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Everything You Need to Know About Initial Coin Offerings

U.S. News & World Report - Money logo U.S. News & World Report - Money 11/29/2017 Lou Carlozo
BRUSSELS, BELGIUM - MARCH 9, 2017 : Golden Bitcoins.: ICOs, which operate on the same platform as bitcoin, make people very wealthy in no time. © (Getty Images) ICOs, which operate on the same platform as bitcoin, make people very wealthy in no time.

You don't need to know much about investing and finance to grasp that pro boxers make money by bashing each other's brains in. Perhaps they pull down lots of lucre from endorsements, too. Floyd "Money" Mayweather Jr. does both – he's reportedly worth a half billion dollars – but in the same month he defeated Conor McGregor to go a historic 50-0, he scored another TKO by ICO, as in initial coin offering.

In August, Mayweather hit Instagram to promote Stox, known officially as "a blockchain-based prediction market." Sold in similar fashion to initial public offering, the ICO for Stox raised 134,000 in etherium coins. That's $30 million in a little more than six hours.

What is an initial coin offering? Now if all this digital-finance jargon leaves you punch drunk, here's the gist: ICOs, which operate on the same platform as the cryptocurrency bitcoin, make people incredibly wealthy incredibly fast. How fast? In the time it takes to boil an egg, the Stox ICO raised $1 million: 12 minutes versus the more than 12 years it takes for the vast majority of American households to earn as much.

[See: 7 of the Best Stocks to Buy for 2018.]

The performance of Stox, however, is downright tortoise velocity compared to Brave. In May, it raised $35 million in 30 seconds to fund its upstart web browser, created by Mozilla co-founder Brendan Eich.

"The most important takeaway from all of this is the fact that there is a new way to raise capital and it is one that will prove incredibly disruptive to all capital markets," says Sheri Kaiserman, securities managing director and head of advanced securities at Wedbush.

Thus the ICO isn't selling, say, a new version of the dollar, pound or peso. It works like a digital-platform version of a capital raise for a startup. Despite its catchy name, the ICO is more of an IOVC: initial offering via cryptocurrency.

How does an ICO work? As for how an ICO works, it's important first to understand the milieu where it plays out. In the world of bitcoin and the like, central banks aren't needed as intermediaries for the exchange of money: It happens on a peer-to-peer level, with the transactions recorded on a digital public ledger known as blockchain. Think of cryptocurrencies as a train, and blockchain the rails it rides on.

This brings us to the discussion of tokens – which, speaking of trains, heretofore held the most value for subway riders. It turns out in the ICO world, tokens represent a major building block for the ICO. As Kaiserman puts it, "To be successful, it should first be absolutely clear that a token is needed for this business."

The term "cryptocurrency token offering" is another way of saying ICO. Users of a proposed service such as Stox or Brave – the ICO investors – buy tokens as a way to fund coders to create the new technology, or a digital piece of the action.

If all works according to plan, the coders deliver, their creation goes live, users flock to it and the tokens go way up in price. It's a very tech-falutin' way of getting to "Eureka!" though in this case, you might have better luck with a pack mule and a pick axe.

"The risk is very real," says Micah Spruill, managing partner of Atlanta-based Aurora Consulting, a blockchain startup advisory and consulting firm. "I would equate the risks to those of investing in startups as a venture capitalist – though I'd say some of these projects are so fundamentally flawed that they would never even make it into a meeting with a VC."

Why are initial coin offerings popular? Yet given the hype surrounding ICOs, it's not hard to imagine investors hurrying to get in, and entrepreneurs hurrying to get something out.

"Unfortunately, it appears relatively easy to set up an ICO, as many are doing it and some only have a white paper describing an idea," Kaiserman says.

"In the case of many ICOs, the tokens and networks may still be in a pre-alpha phase, meaning there's significant development and deployment risk for investors," says Matthew Gertler, senior analyst and counsel at Digital Asset Research, a provider of equity analyst-style research on various cryptocurrency plays.

Then there are the legal concerns, which aren't exactly trivial.

"One difficulty with setting up an ICO is complying with the applicable laws and regulations," Gertler says. "These include securities laws and financial crimes laws in all relevant jurisdictions. It's not always clear which rules apply and the industry would benefit from greater guidance from legislators and regulators."

In the meantime, know this: Someone can set up an ICO and skip the regulatory steps mandated by the Securities and Exchange Commission.

"In terms of a typical person, I doubt my beloved aunt would be able to set up an ICO, but doing so requires putting together a business plan or even the simplest elevator pitch to sell to potential investors," says Edward Stringham, president of the American Institute of Economic Research and a professor at Trinity College in Hartford.

"Many companies don't even have the product yet, but seek outside investors to help make it possible," Stringham says. "So without resources or a track record, the successful ICO depends on convincing investors to take a shot with an enterprise."

And so we come to the "Eureka!" moment of this article. The ICO truly represents a gold rush for the times. Some will strike prodigious pay dirt, while others buy the rights to empty mines or chase fool's gold that will never pan out.

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"The market," Stringham says, "is still new and still in its Wild West days."

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