Initial Coin Offering — The Future of Crowdfunding and Investing
Investing by the general public has been an integral part of businesses to enable them to expand their operations. In addition, it is a way people can make passive income by supporting companies or other assets so that they can grow in the future. The field of investing and how companies can fund their projects has not changed much since its formation in 1611. It still contains many of the barriers that prevent smaller companies from successfully using this system.
However, there is a new upcoming method that is changing the field of investing and crowdfunding, Initial Coin Offerings. This new system is leveraging the emerging technology of blockchain. It enables the creation of decentralized tokens on a blockchain that represent the value of the business, which people can purchase to own. What actually is the ICO process, how do tokens work, and how do they help a business attract investments?
Initial Public Offering
In order to understand what ICOs are, we need to first understand how majority of crowdfunding is done. Initial Public Offering or IPOs are a fairly popular method that is used to raise money for companies. If you have heard of investing, people might tell you to invest in company stocks. At the basic level, this is what the IPO allows the companies and the public to do.
In a company, people split the ownership of the company as shares. Shares are a part of the company an individual or organization (usually venture capital firms) own. In order to crowdfund for money, companies take some of their stock and put it out for the public to purchase and sell them. In order to understand this concept further, let us imagine we have a company called Apple and they are going to do an IPO. Let’s also suppose that have a total of 1 million shares and they are allowing 50% of their total shares to be purchased by the public. The other 50% is owned by the founders, investors, and other employees of the company. Each share is priced as per the estimated value of the company. People start to purchase the shares as they really believe that the company will grow. This allows the company to fund its investments for the growth of the company.
As the company grows in size so does its share’s value. Most people often purchase shares for their value to increase so they can sell them in the future. In addition, the shareholders get some portion of the future business profits as dividends.
Initial Coin Offering
Initial Coin Offering or ICOs are a new alternative method for crowdfunding as compared to Initial Public Offering. In this method, people can invest in the company by paying a certain amount of money. However, in this case, shares are not distributed amongst the public but stay within the company. Instead, tokens are used so people can purchase them to invest in a company’s projects. These tokens can be used to purchase products or services within the company. In this method, the company will get money through people purchasing their tokens and the people can use the tokens to buy products and services.
In this system, there is a certain amount of tokens that are available. A company may decide to allow the public to purchase all of the available tokens or keep some for themselves too. Similarly in the initial public offering, as the company grows in size so does their share’s value. People also often purchase tokens for their value to increase so they can sell them in the future. A successful ICO provides returns for an investor as the price of the token increases in value based on the growth of the company.
Supermarket Walk Throughout
In order to better understand the concept of ICOs, let’s use an example. Let’s imagine that we have a supermarket named Bob’s Market. The supermarket wants to get money to fund the creation of several other supermarket stores to add to their chain. They start the creation of their ICO in order to gain the funding to conduct their project. Let’s suppose they created a total of one million ICO tokens. In this scenario, they allow the public to potentially purchase 50% of the total ICO tokens or 500,000 ICO tokens. The investors can use these tokens to buy products or hold on to them with the hope of increased value of the tokens as the company grows.
ICOs Backend — Blockchain
Now that we understand what ICOs are and how they are used in the real world, let’s see how they work in the backend. They normally run on a token system just like cryptocurrencies.
In order to understand how the token systems for ICOs function, we need to first understand how the key technology behind them, blockchain, works.
Blockchain is a decentralized system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system. It is similar to Google Docs, where we can create a document and share it with people. When the document is shared, it is distributed instead of copied which creates a decentralized chain that gives everyone access to the document in real-time. All of the changes are available to everyone so no one can change anything without everyone knowing about it.
Blockchain is made of blocks that store information. In the case of cryptocurrencies, the blocks store transaction data. Each block also has a nonce and a hash. A hash is a signature for a block that sticks with it so it can be referred to later on. This is similar to a person’s fingerprint because it is a signature for the transaction data. The nonce is the first number a blockchain miner needs to discover before solving any block. In order for a block to be created, a process called mining happens which is where a person finds the nonce that matches the hash. Miners are the people who complete the mining process.
If you want to learn more about the Blockchain, check out this article I wrote on explaining blockchain technology in more detail.
Token
Whenever we hear of the term token, we think of cryptocurrency tokens which include Bitcoin, Etherium, etc. Tokens however are not just used as an alternative option to money, but they have much broader use. Tokens are digital assets that people can transfer to other people. This system is built on the blockchain to maintain security and privacy amongst the trading of the token.
There are various ways people develop tokens, but the most common approach is to leverage the Ethereum blockchain. Ethereum’s blockchain or “Ether” currently has a bunch of different tokens on it including Gnosis (GNO) and Augur (REP).
ICO Use Cases
There have been many successful companies and services that have used the initial coin offering process at the beginning of their growth cycle to raise funds. Some of the largest and most successful ICOs that have been used were created by Ethereum and Stratis.
Unlike Bitcoin, Ethereum is not just a cryptocurrency but also a protocol to run and develop decentralized apps via smart contracts. As the Ethereum blockchain and protocols were starting up, the developers started to fund the company by creating one of the first ICOs.
Another successful ICO was created by the company Stratis. This company created a platform to allow businesses to develop apps on the blockchain while using traditional programming languages. They also ran an ICO campaign to fund the platform which raised 1,000 BTC or worth $675,000 during the time.
While these two cases were the most successful cases of the ICO process working, there are many companies using the process to allow them to fund their projects. The number of companies that are using ICOs is growing each day as blockchain technology expands and grows.
Benefits of ICOs
The initial coin offering process has many benefits for the customers of the token as well as the business owners trying to expand their business.
Foremost, there is a low barrier to entry while trying to get into using ICOs. Its counterpart, the initial public offering process, is generally reserved for the top companies. This is due to the large amount legal systems that are in play throughout this process. This means that smaller companies that are in need of funding for their business are not able to use the IPO process effectively. ICOs create an alternative so that companies of any size can participate and raise money from enthusiasts to fund their projects. Since ICOs are on the blockchain, they are decentralized from any central authority.
Another benefit of the initial coin offering is that it creates a global network where people from anywhere around the world can use the system. This allows companies and people from across the world to benefit from this crowdfunding system. This global network also reduces the barrier to use this process as the companies are not confined to one location and can help them grow globally.
The Future of Investing and Crowdfunding
Initial Coin Offering or ICOs are growing in popularity each and every day with new companies and people trying out this crowdfunding/investing system. It is going to slowly become a very popular investing method and might even overtake IPOs in the future.
Let us review what we just learned:
Initial Coin Offering is a new alternative method for crowdfunding where people can invest in the company by purchasing tokens. These tokens can be used to purchase products or services at the company and in return provides the company with money for their projects. This investment process leverages the blockchain technology to create decentralized tokens that can be traded among people.
Initial Coin Offerings are becoming a key method for companies and people to invest/crowdfund to support their projects and this growth is expanding every day.
Nivan is a 14-year-old Artificial Intelligence developer looking to use technology to help solve problems in the world. He is currently building a company called Lemonaid which is a platform that connects teens with organizations that are in need of help with volunteer/intern recruitment. Send me an email at nivangujral@gmail.com if you would like to further discuss this article or just talk.
