Everything you wanted to know about initial coin offerings but were afraid to ask

Photo credit: Tiger Pixel.

Raising capital as an entrepreneur is no cake walk. At its worst, it’s a grueling slog of pitching, networking, meetings, and waiting. But for blockchain-savvy startups, fundraising has never been easier – or faster – than in the current boom time.

Last week, Israeli blockchain startup Bancor raised more than US$127 million in three hours. In May, a web browser called Brave pulled in US$51 million in less than 30 seconds. Scores of other projects have seen similar success, with millions of dollars’ worth in cryptocurrency, such as bitcoin, pouring in after just a few days.

Welcome to the Wild West of ‘initial coin offerings’ or ICOs, a crowdfunding model made possible by blockchain technology.

Here’s how it works. Comparable to Kickstarter – but uniquely different – ICOs pool funds from numerous backers who are interested in a project. Funds are paid and collected on the blockchain, a distributed database powered and verified by a peer-to-peer network of computers. Support for an ICO typically comes in the form of bitcoin or ether, the cryptocurrency behind the Ethereum blockchain.

You buy a coin for 100 dollars worth in cryptocurrency and hopefully you can flip it to 200.

However, instead of promising a thank-you mug or some kind of product in exchange for cryptocurrency, ICOs give supporters digital tokens that are specially minted for the project at hand. Brave, for instance, sold Basic Attention Tokens for its web advertising system during its ICO. Messaging app Kik plans to sell Kin tokens – the company’s cryptocurrency – when it launches its token crowdsale. Depending on the success or popularity of the project, these tokens can then be resold for a higher value on secondary markets.

In that sense, they’re kind of like stocks (caveats to this analogy later), but without any legal strings – or protections – attached.

“You buy a coin for 100 dollars [worth in cryptocurrency] and hopefully you can flip it to 200. You do not really care about the underlying technology,” says Lionello Lunesu, co-founder of engineering services firm Enuma Technologies, explaining the mentality of many ICO backers.

“Of course, the better that technology, the higher chance that other people think it’s viable and therefore appreciates,” he says.

More than money

If the idea of spending tokens to buy other tokens sounds bonkers, consider ether’s meteoric rise. When Ethereum launched in 2014, bitcoin holders could buy 2,000 ether for a single bitcoin. That put ether at less than a dollar per token.

Today, the digital currency is valued at around US$330 apiece. Call it a bubble, but that’s the dream powering a lot of the craze behind ICOs. According to blockchain publication CoinDesk, ICOs have raised a whopping US$327 million so far this year. Even venture capital firms have cashed in on the action, with one raising US$10 million to invest in blockchain startups.

“Everyone’s aiming for the sky,” says Shaun Djie, co-founder of Digix Global, a Singaporean startup that tracks gold assets on the blockchain. Last March, Digix launched its own token crowdsale, hitting its goal of US$5.5 million in less than 12 hours.

The current ICO market is overheated. The valuation is way off.

Moving forward