ICO stands for Initial Coin Offering. A new crypto project launches its own coin (token), which is sold to early investors. This funding model is similar to a company's primary round issuance of shares. The difference is that the ICO issuance is open to the general public and not just reserved for venture capital.
Most ICOs were and are taking place on Ethereum. In this case, investors who believe in the new project pay ETH and receive the new tokens in exchange. They can use these in the ecosystem of the new app, or simply sell them at a profit at a later stage.
The breakthrough of ICOs
ICOs allow new crypto projects to raise money quickly and easily, and reward the creators and developers for their work. Contrast this with software that was built when this was not possible. The inventors of, say, the smtp protocol (a standard for sending emails) didn't make any money from it at the time. Or take the early developers and users of Twitter. Suppose those developers and early adopters had been able to buy smtp coins or Twitter coins for a bargain? They would have been worth much more now and would have been rewarded for their faith and effort in their project. The issuance of tokens thus solves the chicken-and-egg problem of how to encourage people to join a network when it is still small: give them partial ownership.
ICOs also unlock a new realm of opportunities for investors. ICOs make it possible for ordinary folks to become an investor in startups of a rapidly growing industry.
So, a win-win situation? In principle, yes, were it not for the fact that this new financing model has also encouraged all sorts of dubious project launches. So it's no wonder that ICOs are under scrutiny of financial watchdogs.
The SEC and ICOs
The term ICO is derived from IPO: Initial Public Offering. This is the initial public offering of a traditional company. Such an IPO allows anyone to become a shareholder and allows early investors to recoup their investments. In order for a company to go public, it must meet requirements set by the watchdog of the financial markets. In the United States, for example, this is the SEC. One concern of crypto projects is that their currency is seen by the SEC as a security: in which case they may not issue it without first getting approval. For example, Ethereum went to great lengths in 2015 to get confirmed that it is not a security.
The DAO: one of the first ICOs
One of the first ICOs was the Genesis DAO, or DAO in short. This first Decentralized Autonomous Organization was a purely software-based investment fund built as a smart contract on Ethereum. Investors in DAO tokens were given voting rights in the projects in which the DAO might invest. The DAO's ICO raised over $160 million in Ether in 2016: a breakout success. Things went wrong when a hacker found a flaw in the code and siphoned ETH out of the DAO. In order to plug this leak and undo it, the Ethereum Foundation decided to roll back these "illegal" transactions, but only after heated debate. The Ethereum blockchain was forked from the point where the malicious transactions took place. This so-called Ethereum hard fork created two Ethereum chains.
The ICO boom of 2017 and 2018
Hundreds of projects raised money in 2017 with an ICO on Ethereum. The peak of the mania was around December 2017, when over $1.5 billion was raised per month. It explains why the price of Ether exploded in 2017, to over $1400: Ether was the "raw material" needed for all the transactions. In the spring of 2018, the mania was over and the number of new ICOs fell hard. The prices of the new tokens dropped just as hard.
Some of the projects from the ICO boom still exist and have proven successful. Examples are Tezos and IOTA: still alive and kicking. Or take Cardano, which raised $62 million with an ICO in January 2017. Cardano's current market value is in the tens of billions.
But many of those ICOs proved unsuccessful. Dragon coin, to name one, raised over 300 million but is now only worth 1 million, if the coin is still traded at all. And while the intentions of many projects were no doubtgood, there were also outright scams. The so-called "exit scams," where developers and promoters suddenly pack their bags after having sold their coins. In these cases, as many ICOs were not registered with a country's financial authorities, investors had no protection.
The number of ICO’s has been on the decline. These days, crypto projects can also raise funds through a Security Token Offering (STO) and Initial Exchange Offering (IEO). These offerings vary in the way they comply with securities laws and who is allowed to invest. The early days of the crypto wild west are over.
The crypto industry's first killer app
From a distance, the ICO boom and bust might have looked like a bubble bursting. All hot air, a bystandermight say who saw the prices of the new tokens collapse. In a sense, it was a bubble of course. But as mentioned, a small number of projects turned out to be very successful - exactly what you would expect from a competitive market with super-fast innovation. If you, as an investor, had spread your money over a large number of ICOs, you would still have done just fine.
Not counting Bitcoin, the principle of the ICO is in fact the crypto industry's first killer app. The idea that you could set up an investment and trading platform that was decentralized and (almost) purely software-based was revolutionary. The ICO was one of the first forms of decentralized finance (defi) and ignited the defi revolution.