ICOs – a Detailed Walkthrough

Article ICOs – a Detailed Walkthrough

ICOs a Detailed Walkthrough

What Led To The Development Of ICOs?

The proper lens within which to view ICOs is in the context of lowering the barrier to entry for the average person to gain equity-like compensation for investments in early-stage ventures - it is an evolution from crowdfunding. The world of investments has often been closed to most, especially when we’re referring to early-stage ventures. Private companies typically raise their initial rounds of funding - from seed through Series A, B, C, D, and so forth - through private investors, like angels, venture capital firms, and further through private equity firms. In all these cases, accredited investors are the major contributors to and beneficiaries of early-stage ventures and their funding. When early-stage investors contribute their funds to a company, they receive a portion of said company, expressed through shares - these private shares become public shares during IPOs, the point at which everyday investors finally get the opportunity to invest in a newly-public company via public exchanges.

For every Facebook, Microsoft, and Apple there are thousands of companies that we’ve never heard of and which have lost investors billions of dollars. In many respects, the division between accredited investors and everyday non-accredited investors was a security measure to protect those with little savings from partaking in the riskiest class of investments that could eliminate all of their holdings. This made sense in an era - like in the late 1990s - where the lifecycle from the starting of a given company to IPO took only4 years with annual revenues in the range of $20 million, and where the public capital markets had greater percentage-wise returns than the private capital markets. In such circumstances, the wait time was justified to weed out the truly risky investments. However, following both the dot-com crash of 2000 and the Financial Crisis of 2007-2008, requirements around IPOs became more stringent, which has shifted the median time-to-IPO to 11 yearssince 2014, with median annual revenues hovering at around $100 million.

The added regulation has reversed the profitability of public and private capital markets such that private capital markets now have more lucrative returns. Structurally, the act of delaying IPOs moves returns from public investors to private investors - company investment needs are time-dependent and when a vast majority of those needs are being fulfilled in the private market, there is simply less need for public market capital.To flesh this out, we first need to understand that many companies that would have done an IPO in the past are now doing late-stage private rounds. When the rounds approach $40 million, they are effectively what would have been IPOs in the past - this means that non-accredited investors are effectively losing opportunities to invest. The fact that these late-stage private rounds now exist, attracts institutional investors - pension funds, buyout funds, etc - that would have traditionally been investing in public capital marketing to invest in private capital markets. This results in less demand for public capital markets, which only worsens the opportunities for non-accredited investors. One more factor adds to this trend: the cost of creating technology companies has dropped dramatically with the introduction of cloud computing and the rise to prominence of open source software. This means there are more new companies seeking private investment rounds at the earliest stages. Ultimately, while the new regulatory environment has resulted in reduced risk for public capital market investors and, in general, more stable IPOs, it has made public capital markets a less rewarding avenue for returns.

It was very much in this post-financial crisis era that crowdfunding started picking up steam, with platforms like Kickstarter and Indiegogo trailblazing a path for this then-emerging financing model. While we could focus on the non-accredited investor aspect here, it would be wrong to not mention the blocks faced by first-time entrepreneurs who often lacked the social capital and the necessary track record to attract private funding.

The private capital market is one that prefers warm leads - referrals from existing entrepreneurs - rather than cold outreaches and more than half of the investment decisions are team-based, with a critical eye to a given team’s experience level. In this sense, it was for both first-time entrepreneurs needing funding and for non-accredited investors seeking to participate in early-stage ventures that crowdfunding emerged as an early-stage financing model through the internet. It is from this recent development in crowdfunding - and all the events that led to the existence of crowdfunding - that ICOs derive their originating impulse. The model of crowdfunding is the foundation upon which ICOs build.

What Is An ICO?

Initial Coin Offerings (ICOs) are used to raise funds for new crypto ventures in a crowdfunded manner. Modelling their name after IPOs, ICOs seek to achieve the identical goal of financing but outside of the heavily regulated capital markets that IPOs are a part of; however, it is limiting to compare ICOs to IPOs since IPOs involve non-accredited investors only several (~4-11) years after accredited investors have accumulated their shares while ICOs involve everybody - accredited and non-accredited alike - from day one. The ICO is principally used to fund the development costs of the project such that the investment floor of the amount being raised is targeted specifically to cover said costs, while the investment ceiling is designed to account for contingencies. Early backers of projects being funded through ICOs receive cryptocurrencies (that is, blockchain tokens) in exchange for fiat or other cryptocurrencies - most commonly, Bitcoin and Ether.

By virtue of how blockchain projects function, the value of the tokens that early backers acquire are tied to the popularity of the underlying protocol. The more applications that are built on the blockchain network running the protocol, the more valuable it becomes, as expressed in the market value of the token attached the protocol. Early backers are motivated to invest in the hope that the tokens they acquire during an ICO rise in value over time. Ethereum's Ether is a great example of how tokens bought during an ICO can rapidly rise in value once the project’s protocol and network are operational.

