When a crypto company reaches a certain stage of development, it seeks to raise funds to secure cash and fund the next stage of development. This happens when companies need more capital to scale quickly compared to what they currently have available.
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Crypto companies are not immune to this, but they have more options at their disposal. Therefore, if a cryptocurrency startup plans to secure capital, it must raise funds.
However, if the startup is too early or too late in the development phase, it may not qualify for traditional forms of fundraising, such as going public and securing a bank loan.
The cryptocurrency and blockchain space is bringing new approaches to fundraising that were not possible in the past.
What exactly is crypto fundraising? How can companies benefit from this fintech revolution? How does cryptocurrency fundraising differ from traditional fundraising approaches?
Before we get into all that good stuff, let’s look at the traditional fundraising approaches: venture capital funding and angel investors.
Next, we’ll see how the initial public offering (IPO) stacks up against the darling of crypto fundraising and initial coin offerings (ICOs), and we’ll cover Initial Exchange Offerings (IEOs), Initial DEX Offerings (IDOs), and Security Token Offerings (STOs).
Venture Capital and Business Angels: Traditional Fundraising
If a company ever wants to raise capital, its owners should turn to venture capital firms. Essentially, a venture capital fund is a group of investors who pool their money and spread their bets on startups.
These companies find potential investors by filing a prospectus, which is a formal document filed with the SEC detailing the merits and risks of an investment. When investors express interest in a project, they tie their funds to the company.
Fund managers review many business plans to find projects that they believe offer the best returns. In return for the funding, they want equity (i.e. shares in your company) so they can walk away with a quick profit.
As an entrepreneur, it is important to understand that a venture capital fund is short-term. These companies want to make a quick profit and move forward by selling their equity.
The good news? When venture capitalists decide to fund a company, it means they are confident, at least on paper, that the company will quickly appreciate in value. The bad news is that the company may have to go out of business.
Angel investors, on the other hand, are usually very wealthy individuals who invest in a company at an early stage.
Their investment focus is on the entrepreneurs and their vision rather than the strength of the company.
Rather than looking for a quick exit, their motivation for funding is to make money, primarily for the equity they may or may not own.
Different approaches to cryptocurrency fundraising
Brief History
In 2017, fundraising exploded in the crypto space. Many analysts and participants remember this as the ICO craze. Thousands of projects have been started with ICOs. Most of them, to no one’s surprise, failed disastrously.
However, a handful of them became coin millionaires. For many analysts, the ICO craze bore all the hallmarks of the dot-com boom, when too much speculation caused a huge bubble in the late 1990s and caused several online startups to fail. Experts were preparing for a similar accident in 2017, but it never happened.
The ICO craze has led to the birth of several other forms of cryptocurrency funding. These include STOs, IEOs, and last but not least IDOs. We will review each in detail below.
Initial coin offerings
The crypto industry’s equivalent of an initial public offering (IPO) is an Initial Coin Offering (ICO). An ICO is a method of raising funds for a company that wants to develop a new app, currency, or service. Let’s first cover what an ICO does and then look at the differences that matter.
The main fundraising tool for blockchain and crypto startups is the white paper, arguably the most important marketing document that invites people to invest in your business.
Steps to starting your own initial coin offering
Here is an overview of the fundraising process to launch a successful ICO:
1. Confirm if the project really needs an ICO or if an ICO is the best approach to fund your business.
An ICO is not suitable for all companies. While an ICO is easier to launch than a traditional IPO, it shouldn’t be viewed as circumventing the strict regulations that surround it.
The main concern of any company considering an ICO should be whether their token will be of real use. However, if it’s just to facilitate sales and that’s its sole purpose, an ICO is definitely not the way to go. However, if the business token has a real use case, the company should proceed to step 2.
Users also need to make sure it fits their business strategy and business model.
2. Assemble a team
When the token has a real use case, it’s time to call in the experts. From product development to commercialization, there is work to be done on everything.
The team may or may not include consultants. Regardless, advisors must have experience launching successful ICOs.
