The first thing anyone needs to know about ICOs is that they are no longer referred to as ICOs. You may remember the insane days of 2017 when projects with little more than a white paper raised over a million dollars in less than a day with an initial coin offering, an ICO. Some of these ICOs turned out to be downright scams while others were legitimate and the funds raised helped launch some of the most successful blockchain projects.
Today, blockchain technology is sure to make it easier to invest outside of traditional capital markets. Crypto tokens facilitate capital formation and provide incentives within blockchain networks. Token sales have become an integral part of the crypto-economic ecosystem, showing how projects are growing in importance.
About the author
Ray Mayo is the Tokenization Lead at Republic
History of the ICO
Bitcoin was the world’s first cryptocurrency and arrived in 2010 via a shadow figure, Satoshi Nakamoto. As the whitepaper went through the crowd of technocrats and entrepreneurs, it became clear to the world that this novel use of decentralized technology can unleash myriad innovations that can serve as the new foundation for the world’s financial infrastructure. The most prominent functionality at the time was Bitcoin’s ability to create a native digital currency that operated outside the confines of the reach of states. If Bitcoin could be used to incentivize activity on the network and therefore have intrinsic value, this model could be replicated.
Back in 2012, people realized that they could mint new cryptocurrencies that could be sold to raise money for their projects without the need for VC support. The best known early example of a cryptocurrency sale was Ethereum’s public token offering. Ethereum raised around $ 2.3 million in the first 12 hours. Participants paid using Bitcoin, which was the only way to access Ethereum at the time.
Since then, token offerings have become increasingly popular. 2017 was the year of ICO madness, with token sales finally arriving. There were over 400 sales during that year, up an average of $ 12.7 million. These token sales were extremely lucrative for early buyers – it was common for investors to get 10x returns. In addition, they helped cryptocurrency projects secure the funding needed to expand their operations. By June 2018, more than 15 projects had grossed over $ 100 million. The total investment in 2017 was $ 5.6 billion. The simple money backing token offers resulted in a foamy token market and generated exceptional wealth and opportunity for those who could make money at the right time.
As an unregulated market, thousands of investors were scammed during the 2017 ICO frenzy. These scams drew the ire of businesses and regulators alike. The People’s Bank of China has completely banned token sales and has banned banks from offering services for projects that use token sales to raise capital. Facebook, Google and Twitter have now blocked ICO advertising on their platform. Token sales occupied a legal gray area within the United States. The SEC implemented the Howey test to determine if a token was launched only to raise capital without providing any actual benefit within a blockchain network. People don’t like the term ICO today because it suggests a connection with going public, selling a security, and from a regulatory perspective. We are still seeing the lingering impact of these early token launches and the harsh legal impact on projects accused of violating securities laws. Ripple, the organization that launched the XRP token in 2021, is in an ongoing legal battle after allegedly selling $ 1.3 billion through an unregistered, ongoing offering of digital asset securities. The token sales business at the time was high risk and high reward in several ways.
How token sales works
In theory, you can tag anything valuable – stocks, bonds, art, gold. Starting a token and the idea of ”tokenizing” something can be done in many different ways.
Utility tokens are created to perform a specific function or to provide a function. For example, within the Ethereum network, ether is used as a gas to pay for transactions and computing power for programs that use the Ethereum blockchain. Think of these utility tokens as crypto goods. When starting a utility token, one thing must be understood in order not to trigger securities laws: The token does not represent any part of a project. As a result, they have no real intrinsic value and they have no legal protection. They have value when used in conjunction with a particular technology.
Whereas security tokens are intended as digital representations of actual financial instruments. They can represent fractions of assets such as real estate or stocks and must be traded in accordance with local securities laws. Financial services institutions use security tokens to make the markets efficient and transparent.
A newer token model is the profit sharing token, which balances the incentives of the community with the activities on the associated platform.
The central theses
Token sales have been one of the major innovations in the cryptocurrency sector. The ease with which entrepreneurs can launch tokens to obtain funding through the internet greatly reduces the barriers to accessing capital.
In recent years, token sales coupled with regulatory changes have reduced investment barriers for startups, and we see native non-blockchain projects using token models to innovate their industry. Token sales make our financial system global, open and more liquid.
In summary: Token sales …
- Are a new way for startups to raise money
- Use new technology to make capital formation easier
- Are mostly built according to the Ethereum ERC20 standard
- Are very risky, so an investor should never invest more than he can afford to lose