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Bitcoin Explained: What's an Initial Coin Offering?

Having got to grips with “cryptocurrency” and “blockchain”, now Bitcoin enthusiasts must grapple with a new term: initial coin offering or ICO. But what does it mean?

James Gard 22 August, 2017 | 7:40AM
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Know what an initial public offering is? What about initial coin offering? ICOs, according to Pitchbook’s Evan B. Morris, allows technology start-ups to raise millions of dollars by offering early investors access to its software services. Imagine if Google in its early stages launched a digital currency to use its products – its virtual tokens would have surged in value as the company succeeded, and they would have been tradeable with other investors who would be keen to capitalise on the success of the firm.

Companies have now raised $1 billion in funding so far this year, according to research from Smith & Crown. Industry publication CoinDesk estimates that this year ICOs have outstripped venture capital (VC) funding for start-up ventures. Web giants such as Facebook, Google and Twitter relied on VC funding to raise money in the early years.

A recent example of an ICO is the Digital Developer Fund, which raised $1.85 million in July, allowing investors to receive a quarterly dividend.

Some commentators say that a successful ICO is like a popular project on crowdfunded website KickStarter given some added glamour by associating with Bitcoin mania.

What are Bitcoins?

Bitcoins are an anonymous digital currency that has surged in price from $400 to $4,000 a coin – creating fears of a bubble as new investors from over the world pile in. Bitcoins can be spent for on real-world products – Microsoft for example accepts them – but are also a speculative tool. They are a like a means of payment and an asset class combined.

The digital currency is not issued by a central bank like the Bank of England, but transactions are logged by the “blockchain”, a virtual ledger that allows users to monitor all transactions – although not who is buying or selling Bitcoins. The tokens issued by companies in an ICO also use the blockchain.

So far Bitcoin mania has generated a range of products – Bitcoins themselves, partial Bitcoins, Bitcoin cash, Bitcoin rivals such as Ethereum, and tradeable Bitcoin derivatives.

The process of participating in an ICO requires some technical knowledge and ideally some familiarity with buying Bitcoins through an exchange like Coinbase. In its simplest form, users must buy digital currency first before taking up an ICO.

In return, the investor receives a private digital key for the new token that allows access to a company’s technical services. On a simple level, they just provide access to platforms – but tokens in successful ventures become valuable and tradeable in their own right.

Morris explains the process a company must go through to reach the market: “The mechanics of an ICO involve first setting up a website and whitepaper with information about the business model and founding team. Details in the whitepaper will include the problem the platform is trying to solve, management structure, plans for development and allocation of resources.”

In conclusion, Morris says that investors should be wary of the risks involved, which are common to many tech start-ups. Many projects may be unable to implement their ambitious business models despite raising millions in funding. The US regulator the Securities and Exchange Commission has started to take an interest in cryptocurrencies after a recent high-profile scandal. And the tokens investors buy in an ICO will be closely associated with the fortunes of the companies themselves.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

James Gard  is content editor for Morningstar.co.uk