There are many crypto projects that are launched without advisors, but it is uncommon for larger projects not to have advisors on their board.
3. Check all regulations for conducting an ICO in the country concerned
Some countries have strict regulations about what classifies investment security. Other countries like China have completely banned ICOs.
Users must ensure that they are free from regulatory oversight. This will ensure that there are no legal or technical obstacles to moving forward.
4. Prepare a project roadmap
The project roadmap provides potential investors with a timeline. This means they have a sense of progress and what to expect as the project progresses.
As long as the team can achieve the defined milestones, investor confidence should remain high. This is of course beneficial for funding but also goes a long way in keeping the crypto community active and enthusiastic.
5. Write and release the white paper
Check marketing material published by competitors. This includes reviewing successful ICO whitepapers – as well as less successful ones – to understand what happens in a good one.
The purpose of the white paper is to inspire and build trust among investors. Therefore, it should include what the project is about and what problems it solves.
Users should also mention why the team is uniquely qualified to solve them. Finally, mention details that will persuade a potential investor to support the project. It might be worth investing in an author who specializes in white papers for the cryptocurrency industry.
6. Build an online presence
Having a website is essential for any self-respecting crypto project. The website is the advertising basis. Any potential investor can find out more about the project and read the white paper here.
Community building and nurturing will also go a long way. Users can contact cryptocurrency influencers to see if they are interested in promoting the project.
Finally, it is crucial that the project is featured in the ICO listings. Many reputable investors regularly check these listings to find projects they wish to support.
7. Choose a token sales model
Various models are available, from Dutch auctions to limited or non-limited fixed price auctions. Users can even consider a hybrid model. ICO can also be divided into different phases.
There may be a pre-sale or private sale before the ICO is even open to the public. Ensure the token sale model is investor and community-member-friendly. Community reaction due to perceived injustice can destroy a project in its infancy.
8. Release a smart contract and start minting tokens
The project details should include in advance which blockchain the project will be built on. Traditionally, most projects live on the Ethereum blockchain because it was the first to use smart contracts.
However, many competitors with faster transfer rates and different technical architectures are emerging today.
9. Launch ICO
This final step marks the end of the fundraising process. Once the ICO is launched, much will depend on the project meeting its fundraising goals. If so, keep your focus on nurturing the community and improving the project. Check future plans. The rest will follow.
For the actual ICO campaign, any potential investor can buy tokens using either fiat currency or a predefined digital currency. Users can think of the token as part of the company.
In contrast, in an IPO campaign, a private company decides when to go public. However, for a company to be eligible for an IPO, it must meet many strict conditions, such as an underwriter guiding the IPO through book preparation that attempts to set the price.
The underwriter builds the book by asking investors how many shares they might want in the company and how much they are willing to pay.
In addition, an IPO also requires a third-party audit to ensure that all financial activities conducted by the company are compliant with the law. This ensures investor protection and increases confidence in the reputation of the project.
| INITIAL PUBLIC OFFERING | INITIAL COIN OFFERING | |
| Regulations | Strict | Little regulatory scrutiny |
| Investor protection | Yes | No |
| Risk/Reward | High | Low |
| Asset purchased | Shares | Tokens |
| Speed of execution | Slow | Fast |
As shown in the table above, launching an ICO can be a simple process and due to the lower barrier to entry compared to IPOs, any crypto-savvy blockchain developer can launch one. Finally, project owners can launch an ICO quickly, even within a few days.
Keeping these points in mind, it’s understandable what happened at the end of 2017’s ICO madness: it turns out that most of the thousands of projects being pushed around as the “next best thing” were basically poorly planned or straightforward projects.
Rug pulls (rug pulls are when a project team deliberately engages in a pump-and-dump program by coaxing investors into buying, thereby raising the price quickly before the team dumps its market holdings and causes prices to drop.)
Already, virtually everyone could launch an ICO, and many people did. Many founders waited for the token price to spike before disappearing with the funds.
To better protect investors and increase trust in token issuers (i.e. the owners) of real projects, the next was the IEO.
