How do initial coin offerings work? In this blog post we look at initial coin offerings: what they are, how they work, and the things to bear in mind if you’re intending to launch an ICO that raises funds and does your reputation good.
Initial coin offerings or initial currency offerings (ICOs) have exploded in popularity in the last couple of years. It’s not entirely clear whether this is because of the omnipresence of cryptocurrencies in the media or the fact that ICOs make it easier for contributors to support a project – but they’re certainly on the radar of people and organisations looking to harness the latest technology to raise funds from a larger circle of potential investors.
ICOs are also on the radar of regulators and critics worried about the potential for fraud and hacking. The Wikipedia article on ICOs, for example, paints a very black, and one-sided, picture. As always in these cases, there’s truth on both sides. In this blog we want to shed some light on the controversy and briefly explain how with care, savvy and the support of people with experience in the blockchain space, there’s no reason why you can’t stage an ICO in Switzerland that achieves the aim of raising funds while maintaining or even boosting your reputation.
The nuts and bolts
At this point readers who aren’t cypherpunks, or who are relative newbies to the blockchain space, might appreciate a few brief definitions.
Basically, an ICO (initial coin offering or initial currency offering) is an instrument that combines crowdfunding and blockchain technologies.
Crowdfunding is a form of alternative finance where small amounts of money are raised from a large number of people.
Blockchain technology enables transactions to be verified, executed and recorded without the need for a central authority (such as a bank). Basically it involves linking together blocks of data (for example transactions where people are buying and selling bitcoins) to form a database, which is considered public because it’s shared with hundreds or even thousands of computers. Any changes made to the public database need to be verified by more than 51% of the computers on the network. The fact that a single institution doesn’t control all the nodes means that the blockchain is decentralised and thus more secure than a database owned by a unique entity. It’s very difficult to hack because that would mean taking control of 51% of the computers at the same time. Many people associate blockchains with cryptocurrencies such as bitcoin or ether. But the exciting thing is that a blockchain can keep track of much more than just transactional data. It could be virtually anything, for example a car or an electricity bill.
To do this you need to create a so-called token to represent the value of the thing you want to work with on the blockchain. Tokens can’t be applied directly to the blockchain (blockchains can typically only process transactions of their own cryptocurrency) but must be processed using an application called a smart contract, a piece of computer code that can automatically process transactions. These transactions are triggered only when the right conditions are met (for example “WHEN Sue pays 100 Ether into the smart contract, THEN Sarah’s share token is sent to Sue”). Smart contracts use blockchain technology, so their conditions can’t be changed.
Back to ICOs
If you want more detail on how these technologies are combined to stage an initial coin offering, read our article called "How do ICOs work? – launching your ICO in Switzerland".
To cut a long story short, ICOs are already taking advantage of smart contracts and blockchain technology to crowdfund projects. They’re like a blockchain version of Kickstarter, with the big difference (and advantage) that they automate the entire crowdsale process in a secure, trustless way. Thanks to the ease of getting involved in an ICO – and the fact that you see the results of your investment in real time – people who might not have considered investing before can do so. The ICO model allows worldwide participation, so given the proper conditions the investor market is a lot bigger than companies looking for financing may have realised.
In the wake of the first ICO held by Mastercoin back in 2013, there have been many successful ICOs, some of which have raised billions of dollars.
How do you make sure your ICO is successful – in financial and reputational terms
What do you have to look out for to make your ICO a success? Here’s a brief (and by no means exhaustive) checklist.
- Choose the right base and be aware of the rules in that country
Six of the biggest ICOs since 2016 have been staged in Switzerland. Given that ‘crypto nation’ Switzerland has positioned itself as one of the leading ICO hubs in the world by creating a favourable ecosystem for blockchain technology and cryptocurrencies, this is probably no accident. The legislative and regulatory authorities are vigilant but sympathetic. Even though Swiss law is favourable to ICOs, however, it’s important to consider the full range of legal and regulatory factors when planning an ICO in Switzerland.
One important point to think about in this context is whether or not the tokens you create as part of your ICO will be treated as securities by the regulator (more in our article).
- Be aware of the alternative platforms and cryptocurrencies and their relative strengths and weaknesses
Projects like DAO or Filecoin have used the Ethereum network to organise their ICOs. However, there are Ethereum alternatives out there. One of them is EOS, a new, as yet unfinished, blockchain project that aims to build a robust network capable of processing millions of transactions a second (solving the scalability problems of slower alternatives such as Ethereum, which can handle only 15 per second). Another ambitious contender vying for the No. 1 spot is NEO, a Chinese cryptocurrency which has gained a lot of ground on Ethereum. It’s popular in the developer community because it supports multiple programming languages, it’s fast, and it works with two different coins (more about the differences between these options in our article).
- Think the details through and explain them clearly to the community
This means, for example, deciding if a separate blockchain is needed to create your cryptocurrency. Making a cryptocurrency with a separate blockchain requires more funding and time. If a separate blockchain isn’t needed, a token can be created instead in the form of an app running on an existing blockchain such as Ethereum or NEO.
When you create a cryptocurrency you should be clear about the idea behind it and how it’s different from existing solutions. You should consider what programming languages your developers will have to be proficient in, and whether their work will involve creating a smart contract (which will be the case if you’re organising an ICO to crowdfund).
It’s a very good idea to get your code audited by professionals to avoid security issues and hacks that could wreck your project.
And it helps a lot to produce a clear, concise and informative white paper summarising the project and answering any questions a potential contributor might have. Maybe get this information translated into different languages to increase the global appeal of your ICO.
- Choose smart options for publicising your ICO
Google, Facebook, Mailchimp and Twitter have already banned ICO advertisements. Luckily they’re not the only, or even the best, options for getting your ICO known in the community. Platforms such as LinkedIn, Reddit and Telegram might be a much more suitable route to cryptocurrency enthusiasts, provided you take account of precisely what kinds of promotion each platform does and doesn’t allow.
We’ve tried to demystify ICOs and explain how they can be made to work. As already mentioned, our article "How do ICOs work? – launching your ICO in Switzerland", goes into more detail and is well worth checking out if you want to familiarise yourself with the ICO space. Ultimately, however, the success of your ICO will depend on the interplay of a whole range of technical, tax, legal and regulatory details, plus your ability to communicate your proposition clearly, accurately and sympathetically. These are precisely our areas of expertise. Feel free to contact us for a more in-depth conversation.