Initial coin offerings are all the rage. Many companies have raised nearly $1.5 billion via the novel fundraising mechanism just this year. Celebrities from Floyd Mayweather to Paris Hilton have jumped around the hype train. But don’t feel bad if you’re still wondering: precisely what the hell is an ICO?
The acronym probably sounds familiar, and that’s on purpose-an ICO does indeed work similarly with an initial public offering. As opposed to offering shares in the company, though, a strong is instead offering digital assets called “tokens.”
A token sale is like a crowdfunding campaign, except it uses the technology behind Bitcoin to ensure transactions. Oh, and tokens aren’t just stand-ins for stock-they can be set up in order that instead of a share of the company, holders get services, like cloud space for storing, for instance. Below, we run on the increasingly popular practice of launching an ICO along with its potential to upset business as we know it.
Let’s start with VTC, the most common token system. Bitcoin and also other digital currencies are derived from blockchains-cryptographic ledgers that record every transaction conducted using Bitcoin tokens (see “Why Bitcoin Might Be Much Greater than a Currency”). Individual computers all over the world, connected online, verify each transaction using open-source software. A few of those computers, called miners, compete to solve a computationally intensive cryptographic puzzle and earn the opportunity to add “blocks” of verified transactions towards the chain. For work, the miners get tokens-bitcoins-in exchange.
Blockchains need miners to operate, and tokens will be the economic incentive to mine. Some tokens are constructed on top of new versions of Bitcoin’s blockchain that have been modified for some reason-these include Litecoin and ZCash. Ethereum, a popular blockchain for companies launching ICOs, is a newer, separate technology from Bitcoin, whose token is referred to as Ether. It’s even possible to build brand-new tokens in addition to Ethereum’s blockchain.
But advocates of blockchain technology say the potency of tokens goes past merely inventing new currencies from thin air. Bitcoin eliminates the demand for a trusted central authority to mediate the exchange of value-a charge card company or possibly a central bank, say. Theoretically, which can be achieved for other activities, too.
Take cloud storage, as an example. Several companies are building blockchains to facilitate the peer-to-peer selling and buying of space for storage, one which could challenge conventional providers like Dropbox and Amazon. The tokens in cases like this are the method of payment for storage. A blockchain verifies the transactions between buyers and sellers and serves as a record in their legitimacy. How exactly this works depends on the project. In Filecoin, which broke records recently by raising over $250 million via an ICO, miners would earn tokens by supplying storage or retrieving stored data for users.
Among the first ICOs to produce a big splash happened in May 2016 together with the Decentralized Autonomous Organization-aka, the DAO-which was essentially a decentralized venture fund built on Ethereum. Investors can use the DAO’s tokens to cast votes concerning how to disburse funds, and any profits were supposed to return to the stakeholders. Unfortunately for all involved, a hacker exploited a vulnerability in Ethereum’s design to steal tens of huge amounts of money in digital currency (see “$80 Million Hack Shows the risks of Programmable Money”).
Some people think ICOs might lead to new, exotic ways of building a company. If a cloud storage outfit like Filecoin would suddenly skyrocket in popularity, by way of example, it will enrich anyone who holds or mines the token, instead of a set band of the company’s executives and employees. This would be a “decentralized” enterprise, says Peter Van Valkenburgh, director of research at Coin Center, a nonprofit research and advocacy group focused entirely on policy issues surrounding blockchain technology.
Someone has to build the blockchain, issue the tokens, and maintain some software, though. In order to kickstart a fresh operation, entrepreneurs can pre-allocate tokens on their own along with their developers. And they can use ICOs to market tokens to people considering using the new service when it launches, or in speculating as to the future value of the service. If the price of the tokens rises, everybody wins.
With the hype around Bitcoin as well as other cryptocurrencies, demand has been extremely high for a few of the tokens showing up in the market lately. A small sampling of the projects that vtco1n raised millions via ICOs recently contains a Web browser aimed at eliminating intermediaries in digital advertising, a decentralized prediction market, and a blockchain-based marketplace for insurers and insurance brokers.
Still, the future of the token marketplace is highly uncertain, because government regulators continue to be trying to puzzle out the way to address it. Complicating things is that some tokens are more much like the basis of traditional buyer-seller relationships, like Filecoin, and some, such as the DAO tokens, seem a lot more like stocks. In July, the United states Securities and Exchange Commission claimed that DAO tokens were indeed securities, and this any tokens that function like securities will probably be regulated therefore. A week ago, the SEC warned investors to take into consideration ICO scams. This week, China went to date with regards to ban ICOs, as well as other governments could follow suit.
The scene does seem ripe for swindles and vaporware. Many of the companies launching ICOs haven’t produced anything over a technical whitepaper describing an understanding that may not pan out.
But Van Valkenburgh argues that it’s okay in the event the ICO boom can be a bubble. Despite the silliness of your dot-com era, he says, from it came “funding and excitement and human capital development that ultimately resulted in the big wave of Internet innovation” we enjoy today.