Initial exchange offering
An IEO is like an ICO, except all issuance is through select cryptocurrency exchanges. The project owner has peace of mind knowing that their token will be available to any investor with access to the exchange.
When an exchange is reputable and well-established, the backers of the exchange can give investors peace of mind that their funds are protected.
The downside is the high cost of managing the coins directly through the exchange. This includes paying a listing fee for the token as well as forgoing a percentage of token sales. Essentially, the exchange lends its reputation to the project for financial gain.
This situation differs from when a cryptocurrency exchange decides to list a project’s token. Based on the exchange’s own terms, an exchange may list a token once it independently verifies which project is worthy of listing.
Security token offering
The less popular security token offering is a more cautious approach to raising crypto funds. As the name suggests, this approach already recognizes the token as collateral. This means that they comply with the necessary safety regulations.
Regulations may include Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements. KYC and AML policies ensure financial service providers identify and mitigate risk in compliance with government regulations.
Initial DEX offering
DEX is a decentralized exchange. DEXs work like automated market makers. They rely on smart contracts to carry out money transfers, eliminating the need for third parties.
KYC and AML compliance is also not required. Later, when the hammer falls, they can subject it to strict regulations. Instead of a personal ID, someone only needs a digital wallet address to receive the respective coin to participate.
Steps to launch an initial DEX offering
- Get the project unto a dex launchpad. Once the project meets the requirements of the platform, It will be eligible to be voted on. Voters include cryptocurrency community members who decide whether the project has any merit.
- Create a token pool where they presell their tokens to raise funds (no potential investor actually receives any token). Instead, they receive a guarantee that they will have secured a Y number of tokens. As the project owners and issuers, users can benefit from not having to run the token pool at a fixed price. Instead, they can run the price based on how much demand the token is able to generate.
- Once the IDO ends, the token is issued via a token generation event. This means your token will be listed in the DEX automatically.
Regulatory risks you must be aware of
As with any emerging industry, users should be aware that their projects may come under closer scrutiny.
Since regulators in different countries classify cryptocurrencies and crypto-assets differently, it is best for users to look into the legal implications of launching an ICO in their respective jurisdictions.
This gives both project owners and investors peace of mind that their projects will not run into legal problems down the road.
While public blockchains are transparent and allow for customer identification, there is an increasing number of obfuscation measures aimed at protecting the anonymity of crypto-asset owners.
However, no organization is responsible for collecting and verifying KYC data about customers, such as g. their names or addresses, or to monitor transactions for suspicious activity when there is no central clearing hub or exchange.
A series of new financial crime laws have come into force around the world to fill gaps in the supervisory and regulatory framework and combat money laundering threats.
Money laundering is the practice of turning large sums of money, derived from criminal activities such as drug dealing, into legitimate funds.
To prevent money laundering risks, some countries have enacted money laundering laws, while others have enacted stricter measures. AML policies are implemented by regulators to keep criminals out of the financial system.
Fluctuations in risk appetite provide regulatory arbitrage opportunities for undesirable actors. This can lead to a shift towards less formalized work environments that allow for greater agility and the ability to innovate quickly.
However, others may prefer more regulations to demonstrate their solidity, security, and confidence.
Final verdict
As cryptocurrencies and blockchain technology went mainstream, they caught the attention of traditional gatekeepers. These include regulators, banks, and financial institutions.
As mentioned, some regulations can be a good thing as this market is full of scams and low-quality designs. Introducing investor protection and more stability through regulation might not be such a bad thing after all.
Since the advent of ICOs, cryptographic innovation has come a long way in such a short amount of time. IEOs, IDOs, and other newer fundraising innovations are here and they are quickly catching up in popularity compared to other innovative approaches like ICOs.
What new fundraising technologies will emerge in the future? This remains to be seen. But the industry will be shaped by the regulatory landscape and the creativity of cryptocurrencies or digital finance will shape the industry.
There’s no doubt about it. Fortunately, they also meet the needs of project investors and issuers.
