legal, fiscal, and accounting terms
Another document to be produced to launch an ICO is the terms and conditions.
This document defines the obligations between the issuer of tokens (more or less the equivalent of shares in an IPO) and the investor.
The legal framework of an ICO project must be integrated from the beginning.
#5.Drawing up a smart contract and putting it online
Now it’s time to translate all this documentation into code, and thus to write the smart contract.
This computer program must be audited to ensure that it includes the information in the white paper and that it does not contain any bugs.
That’s because it relies on blockchain technology to secure the terms of its execution and make them unforgeable,
#6. Connecting the smart contract to a purchase funnel
Then comes the time to put the tokens on sale.
This is done in three phases, or even less if the initial objective is reached more quickly than expected.
The phases include:
- Private sale, i.e., the private sale reserved for professional investors.
- Presale, which is open to a broader panel of investors but who remain qualified.
- The crowd sale, which is the public sale intended for regular individuals.
#7.Promote your ICO
The key success factor for cryptocurrency is community, community, community.
That is access to the community, the knowledge related to this community, and the recognition of this community.
The operation is the creation of an ecosystem, i.e. a set of stakeholders around a subject of innovation, future customers, and developers.
The Conclusion on ICOs
Now you know how ICOs work, the risks associated with them, and the main difference between ICOs and traditional financings for crypto startups.
As you have seen, it is a powerful tool to raise funds when you are a startup because there are far fewer regulatory constraints to adhere to.
Therefore, you also have to be very careful before participating in an initial coin offering.
Even if some projects seem exceptional on paper, it is always necessary to do your research in order to avoid falling into a scam.
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