Is an Initial Coin Offering a New Way to Raise Money?

What to do when an IPO requires too much legal work and is subject to regulation and finding a venture capital partner takes too long and is full of unknowns? Mint your own money, of course.  In this case, however, companies are minting digital coins rather than churning out physical objects.

How Do Initial Coin Offerings (ICOs) Work?

Several companies have opted for Initial Coin Offerings (ICOs) as a way to raise money.  Rather than selling equity as in a traditional IPO or venture capital raise, companies sell digital tokens that investors can use to later buy a product or a service that the company intends to offer.  Instead of receiving ownership, investors are betting that the coin’s value will increase if demand for the company’s product or service increases.  If the services become wildly popular or the products are in high demand, the coin has the potential to be sold for much greater than its purchase price.  On the other hand, if the products never make it to market or the services fall short of expectations, the coin could become worthless.  Often, the digital tokens are backed by other cryptocurrencies, such as Bitcoin.

Companies Who Have Raised Money Through an ICO

Several companies have successfully raised money through an ICO, often in an incredibly short period of time.  The wait is on to see how much return investors will realize.

• In April 2017, Gnosis, a platform for market predictions, raised $12.5 million through digital token sales. Gnosis’ tokens were backed by ether, another digital currency, and the entire supply of digital tokens was sold in under 15 minutes.
• In June 2017, Bancor’s token offering raised about $147 million in the second-largest coin-based fundraising campaign at the time. The Bancor tokens were exchanged for ether.
• Tezos (which is backed by Dynamic Ledger Solutions, Inc.), seeks to launch a new blockchain platform and currency system (tezzies). In order to raise money, Tezos offered token in exchange for either Bitcoin or ether.  Between June 1 and June 13, 2017, Tezos raised over $232 million, setting a new record for ICO fundraising.

How Safe Are ICOs?

Coin offerings can be risky for investors, however. No rules, standards, or regulations govern the world of ICOs or cryptocurrency.  A recent Wall Street Journal article suggests that ICOs are actually more akin to crowdfunding than an IPO.  Companies will frequently publish a white paper outlining plans and future ideas, but are not required to issue a prospectus.  It is possible, then, that the ICO-funded business models will not have undergone the same level of scrutiny that would be expected in a registered IPO or a competitive venture funding round.  Other risks include the relative value of the digital currency underlying ICOs – as the price of Bitcoin and ether fluctuate, the amounts that can be raised by companies also moves.

Companies have raised more than $1 billion through ICOs so far this year, 10x the amount raised in 2016.  The increased use of ICOs could result in increased attention from the SEC or other regulating bodies.  Additionally, some industry watchers are beginning to voice concerns about the creation of a coin bubble, as there are already more than 200 different types of digital currency.  In the meantime, it appears that ICOs will continue to be a viable path for certain start-ups to raise funds. For investors, though, it will be interesting to see if this market for coins and tokens comes to be defined as an investment in a security, a currency, or merely a novelty.

Related Links

• Crowded Out?
• IPO Supply and Demand
• Crowdfunding to Provide Alternative Capital Source to Early-Stage Companies
• Crowdfunding: SEC Issues an Investor Bulletin