Understand ICO, STO and IEO
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On the listed equity market, in the image of IPO (Initial Public Offering or what it’s called an equity issue for a company listing on the stock exchange), an ICO (Initial Coin Offering) corresponds to an entry of a digital token on the primary market. Even before setting up the promised service, at the very start of the project, the right of use is therefore sold in advance through the issued token. In this way, an entrepreneur can raise funds by selling in advance a future right of use.
Therefore, we can distinguish 2 different types of stakeholder for that kind of operation :
- a/ The project’s contributors who are rewarded through the token and the projects’ founders who keep a share of the tokens and who obviously get a business valuation
- The investors (who acquire the token in the quest of capital gains) and also consumers (they often play both roles) who buy a future ‘utility’.
A financing through an ICO intuitively applies more to the ‘services economy’, without being restrictive.
We have to however note that ICO is not a prerequisite for a successful blockchain project.
For history, the first ICO took place in July 2013 with Omni (‘open-source’ platform), which was followed in 2014 by the famous Ethereum ICO USD18 million project.
It was in 2017 that ICOs emerged with increasingly raised funds, thanks to an enthusiasm drawn by the strong gains of Bitcoin and other crypto- currencies prices. In 2017, starting from USD 64 million distributed among ten projects in April, to USD 1.5 billion distributed among 197 different projects in December, the number of ICOs and the raised funds increased rapidly. According to Coindesk, at the end of 2017, the success of the blockchain projects was so strong that funds raised through ICOs greatly surpassed that raised through the traditional way (venture capital) with (USD797 million compared to USD235 million).
NUMBER OF ICOs and MONTHLY AMOUNT RAISED – 2017- 2018
Following the sharp Bitcoin price drop during the first half of 2018, obviously, amounts raised in the second half decreased dramatically too with an average funding raised per operation close to UDS 3.3 million. However, the number of transactions remained high (see the chart – source Coindesk- Techcrunch), which shows the blockchain world dynamism.
An ICO includes its own key features that distinguish it from other traditional financing :
- Free circulation of tokens enables the market to directly value the associated use function
- Financing through an ICO allows to raise funds for projects that might probably never have seen the light of day through traditional financing channels and investors to intervene on stories they might not have access to. So, this type of financing (ICOs) are a virtual unfiltered form of Crowdfunding pushed to the extreme, but through its own ‘platform’ for each project carries, without any aggregator, and so; without any centralized interference.
- ‘Peer-to-peer’ access to large amounts of money reduces the barriers to entry. Lower cost access to existing ‘open source’ infrastructures fosters competition.
- Using tokens enables aligning interests in this new ecosystem.
- Finally, several existing issues inherent to capitalist business and traditional financing are avoided (conflicts of interests : between shareholders and debt creditors – let read research by Stiglitz and Weiss -1981) but some others are rising, especially the potential conflict of interest between tokens holders and consumers–users (of the same tokens).
- ICO democratises risk capital. Furthermore, the investor can also benefit from the utility of the token and can also take profit from it as a user (early adopter). The barrier between professional investors and individual token holders is removed. But it raises important questions about wise projects selection, and above all, protecting individual investors.
- Opportunities and money flooding in ICOs that multiplied in 2017 have highlighted their limits and risks. The investors projects selection and the excessive enthusiasm due to all crypto assets prices increase made obviously appear the characteristics of a bubble mechanism :
- Capitalizations surge attracted too many (too) ‘early stages’ projects to finance, projects which were insufficiently prepared
- This phase also generated an obvious overvaluation of too many projects and even pushed meaningless stories
- To the extreme, numerous scams and frauds appeared and broke out, and,
- The lack of regulation of these operations caused big disappointments
These periods never last long, the natural selectivity combined with price fall becomes one day a saving event which helps to clean up and professionalize the market.
As many scams somewhat tarnished the image of the blockchain and crypto-assets, it is needed to look at an ICO project’s financial and strategic analysis with seriousness and rationality despite the risk and uncertainties specific to high potential segments emerging projects.
Here below few analysis key points which combined :
a/ traditional analysis key points of a start-up as :
- Team composition and experience
- Business model and market addressed
- Technology competitiveness – barriers to entry
- Competitive environment
b/ specific analysis key point of an ICO start-up (with a ‘token financing’)
- Analysis of the role of the token in the Business Model
- Initial token offer : monetary policy, destruction mechanism (tokens ‘burning process’)
- Targeted operations ‘road-map’
- Use of the funds raised
- Visibility within the ecosystem and specialized media
- Building and development of a community: a community can carry the project forward in difficult times. Building up a community around the initiative is essential.
Face to ICO issues that were sometimes hard lived during the euphoria period in 2017, and some disappointments, especially because of the lacking regulation and well adapted legal status, but also because of failures and frauds for some projects during this period (one estimate that only less than 10% of the smart and robust projects survived the purge phase of 2018), is flourishing ‘asset tokenization’ on the called STO form (Security Token Offering) since 2019.
Simply said, a ‘security token’ is a digitalized and exchangeable share on a blockchain. A STO operation constitutes a first step to a larger scale financial (or real estate property) tokenization – see the article published March 31 about real asset tokenization.
The main advantage essentially lies in a connection with positive law, easier when it’s about a ‘security token’ instead of a standard crypto asset or a ‘utility token’ for example. Indeed, the nature of the rights associated with a ‘no blockchain security’ is well referenced on a legal basis. Under the French law, it is worth mentioning that through a blockchain, existing financial unlisted securities ‘peer-to-peer’ trades were authorized since 2018. This mechanism can enable increased assets liquidity and will improve the financial system’s operational efficiency, among other things thanks to the fluidity of operations and to the possible and large processing costs cutting.
Finally, let’s mention the IEOs (Initial Exchange Offering) which are growing for some time. It is about a kind of a token offering or an ICO but the operation is directly administered by a crypto platform (exchange). A facilitation (but also centralization in some extent) of the offering and information mechanism is then brought by this way.
Following the innovative and highly speculative ICO, use and development of Security Tokens through STO are representing an important step in the ‘assets tokenization’ wave. Thanks to the creation of new rights, modular and ‘peer-to-peer’ exchangeable, these new models will allow emergence of new asset types and new business models.
About the editor…
A passion : Economics, behavioural finance and emerging digital assets
Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).
He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.
Yves Maillot
Financial markets and asset management
Yves Maillot
Financial markets and asset management