Cryptocurrency basics: How initial coin offerings work
ICOs are an efficient way for companies to attract more investors in exchange for assets or services as well as raise funds for operations.
In addition to being a hot trending topic in the business news, the blockchain has also revolutionized the way we can store, share and secure information across public and private networks. The ability to process information on the blockchain has also created new opportunities for business to take more control of their own finances.
Based on the way Bitcoin works, companies can create their own digital currency or ‘tokens’ that represent a unit of value that is exclusively tied to that particular company. Companies set up an Initial Coin Offering, or ICOs, as a way of getting investors in on the ground floor in the hopes that the value of the token will increase as the company’s value does. Ultimately, the tokens would be exchanged for another form of tenders such as local currency, Bitcoin or another cryptocurrency, or a product or service usually produced or offered by that company.
While the tokens are written to the company’s individual blockchain, some go a step further by creating physical coins that can be held by investors and may offer some commemorative or symbolic importance as being the ‘first coin’.
Two types of tokens with two different results
The tokens that companies put on the market are (or should be) backed by some sort of value and are can be deployed in two different ways.
- Asset-backed tokens are directly tied to the company’s value. Much like a stock, the company’s coins value could rise and fall based on the operations of the business.
- Utility tokens are backed by a promised product or service at a certain timeline. The price of a utility token may vary depending on the increase or decrease in the value of the product or service offered.
Asset-backed tokens are ideal for companies who need straight up funding cash to keep developing whatever product or service they are working on. ICOs are like stocks where values can go to zero so there is still risk involved but companies can exert greater control on token allotment and deployment. Trading of tokens and transactions can also be controlled and monitored as the assets are backed on the company’s own blockchain platform.
Companies offer utility tokens as a way of raising money for business operations in exchange for the product or service that the company is developing. These tokens also pose risks as the company may not be able to deliver the promised product or service for whatever reason. Companies that produce in-demand products such as luxury watches or handbags could see the value of their utility tokens increase as allocated production sells down and demand increases.
Investors jump in head first blindfolded
There is always a dark side to new technology and the blockchain is not without its faults when it comes to nefarious activities. The ease of which ICOs can be setup offers opportunities for online scammers and thieves that exploit the hype associated with cryptocurrency. Thousands of investors have lost millions of dollars to illegal and fake investment schemes, online phishing scams and outright hacking. An emotional mad rush to get money into the market sometimes puts thorough background research and due diligence into jeopardy. Crossing your T’s and dotting your I’s is a must for any ICO type investment.
ICOs still represent somewhat of a risky investment. The latest stats indicate that 50 percent of coins fail within four months of their launch which means investors need to double and triple up their research efforts before allocating any capital to such investment vehicles. Undeterred though, ICOs were able to raise around $7 billion in capital in the first half of 2018 alone suggesting there is a valid and thriving marketplace for the investment-grade digital cryptocurrency.
Will regulation build integrity for ICOs?
ICOs have their place in the investment market. They provide an efficient way for companies to make their value public and raise capital for ongoing business operations. This type of access and ‘decentralized’ platform does create vulnerabilities which are constantly exposed by those with nefarious motives.
Many governments have recognized the importance and efficiency of the blockchain and have begun exploring ways to regulate and control businesses that are spun off from the blockchain. ICOs have become a more urgent concern for business enforcement agencies because of the instability of the market and the potential for scamming and hacking. Government intervention may build some integrity into the ICO business, but really it is up to the individual to make sure they fully research the business on the other end of the investment.
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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