How Do ICOs Compare With Crowdfunding?

Compared to traditional capital markets, ICOs and crowdfunding are extremely similar but there are structural differences between them that derive from their underlying technology. In terms of similarities, both empower non-accredited investors to stand alongside accredited investors for early-stage venture investments. One would think that this would reduce the need for capital markets; however, their respective relationship to capital markets is the first schism between ICOs and crowdfunding.

While crowdfunding, in one sense, managed to become part of the traditional financing model, ICOs are in the process of creating something entirely separate. Extremely popular projects on crowdfunding platforms like Kickstarter and Indiegogo ended up being sought out by venture capital firms or even bought up by existing companies. For instance, Oculus Rift raised a whopping $2.4 million on Kickstarter and, within two years, was acquired by Facebook for $2 billion. This is in stark contrast to ICOs for blockchain tokens where, if successful, they create self-reinforcing economic ecosystems around the token and its core protocol. The greater the popularity of the protocol and its token, the less need there is to rely on capital markets.

The Oculus Rift example, mentioned above in the context of crowdfunding, is particularly noteworthy because it raised the issue of whether or not early backers of projects should get equity. This equity debate further set the stage for ICOs, in terms of outlining a conceptual space where there was gap that crowdfunding did not adequately fulfill. At present, there are actions being taken towards enabling equity-based crowdfunding but this is much after the initial wave of ICOs from 2013 to 2016, which set the stage for the explosion of ICOs in mid-2017 and onward. How ICOs provide equity-like rewards is related to the fundamental technological differences present in blockchain-based projects.

Joel Monegro wrote one of the first articulations of the structural differences between how value is created in blockchain-based projects, as contrasted against internet-based projects. Fundamentally, data is the core asset in the virtual world, so where data is stored determines where the value accumulates. The protocol layer (TCP/IP, HTTP, SMTP) in internet-related technologies does not store data and accordingly retains little value while the application layer (Facebook, LinkedIn, Twitter) collects massive amounts of data and therefore value. Blockchain projects, reverse this logic where the protocol layer stores data across an open and decentralized network so that the majority of the value remains within the protocol; the application layer in blockchain projects structurally has less opportunity to acquire data and therefore is less valuable from a data-centric lens. The more data that accumulates to a blockchain project’s protocol layer, the greater the corresponding value of the tokens, which is how ICOs can provide equity-like rewards. The tokens that early backers acquire in an ICO rise and fall in value according the utility, and therefore the user adoption of the underlying protocol - there is a dynamic element of future potential gains that ICOs enable, which internet-based crowdfunding originally failed to provide.

With this in mind, all of the existing crowdfunding platforms are internet-based applications that deal in fiat currencies and fit within the lifecycle of an underlying capital markets framework as a pre-VC stage of the funnel. Conversely, cryptocurrencies are blockchain-based protocols that create their own self-reinforcing economic ecosystems independent of fiat money; the tokens act as an internal currency whose value dynamically reflects the amount of data stored in a given project’s blockchain network, acting as an indicator of utility measured through usage and user adoption.

Assessing the Merits of ICOs

Before we begin this section it is important to make a delineation between the structure of blockchain tokens and the launching of new blockchain tokens through ICOs. The structural issue is central to the definition of blockchain tokens as distinct from securities and involves various interpretations of the Howey Test; however, the process of launching a new blockchain token has many criteria to assess, which are distinct from architectural elements and involve human-oriented project management aspects. In many ways, the criteria used to assess ICOs are not too different from criteria used in venture capital decision making to select investment opportunities - these two domains are united by the fact that human factors are central to early-stage projects, where success rides on the shoulders of the initial team. A relevant analogy would be the difference between the architects that design a building and the development firm that build it - while the architects are judged by the structural integrity of their blueprint, the development group is measured in human terms along a project management trajectory.

The five core pillars of analysis for ICOs - what we at CoinSmart define as a criteria for Well-Implemented Blockchain Tokens - are: (1) value proposition, (2) structure, (3) credibility, (4) transparency, and (5) third party review.

Value Propisition

  • Before we look for any other factor, we want to know why this particular token should exist - when in doubt, start with why. If there is no compelling reason - a specified use case - for the token’s existence, it is likely a security.
  • Once we know why the token should exist, we look for the features, benefits, challenges, and risks associated with its development. We should always be weighing the product features and benefits against the development challenges and risks.

