Add3, Content
March 1, 2023
8.5 min reading
Initial coin offerings (ICOs) are a relatively new method of raising capital for early-stage ventures. They’ve gained significant attention in recent years with the rise of crypto and tokenized assets.
The benefit of ICOs is that they allow businesses to raise funds quickly and easily. Startups and projects can issue digital tokens in exchange for crypto assets or fiat currencies. This new and innovative type of capital raise is an interesting alternative to more traditional sources of start-up financing. Founders are realizing that venture capital (VC) and angel investing are not the only ways to get funded.
In this article, we will explore the advantages and disadvantages of ICOs, as well as the various regulatory responses to this new fundraising method.
So, how exactly do ICOs work and are they a good idea? The basic concept is when a company issues digital tokens in exchange for cryptocurrency or fiat currency. These tokens are similar to shares in a traditional initial public offering (IPO). Their value can increase if the project is successful.
ICOs typically start with the company creating a whitepaper, which outlines their business plan and the details of the token issuance. The company then announces and markets the project and its corresponding ICO. Investors can learn about the opportunity and choose to purchase tokens as a supporting investor. The funds raised are then used to develop the project, with any unsold tokens being destroyed or returned to the investors.
The beauty of using tokens for a capital raise is that anyone can invest, not only accredited investors. With more investors invested in the projects, more capital can be raised. And hopefully, more interest will also translate to more users when the product launches.
The tokens issued in an ICO can have different purposes. They may give the right to use the company’s products or services, vote on important company decisions, or receive a share of the company’s profits. They can also be traded on cryptocurrency exchanges, allowing their value to increase or decrease based on market demand.
One of the main advantages of ICOs is the ability to reduce investment barriers and democratize investing. Unlike traditional startup financing, ICOs allow anyone with access to the internet to invest in a company or project. It doesn’t matter where they are or how much money they have to invest. This opens up a wider pool of potential investors, which can increase the chances of success for early-stage ventures.
Another advantage of ICOs is the speed and efficiency of the fundraising process. Issuing tokens makes the whole process quickly and easily, without needing lengthy negotiations. It reduces paperwork, time, and legal hours. This can result in lower capital costs for the company, freeing up resources for other important aspects of the business.
Finally, ICOs have the potential to raise more money than other forms of crowdfunding. With no upper limit on the amount a founder can raise, raising the necessary funds becomes more attainable. This can be especially beneficial for companies with a big vision that requires a lot of capital.
While ICOs have many advantages, there are also dangers. One of the main challenges is the lack of regulation. Investors may hesitate to invest, and rightly so after the 2017 ICO boom. Not only do unregulated projects make investors wary, it leads to a lack of comprehensive investment information. This makes it difficult for investors to make informed decisions, even if they’re truly interested. The increased risk associated with investing in ICOs can really cripple promising new projects.
Another disadvantage of ICOs is the potential for capital misallocation. There is a higher risk of companies using the funds for purposes other than those in the whitepaper. Or, even if they intend well, founders may not know how to use the capital efficiently. This can cause financial losses for investors and undermine confidence in the ICO market as a whole.
ICOs are also known for their high volatility. The value of digital tokens can fluctuate rapidly, making it difficult for investors to accurately value their investments. Finally, there are limited controls in place to ensure that ICOs are conducted in a responsible and ethical manner. This can result in a lack of trust in the ICO market, further undermining confidence in this new fundraising mechanism.
The regulatory response to ICOs has varied globally. Some countries see the value of tokenized investing. Others are reluctant to approve such a new and untested trend.
In China and South Korea, it’s not surprising that ICOs have been banned outright. But countries like Singapore and Switzerland are more open to the concept. They’re focusing on creating a supportive environment for ICOs and other blockchain technologies.
In the EU and the United States, regulatory agencies initially published warning notices. They wanted both investors and founders to know that securities laws could apply. There was also a push to implement a requirement for new asset registration.
The EU is working on regulating ICOs through a proposed regulation on markets in crypto-assets (MiCA regulation). This legislation will try to provide a harmonized framework for regulating but allowing ICOs across the EU. Some EU Member States are also implementing regulatory sandboxes. These provide a safe and controlled environment for companies to test their ICOs.
The EU’s MiCA decision will likely lay the regulatory foundation for digital assets both in the EU and possibly the world. The bill has been delayed from February 2023 to April, but many people believe a positive vote is coming. The delay allows EU-based crypto businesses to prepare for the upcoming regulatory changes, giving them more breathing room.
The MiCA regulation seeks to establish a licensing regime for exchanges and wallet providers, and ensure that stablecoin issuers have sufficient reserves to back redemptions. Meanwhile, NFTs and DeFi have been deliberately excluded from MiCA's remit, with further investigations and activities to follow.
The delay of the MiCA bill also impacts the entry into force of the Transfer of Funds Regulation (TFR), which focuses on tracing and blocking suspicious on-chain transactions. The final vote on TFR has also been pushed back to April.
An earlier version of the MiCA bill had proposed banning proof-of-work-based digital assets, including bitcoin. But this provision was eventually scrapped in March 2022. Since MiCA is expected to provide consumer protections and environmental safeguards, the EU will likely take steps towards the legalization, which will be a boon for the crypto industry.
