What is an ICO and Why It Matters To You

There is a sea change occurring in how the world invests, and it surrounds the world of crypto currencies. If you aren’t familiar with “initial coin offerings” or ICOs, then here is a basic definition. An ICO is a form of capital raise based on creation of coins or “tokens” that are a cryto currency tied to the activity of a business.

This funding mechanism allows businesses to bypass the existing structure of raising money through venture capital (VC) investors. This is a really big deal. Because now, ordinary people can participate in early stage funding for promising ventures. It is where some of the greatest risk is, however it is also where some of the greatest reward is.

Yes, I understand the argument that if you are not a “savvy” investor (the official term is “accredited”) then you may get taken advantage of. In my opinion, you don’t solve that problem by putting up regulatory barriers that exclude all but the highest net worth individuals from participating. If you regulate, then you require businesses raising capital to fully disclose the investment and punish the companies that fail to do so. Unfortunately, that’s not how it works today. But I digress…

The Worm Has Turned

In the third quarter of this year, ICOs raised more capital globally than VCs. That is a big deal, because what it means is around the world, every day citizens of any size net worth helped raise more capital for businesses than the protected class of accredited investors and VC firms.

Can you say “leveling the playing field”?

Today, a blue-collar worker in Europe and Central America can invest $100 in an ICO with the opportunity to turn that into $1,000. Or $10,000. That’s live changing stuff for them. And this is one way how Financial Technology is changing the world. Now of course, there are some protectionist barriers being thrown up by regulators in order to protect the status quo. That is happening primarily in the United States.

In most countries, ICOs are not regulated much if at all. While that may not be ideal, it’s better than what is happening in the US.  Because of existing financial regulation surrounding the Patriot Act, and especially the Foreign Account Tax Compliance Act (FATCA), ICOs in most countries ban US citizens from participating. Well, we’ll hold our own ICOs then right?

Not so fast. This summer, the SEC stepped into the cryto world and issued “guidance” on US based ICOs. In general, here is what they said. Coins or tokens issues in ICOs fall under one of two categories:

The first is a “security” based token – where the token provides either ownership of equity in the company (this makes sense) or investors in the token can expect the token to appreciate significantly in value (this does not make sense).  Of course security based ICOs require full registration with the SEC and are limited to accredited investors.  It looks to me like protecting the status quo, where only those with money get to make lots more of it. But, I digress again…

The second type is a “utility” based token – when the token usage generates ongoing business activity. An example is Civic, a token that is used to build a secure identity on a blockchain/DLT.  The use of the token is part of the business activity.

Now, there is a third type of token that is strangely absent from the SEC “guidance.” That is a token designed to be money. Maybe it isn’t specifically mentioned because the government doesn’t want to acknowledge that such a thing exists. Lack of guidance in this area is probably a good thing, because I don’t think I’d like what they come up with. It does however, make it interesting for those like myself, who are working to develop a local currency system based on issuance of digital tokens.

The challenge is to create our token in a way that the token derives most of its value from its utility/usage, vs. the value increasing simply because people exchange other forms of money (crypto or fiat) for it and increasing demand for it. Without going into a lot of detail, this is possible using “smart contracts” – literal code written into the token itself that directs certain functions to be performed when it is used/spent. As such, you can program utility value right into your token.

Welcome to the new world of money.

  • Utility tokens.
  • Security tokens.
  • Money tokens.

It is taking shape all around you. What is exciting is, we now have an opportunity to literally rewrite (code) the rules by which we transact with one another, and by so doing change the value system that money promotes. It really is world changing stuff, and you can be right in the middle of it.

Cool huh?