(Make this tables images)

Compelling Reason Why should this token and network exist?
Network Definition What is the proposed network?
Network Use Cases How will the network be used?
Token Characteristics What features does the token have?
Token Utility How can the tokens be used by holders?
Joint Token and Network Benefits How does the system encompassed by the tokens and their network benefit users?
Development Challenges What blocks are the development team currently experiencing? Why?
Development Risks What blocks could happen in the future based on the current development trajectory? Can they be mitigated?


  • Once we knowwhy the token and its network should exist, the next immediate question is howit is going to be created. Structural elements consist of the processes central to the development of the token and its network.
Development Roadmap [Y/N]: Is there an articulated development roadmap?
Time Estimates How long will development take?
Time Lag What is the length of time between the announcement of the presale and the projected launch of the token? The longer this length of time, the greater the room for error.
Cost Estimates/td> How much will the project cost?
Expenses What factors crucial to development require ongoing/regular payments?
Stage-Based Fund Allocation [Y/N]: Has each stage of development been costed?
Milestone-Dependent Fund Access [Y/N]: Has the development team agreed that they are to use only the funds determined for each stage, where access to funds for the next stage are contingent upon the completion of the current stage?
Reporting Schedule for Token Holders [Y/N]: Is there a regular update schedule committed to by the development team?



  • As with startup ventures, the team does matter - as a matter of fact, the team alone is often half of the investment decision with early-stage startups. Establishing credibility in the new token requires articulating who is involved in the project and what their compensation is relative to their contributions.
Key Names of Launch Team Who is on the  development team? Who is advising?
Quantification of Early Contributions What was contributed by early members? What is the explicit monetary value of those contributions?
Remuneration Outline [Y/N]: Is there an outline of what the developers and advisors will be paid?
Remuneration Details What percentage of tokens is set aside for the developers and advisors?
Remuneration Fairness [Y/N]: Does the quantity of remuneration make sense for the services rendered? Should it be increased, decreased, or remain as is?
Remuneration Allocation How will the remuneration be distributed? The general preference is for vesting, where the total funds are released incrementally over time.


  • When we speak of transparency in the assessment of pre-launch blockchain tokens, we are primarily addressing three facets that the development team must communicate clearly with their broader community of  prospective users and customers, namely:
  1. Structural Transparency,
  2. Value Transparency, and
  3. Marketing Transparency.

Structural Transparency:

  • Structural transparency involves how accessible the technology base is by the broader community - genuine structural transparency enables wide participation, permits auditing, and prevents fraud.
  • The goal is to be public, open, and to use standards wherever possible.

<td[Y/N]: Is the token being launched on a public blockchain? The preference is for public over private blockchains

<Public Blockchain
Open Source Software [Y/N]: Is the source code open source? The preference is for open source over proprietary.
Consistently Updated Code Repository [Y/N]: Is there a git repository with viewable updates on a consistent basis?
Standardized Token Contracts [Y/N]: Where relevant, are known standards being used?

Transparency | Value Transparency

  • Value transparency relates to the sales process of the tokens in development. This is about articulating how many tokens are being sold, at what price, within what limits, and in what currency. Being extremely clear in this domain strengthens buyer confidence.
Maximum Number of Tokens [Y/N]: Has the maximum number of pre-launch tokens to be sold been defined? What is the rationale?
Non-Incremental Pricing Mechanism [Y/N]: Is the price stable for all token buyers at all stages of the presale?
Investment Ceiling [Y/N]: Is there an upper bound set for how much capital is to be raised? What aspects of development does this upper bound enable to be built?
Investment Floor with Return Condition [Y/N]: Is there a lower bound set for how much capital needs to be raised? Will funds be returned if this minimum threshold is not met? Is this lower bound related to the minimum costs and expenses required to be covered for the development of the project to proceed?
Single-Currency Denomination [Y/N]: Is the price for the tokens denominated in a single currency? Are there hidden arbitrage opportunities?

Transparency | Marketing Transparency

  • Marketing transparency involves making sure that the core brand promise to prospective customers is firmly centred around a message of utility rather than speculative investment.
  • Communicating this message of utility results in aligned expectations: prospective customers will buy the tokens as products rather than as investments.
Utility-Oriented Positioning [Y/N]: Is the token being communicated to prospective buyers as a product with a defined utility and use cases?
Statement of Risks [Y/N]: Does the marketing collateral include brief descriptions of product-oriented risks around the tokens, protocol, and network?

Third Party Review

  • Going hand-in-hand with an understanding of the development team and advisors is planning for third party reviews of the technology. Once prospective buyers know that there is a team capable of building the articulated token and network, they need reassurance that said team has made good on their development promises
Expert Review [Y/N]: Has a usability expert tested the technology, walking though it in the shoes of a typical user?
Security Audit [Y/N]: Has the blockchain network undergone penetration testing?
Bug Bounty Program [Y/N]: Are there funds set aside to compensate individuals who report bugs?

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