Initial Coin Offering (ICO)

What is an initial coin offering?

Initial Coin Offering (ICO, first offering of digital tokens) describes the issue of newly created digital units (tokens) to a large number of buyers in order to finance a project. The buyers pay for them in euros, another currency or cryptocurrencies. The tokens are kept on a blockchain, a digital register that is held on many computers at once and can hardly be altered afterwards. The proceeds are often used to develop a network or platform in which the tokens are later to be used. As a rule, the tokens do not confer shareholder rights in the company.

ICOs come from the crypto industry and resemble crowdfunding in their broad reach. They peaked around 2017 and 2018, when many projects raised money without binding rules. Those involved are the issuer, that is, the publisher of the tokens, often a company or foundation behind the project. Added are the buyers, trading platforms for crypto-assets and, in Germany, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) as the competent supervisor. The central document is an information document, the white paper, which describes the project, token and risks.

Process and types of token

The issuer fixes the total quantity, distribution and price of the tokens and publishes the white paper. The tokens are created via a smart contract, that is, a programme on the blockchain that records incoming payments and allocates tokens automatically. A part of the total quantity generally goes to the founding team, early backers and a reserve of the project. After the sale ends, the tokens are meant to become tradable on trading platforms.

Utility tokens and security tokens

The legal classification depends on the rights that a token embodies, not on its label:

• Utility tokens grant access to a product or service of the issuer, for example use of a platform. They resemble a voucher more than a capital investment.
• Security tokens confer property-law claims typical of securities: profit participation, interest or repayment. They are subject to capital markets law; their issue is the security token offering.
• Payment tokens serve as a means of exchange. Tokens whose value is tied to a currency or a basket of assets (colloquially stablecoins) are subject to their own, stricter rules.

Many early ICOs described their tokens as utility tokens although the buyers relied mainly on appreciation and the benefit was to arise only in the future. In such cases, supervisory authorities look to the economic substance.

Regulation in the EU and in Germany

Crypto-assets that are not financial instruments, that is, neither securities nor comparable investment instruments, have been governed since the end of 2024 by a dedicated EU-wide regulation. It is the Regulation on Markets in Crypto-Assets (Regulation (EU) 2023/1114, MiCAR or MiCA for short). It requires the offeror to produce a crypto-asset white paper with prescribed minimum content and to submit it to the competent authority. The white paper may not contain statements about the future value of the tokens; what is prescribed instead is the warning that the tokens may lose their value in whole or in part. Added are rules on marketing communications and liability for incorrect information.

A substantive approval as with a securities prospectus does not take place for ordinary crypto-assets. Exemptions from the white paper obligation exist, for example, for offers to a very small circle of persons, with a small total volume or exclusively to qualified investors; their conditions must be examined in each case.

If a token, by contrast, embodies rights similar to securities, MiCAR does not apply but capital markets law does: for a public offer, an approved prospectus under the EU Prospectus Regulation is in principle required unless an exemption applies. Service providers who hold, exchange or trade tokens for others need a licence in both cases, depending on the type of token under MiCAR or under banking and securities supervision law. Which rules apply in a specific case depends on the design of the tokens and requires a supervisory-law review before the first offer.

Why ICOs rarely play a role in funding rounds from EUR 1 million

For technology companies with a product on the market and running revenue, an ICO is as a rule no substitute for an equity round. The reasons lie in the structure:

• Venture capital investors acquire shares with voting, information and preferential rights. Tokens do not confer these rights and do not appear in the cap table, the overview of the shareholders and their shares.
• Obligations towards token holders, for example performance promises, compete economically with the claims of the shareholders and complicate valuation.
• The supervisory-law classification, liability for the white paper and the anti-money-laundering obligations are examined in detail in due diligence and can delay a transaction.
• A broad, largely anonymous circle of token holders and a fluctuating token price have repercussions on reputation and customer relationships.

A token makes sense above all where it is indispensable for the function of a network. If a company has its own token, investors' claims to future tokens are regulated separately in funding rounds alongside the shareholding.

Worked example

A project creates, in simplified form, 100 million tokens. Early backers receive 20 million tokens at EUR 0.05, the founding team 20 million tokens that are released gradually over four years (vesting), the project's reserve 35 million tokens. In the public sale, 25 million tokens are offered at EUR 0.12 and sold in full.

• Proceeds from the public sale: 25 million × EUR 0.12 = EUR 3 million
• Proceeds from early backers: 20 million × EUR 0.05 = EUR 1 million
• Total inflow of funds to the project: EUR 3 million + EUR 1 million = EUR 4 million
• Notional value of all tokens at the sale price: 100 million × EUR 0.12 = EUR 12 million
• Price ratio: Public buyers pay 0.12 / 0.05 = 2.4 times the price of the early backers
• If the price falls to EUR 0.06 after trading begins, the value of the publicly sold tokens drops to 25 million × EUR 0.06 = EUR 1.5 million, a loss of 50%; at EUR 0.06 the early backers are by contrast still 20% above their entry price

The notional value of EUR 12 million rests on a price at which only a quarter of the tokens was actually sold; EUR 4 million flowed in. The price risk is borne above all by the buyers who came in last. If locked tokens of the team and early backers are later released, the tradable supply rises without any new funds flowing to the project.

Distinction from related terms

• Security token offering: issue of tokens with rights similar to securities under capital markets law, in Germany also as an electronic security under the German Electronic Securities Act (Gesetz über elektronische Wertpapiere, eWpG).
• IPO: public offer of shares with prospectus, admission to stock exchange trading and full shareholder rights.
• Crowdfunding: financing through a platform by many backers, usually via subordinated loans or rewards, without a blockchain as a prerequisite.

Common mistakes

• Classification by label. The description as a utility token does not protect against capital markets law if the token in fact has the character of an investment.
• White paper as an advertising brochure. Return promises and unsupported timetables create liability risks. MiCAR expressly excludes statements about the future value of the tokens from the white paper.
• Token instead of equity. A token without a function in the product does not replace a funding round and makes later equity rounds harder.
• Distribution without lock-up periods. If tokens of the team and early backers are immediately tradable, considerable selling pressure arises after the sale.
• Anti-money-laundering underestimated. Identification of the buyers and the origin of funds must be evidenced, including to later investors and banks.

Frequently asked questions

Is an ICO permitted in Germany?

Yes, within the supervisory framework. For crypto-assets without securities character, the rules of MiCAR apply, for tokens with rights similar to securities, capital markets law.

Do token holders become shareholders?

No. Token holders acquire the rights embodied in the token, for example claims to use or payment, but no shares and no vote in the shareholders' meeting.

Is the white paper reviewed by BaFin?

For ordinary crypto-assets, that is, neither stablecoins nor financial instruments, not in the sense of an approval. The white paper is submitted to BaFin before publication, and it can prohibit offers. Responsibility for the content, however, lies with the offeror.

Can investors in a funding round receive tokens?

Yes, if the company issues a token. Such claims are agreed separately and must be coordinated with the rights under the shareholding.

The Roemer Capital view

The funding rounds we support are based on a capital increase: investors acquire shares, and their rights are set out in the participation agreement and shareholders' agreement. A token does not replace this structure. For a software company with recurring revenue, an ICO is therefore as a rule not a route to growth financing.

If a company has already issued tokens, we record early which obligations arise from this and how they affect valuation and due diligence. The supervisory-law classification is handled by the company's law firm.