Reverse ICO: What It Is, How It Works, FAQs

What Is a Reverse ICO?

A reverse initial coin offering (ICO) is a method used by existing, established real-world businesses to issue a token to decentralize the business ecosystem, raise funds, and get into cryptocurrency. These enterprises have existing products and services, and they cater to real-world customers.

Essentially, a reverse ICO acts like an initial public offering (IPO), allowing an existing enterprise to launch cryptocurrency tokens and seek funds through crowdsourcing. In the last several years, this similarity has prompted the U.S. Securities and Exchange Commission (SEC) to argue that token issues through ICOs may be securities and not currencies.

Understanding Reverse ICOs

The process for a reverse ICO works exactly the same way as for a standard ICO. Often, a company launches an ICO when it is looking to secure funding. The company generates crowdsourced funding by selling tokens to investors in a similar way to an IPO.

The major difference between an ICO and a reverse ICO is that, in the latter case, the company issuing the token is already well-established in another business area and offers a crypto token for sale to raise cash and enter into the decentralized realm of the digital currency world.

Companies can launch reverse ICOs for a variety of reasons. Preexisting companies can sell tokens to interested investors to decentralize business, to launch a new business line in the blockchain industry, or simply to raise funds. Because some IPOs are available only to accredited investors, they have a smaller pool of potential funders compared with a reverse ICO.

Potential Issues with Reverse ICOs

While there are numerous potential benefits for a business launching a reverse ICO, there are also potential issues—some of them significant.

The use of reverse ICO tokens as money is somewhat dubious, as businesses conducting reverse ICOs were able to grow and thrive using conventional fiat currency. The possibility that every business would ask you to convert your fiat money into their proprietary token—as if you were required to load up your Starbucks gift card before you were permitted to buy a cup of coffee—is not practical, to put it generously.

Another problem with reverse ICOs is how to understand their tokens. Are they a medium of exchange, or are they securities? This was the problem that the Kik messaging app had when it launched a reverse ICO in 2017 that raised $100 million. The SEC sued Kik over the process, alleging that the company sold tokens to U.S. investors without properly registering the offer and sale.

The SEC sued Kik, claiming that it misled investors because their reverse ICO was actually just another form of security like a stock. But unlike a stock, there is no return on investment in Kik’s coin, Kin.

In 2020, a federal district court entered a final judgment on the SEC’s lawsuit against Kik. Among other penalties, Kik was required to pay a $5 million penalty.

Reverse ICOs: A Fad During the Crypto Bubble

During the height of the crypto bubble in 2017 and 2018, companies that said they were adding blockchain to their businesses increased in value. A notorious example from early 2018 is Long Island Iced Tea Corp., which changed its name to Long Island Blockchain and saw a huge spike in the value of its shares that were listed on the Nasdaq—despite the fact that the company had no apparent business in blockchain. It has since been delisted, and some of its top shareholders have been charged with insider trading.

Because existing businesses face regulatory hurdles if they want to raise capital by selling stock, and because banks often have stringent requirements that businesses prove their good credit and viability, the reverse ICO seemed like an easy, unregulated way to raise money with few strings and no oversight. The temptation to do so was even stronger when parody coins like PonziCoin, which openly warned investors that the ICO was a scam, still made an estimated $250,000.

The SEC went so far as to create a fake ICO page selling a made-up shitcoin called HoweyCoin—a play on the Howey test that the SEC uses to determine what constitutes a security—to teach unwary investors to read the fine print before they invest. The agency’s suit against Kik may be one reason why the reverse ICO market has dried up since the bursting of the crypto bubble.

The Future of Reverse ICOs

The possibility of a reverse ICO isn’t totally dead, however. The Meta reverse ICO proposal for its Libra token ran into resistance from states and central banks when it was announced in 2019; and as of 2022, the Libra project—later renamed Diem and sold to Silvergate Bank—appeared to have been postponed indefinitely.

Other organizations may also find value in creating a blockchain-based token system that doesn’t appear to be an illegal or legally gray attempt to dodge securities regulation, but the appeal of reverse ICOs as they existed in 2017 has largely worn off.