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Photo: iStock
Photo: iStock

De-jargoned: What is initial coin offering

In initial coin offering, the company creates digital tokens; these tokens are then issued based on the amount that the company wants to raise

In the world of cryptocurrencies, initial coins offerings (ICO) are used to raise money for business purposes. Here is a look at these offerings and how you, as an individual, can respond to them.

If a blockchain technology platform start-up wants to raise money, it can do so through the usual process of getting funded by venture capital or angel investors.

However, many blockchain startups are using the ICO route. In ICO, the company creates digital tokens, which are in cryptocurrencies. The tokens are issued based on the amount that the company wants to raise. These tokens have a predetermined value. It then sells these cryptocurrencies in an initial offer. In a way, ICO is similar to an initial public offer (IPO). In an IPO, a company sells its shares for the first time in the market. It sets a price band in which the investors can bid. In case of an ICO, tokens are generated and a price is set on those tokens. The tokens are on a blockchain and derive their value based on demand. The concept works on the theory that on blockchain you can transact without the need of a central authority such as a central bank. Anyone can invest in an ICO. You can buy it online on cryptocurrency exchanges that supports it. The newly created tokens can then be exchanged with existing popular cryptocurrencies such as bitcoin and ethereum or even with a fiat currency like dollar or rupee. They can also be traded on cryptocurrency exchanges. ICOs are not regulated. Thus, the companies issuing it do not need to inform an exchange, or adhere to any formalised rules as they have to for an IPO.

To begin with, know that almost everyday a new cryptocurrency is generated for various purposes; and very few of these currencies stand the test of time. The ecosystem is such that various external factors can determine the demand for cryptocurrencies, which you might not be able to track.

ICOs are very risky. Before investing, you need to know whether the issuing company’s business plan is worth the investment. There have been instances of scams and frauds. Also, in the past, many ICOs have failed and investors have lost their capital. Like in any other investment strategy, venture into this space only if you know the product well. If you don’t understand its fundamentals, you are likely to risk your money. Hence, it is better to stay away from it.

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