Initial Coin Offerings have come to be the buzzword for crowdfunding by companies across the world, with many wanting to cash in on the euphoric rise behind the speculative market of digital currency. With the possibility of exploring a new method for piquing interest in a company’s potential come challenges for enticing investors to understand and invest in the market of ICOs.
Here, we look at some concerns that an investor would require directing attention to before making the decision to invest in a company’s ICO stock:
The Nature of the ICO
A primary difference between an Initial Public Offering and an Initial Coin Offering is the nature of the nature of the investment asset and the rights carried in its ownership. In an initial public offering of equity stock, companies issue securities to public investors which represent an ownership interest in the company and by nature entail voting and dividend rights depending upon the class of equity shares. Essentially, investors in an IPO acquire ownership in the company itself. An initial coin offering, however, is not geared towards monetising the ownership interest in a firm through its sale to a varied set of interested investors. ICOs are a mechanism for blockchain startups to monetise their product/asset by offering “coins” or digital tokens to buyers which enable them to use the blockchain platform established by them with the coins as valid currency for transactions. A popular example of this is Dmarket, a blockchain based database which allows gamers to buy and sell virtual assets across gaming platforms by establishing a decentralised repository (their product). Interested gamers would then purchase the digital currency offered by the market to be used for entering into transactions on this platform. Therefore, ICOs generally involve the development of a product based on blockchain technology which has an essential or innovative use for customers and use ICOs to crowdfund its development and use.
For a lucrative investment, it is essential for a potential investor to understand the product and the possibility of its use depending upon its unique service. Essentially, ICO tokens can be understood as the rights to a licence that gives buyers the ability to use a particular application or participate in a network. The market for an ICO token constitutes those interested in purchasing the licence to the product offered and/or those who spot an investment opportunity due to a vibrant market of interested investors. The Whitepaper of the ICO can serve as the reference to understand the nature of the offering.
Public offerings are characterised by the dissemination of information through an offer document or a prospectus, which acts as the information utility to bridge the gap between the company raising funds and a public investor. The public investor’s primary data room and blueprint of the offer which enables decision-making is this document. This traditional method serves a central function of stock trading which can address issues in an initial coin offering just as sufficiently.
In a public offer of equity shares, many unsophisticated investors overlook the relevance of this document and rely upon the market standing and speculative potential of a corporation to make the decision to invest in its IPO, which is ill-advised. It is even more so in the case of ICOs, where the nature of the product forms a seminal basis for determining its potential and its market size. The knowledge of credential of the innovation behind the product, the innovators’ blueprint for future growth and use of proceeds of the ICO, the value of assets underlying the investment amongst a multitude of information about the offering is of essence to the investment decision and is voluntarily offered by Coin Offerers in an unregulated space, which must be effectively utilised by consumers. The motivation for going for an ICO in the first place and its necessity with respect to the business model of the offeror, as opposed to a general public offering of stock, is also an essential factor which can be understood from the Whitepaper of the ICO.
Existing Market Competition
Essentially, all ICOs are based on the use of blockchain technology to solve or enable a new function by the use of its secure and instantaneous transfer mechanism to transmit or store data and value. The idea of the startup, essentially, is where and how the technology will be put to use to solve an existing commercial problem. Digital currencies are offered when they are able to innovate upon prior solutions offered by existing market coins or entail a new service altogether.
Before making the decision to invest in any given ICO, it would be well advised to analyse the market conditions for the digital coins with the specific focus on the degree of innovation brought by them in relation to tokens existing in the market. The technology or the use of blockchain by a company going for an ICO must be sufficiently differentiable and provide a unique or improved service in relation to its existing market’s players to constitute a relevant market for itself which would enable interest in the commodity away from existing coins. Additionally, doing prior market research on how competitors have fared in the market can be insightful in knowing the manner and time of investing in a blockchain, and whether to invest in it at all. The demand for the offered application of blockchain in the market forms an imperative component in undertaking the investment, and the rise/demise of existing parallels can be useful in determining the success of the proposed offer.
Prior Institutional Backing
Initial public offerings by start-up enterprises are regulated by a similar requirement in many jurisdictions, that of institutional backing or pre-existing high net worth investors. A similar pattern is followed in India where the eligibility norms for these new start-up enterprises mandate certain prior investors in the company (be they Alternate Investment Funds, financial institutions, mutual funds etc.) whose shareholding is locked in for a certain duration until after the initial public offering. Similarly, in the U.K’s Alternate Investment Market for startups, which is generally regarded as the smoothest and most successful startup exchange, institutional investment of some sort is mandatory before listing the company.
The rationale behind the prior investor rule is to ensure that the company is controlled by experienced and proficient individuals/corporations that would run it in the best possible manner to increase returns. The rule also instils confidence in potential investors who have followed prior successful investments by these institutions and can rely upon their decision to invest in the given ICO. Although ICOs do not currently implicate any mandatory regulation on the required shareholding pattern or lock-ins, it is useful for investors to look towards the general pattern of shareholding in the company and acquire some knowledge about the history and development story of the given offeror.
Focus on Marketing and Media Reception
ICOs have been characterised as a new era of innovative crowdfunding in the millennium, with an appreciation for a larger outreach than venture capital funding and increased access to the types of investors it caters to. Naturally, the number of attempts at crowdfunding through ICOs has seen a euphoric rise since 2017, when the market began flooding with news of newer services at regular intervals and the drive to cash-in on the technology was at all an all-time high.
The vibrant environment can prove beneficial to companies attempting ICOs in the current marketplace, and companies that are able to understand their core market and build a reputation for their product or service before the ICO would be well-equipped to succeed in capitalising on this demand. A well-campaigned ICO is also advantageous for investors looking to purchase ICO tokens for its uses and those who foresee a high demand for them since demand would ensure prices are buoyant for selling these tokens at a later stage. A large part of digital asset value is based on speculation, similar to the principles of the secondary market for stocks, i.e. exchanges, which means that word-of-mouth and greater perceived interest and market presence are necessary pre-requisites for a larger turnout at the issue stage. Investors should keep a close watch on the media attention and opinions offered by legitimate sources on the ICO since they would be in a position to shape public demand for the product and ultimately, the value of the digital asset.
The above-mentioned factors are some crucial considerations worth examining before choosing to invest in the initial coin offering of a nascent blockchain startup. A multitude of variables can affect the expected value of digital tokens such as the current opinions around the market of digital assets, anticipated regulation across jurisdictions, speculation based on visible investors in the market and news of security breaches amongst others. Yet, a successfully planned ICO investment is not impossible and can be grounded in certain traditional metrics to gauge the returns on an offeror’s product. Early investors are well positioned in time to identify viable ICOs and those who do so would be able to multiply their returns based on the bullish market conditions prevailing around crypto-applications at this time.
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Disclaimer: Trading in cryptocurrencies is subject to market, technical and legal risks. Prices in India vary from international prices due to local demand and supply. This article is for user’s knowledge. Please don’t consider this as any investment advice.