ICO or Initial coin offering is a novel method of raising capital for a venture through cryptocurrency by issuing of tokens. Though in existence from 2013, it became popular in 2017 by the success of the Ethereum ICO that successfully established Ethereum as a potential alternative to Bitcoin.
Let us take a simple example. Somebody wants to start the business of providing laundry services through an app and needs to raise money. He has two choices. He can go to a bank or a venture capitalist and raise money or release an ICO. The advantage of ICO is that it operates outside the boundary of standard regulatory frameworks of raising money and hence the entrepreneur does not need to go through the tedious paperwork.
Now that the entrepreneur has decided to go through an ICO, he creates a token or a new coin say laundrycoin and offers it to the bitcoin community against an established cryptocurrency like bitcoin. Now the community has to be convinced that laundrycoin in future would become a very successful cryptocurrency and hence they would have to be agreeable to part with their precious bitcoins. This is what Ethereum had done and became another strong cryptocurrency. However in ICO you do not get a share of the company concerned unlike in IPO.
This is a very simple explanation of an ICO. To understand ICO further let us first understand what is a token. A token is a representation of certain rights in a particular blockchain ecosystem. A token is developed as a layer on the top of the cryptocurrency to invoke certain rights that can be purchased by using cryptocurrency. Tokens may be of two types, Security Tokens that need to pass the Howey Test and have power to participate in external tradable assets and hence come under Government regulations or an Utility Token that gives certain rights in a blockchain network.
Now the company releases a fixed amount of tokens and markets the same aggressively on the web to create attention and intention to buy on the web. The token prices fluctuate based on normal demand and supply rules.
The major advantage of ICO is that it is a relatively uncomplicated method of raising capital. It encourages developers to come up with innovative projects and raise capital. The fact that in the last two years approximately $15 billion was raised through ICO is a testament to the popularity of this method. ICOs create a bonding within the blockchain community and create a healthy development environment.
The major downside of ICOs is that a significant number have failed within four to six months of their inception. Also this booming market has attracted scamsters who create dummy projects to raise capital. This has prompted regulatory agencies like SEC to step in and create regulations to bring about controls in the use of ICOs.