When Kickstarter launched in 2009, it rapidly changed how businesses obtained funding. Rather than approaching banks, institutional investors, or venture capital firms, the company could go directly to the consumer. This led to a swathe of crowdfunding platforms, many of which still exist over a decade later.
However, crowdfunding became decidedly less popular after several high-profile failures and scams. Investing directly in an unknown company with no direct accountability or experience in the market meant that people were out of pocket and disillusioned with the practice.
Despite this, the cryptocurrency boom of 2017 saw a new form of crowdfunding to support crypto launches and blockchain-based projects. These Initial Coin Offerings (ICOs) were controversial, even then, but the hype around ICOs was short-lived.
That said, you can still find some businesses with these offerings, so it's essential to consider what a cryptocurrency ICO is before you invest your hard-earned money.
What is an Initial Coin Offering?
Bitcoin is the best-known blockchain-based project. The cryptocurrency was first launched in 2009 by the creator(s) known as Satoshi Nakamoto. Since then, many other blockchain systems have come online, including Ethereum. Although there is an ETH cryptocurrency, the platform's main strength is handling smart contracts. This technology allows Initial Coin Offerings (ICO) to take place.
The ICO event is a form of crowdfunding with cryptocurrency as a reward for backers. As the blockchain is decentralised, there's no need for third-party involvement, allowing you to interact and invest directly with the company. Fittingly, the first major ICO was for Ethereum. The platform's development was funded by issuing Ether, Ethereum's value token, in return for Bitcoin.
Since then, the development of the Ethereum Virtual Machine (EVM) has allowed for the creation of smart contracts. These utilise the Ethereum blockchain but are separate from the ETH cryptocurrency. As a result, anyone can develop applications that run on the Ethereum blockchain and create contracts.
This is how many companies construct digital tokens for use in an ICO. It's also the way that the creators of the Brave Browser approached the launch of the Basic Attention Token (BAT) — a token designed to reward users for watching privacy-friendly ads.
ICO vs. IPO
In effect, investors were trading one known cryptocurrency or fiat currency for an unproven one. Although Ethereum was a resounding success, in essence, by investing in ICOs, you are gambling with your money. Traditional funding methods, like Initial Public Offerings (IPOs), are regulated and require the business involved to meet regulatory standards and be transparent with financial matters and the company's health.
Not so for ICOs. This largely unregulated space moves quickly, allowing investors to take high-risk stakes in an unknown business, but the potential reward is more significant, too. However, by the time a company reaches an IPO, there is a viable business behind it. Most ICOs are based on future potential or an idea. There may not be anything other than a brief White Paper (often a few pages of marketing) to go on in many cases.
ICOs are inherently risky as a result. In this way, they are very similar to other crowdfunding methods like Kickstarter or Indiegogo. In their heyday, both sites were extremely hands-off with projects launched on their platform. After a backlash against lost money, unfinished products, and high-profile failures, each business has added more verifications for projects and made it easier for you to assess the relative risk of investing.
The 2017 ICO bubble
Alongside a rise in the popularity of Bitcoin, ICOs were a craze in 2017. There was a 40 times increase in capital raised through ICOs compared to 2016. The unregulated market was awash with ICOs from a range of companies. Like Brave (creators of the Brave Browser) and Filecoin, some have continued a successful business. However, according to Bloomberg, 56 percent of crypto startups would fail within four months of an ICO.
With no regulator was overseeing this, ICOs were frequently used for scams and fraud nationally and internationally. Many scams used well-known celebrities to persuade less financially savvy investors to get involved. Among them were Paris Hilton, Floyd Mayweather, Gramatik, and a host of others. They were employed, paid, or incentivised with tokens to promote these ICOs to their followers and fans.
Very few businesses with celebrity endorsements were legitimate or, at least, viable. LydianCoin, favoured by Hilton, was founded by a man with a record of harassment, discrimination, and domestic violence allegations. Centra, promoted by Mayweather, employed a fictional chief executive and made claims about a partnership with Visa that didn't exist.
For his part, Gramatik tokenised himself, offering Ethereum-generated tokens in exchange for his future creative output. This launched just as ICOs were starting to get a bad name, so the musician and partner company SingularTV distanced themselves from the process, opting to call the ICO a token sale instead. The campaign page for the token launch even went as far as to say, "only participate if you don't expect anything in return."
At the time, Jordan Belfort, the trader portrayed by Leonardo DiCaprio in The Wolf of Wall Street, stated that "promoters [of ICOs] are perpetuating a massive scam of the highest order on everyone." He said that many were using "pump and dump" techniques to pique interest and then sell before the coins lost value. His statement should be taken seriously; this is a technique Belfort's firm Stratton Oakmont indulged in, which culminated in his 22-month prison term. In that sense, ICOs have become the modern form of penny stocks.
The future of ICOs
While it's still possible to find businesses hoping to raise funds via ICOs, the bubble has burst, and crypto-enthusiasts have moved onto the latest unregulated speculative asset, Non-Fungible Tokens (NFTs). Regulation exists to prevent scams, fraud, and criminal activity. Unregulated markets have some beneficial side-effects (lower prices, reduced operating costs, higher rewards), but the negatives far outweigh the positives.
More than anything, the shift in perception is what changed ICOs from a promising, exciting investment opportunity to a barely-used funding method. Once stories broke of the celebrity scams, fraudulent activity, and regular people losing substantial amounts of money, the tide turned on ICOs. Around the same time, financial regulators began a crackdown on the funding method.
Over 13 countries now have explicitly regulated ICOs, including China, the US, and some of Europe—although, notably, not the UK. Cryptocurrencies tend to attract libertarian types, so government oversight is a repellent to the leading players. Unlike cryptocurrency trading, financial institutions don't want to become entangled in this chaotic environment, especially with more straightforward, cleaner alternatives like IPOs.