Initial Coin Offering (ICO)

What is an Initial Coin Offering (ICO)?

An Initial Coin Offering (ICO) is the process of raising funds for the launch or further development of a decentralized application project. Think of ICOs as the Initial Public Offerings (in the case of stocks) for blockchain projects. ICOs, just like IPOs, are designed with the idea to help companies reach outside investors and attract capital for the launch or expansion of their product or service.

Projects that are launching their ICOs offer digital assets in the form of tokens that early-stage investors can buy. These tokens serve as an investment certificate (think of them as the shares of a traditional company, but without the voting and corporate ownership rights). There are multiple types of tokens, but the main similarity between them is that they can later be exchanged for money or some sort of goods or services that the issuing company offers. The value of the issued tokens is determined by the team behind the project. The investors, who are willing to back the project, can buy tokens via fiat currency or other digital currencies. After they do that, they hope that the token will live up to its potential and generate a stellar return on investment.

The amount of tokens that are sold is determined by the issuing company and depends on its goal. Some projects offer static token supply that lasts until all tokens are sold. Other companies choose dynamic token supplies that can increase over time, which means that once all tokens are sold, new ones are issued and listed for sale.

The stages of an ICO launch

The first step in the ICO launch is the whitepaper creation. A whitepaper is basically a prospectus that provides guidance and in-depth information about the project and the problem it wants to solve. Whitepapers are usually very lengthy documents as they include everything related to the project and its future development – from the main idea, through the goals and the roadmap, to the team behind it, the financial projections and many other aspects of the business. Whitepapers should be designed in a way to bring transparency and build trust.

Next comes the crowd-sale which is the essence of the ICO. Throughout this stage, the team behind the project tries to gain a following and build an audience that is willing to invest in the idea. The ICO crowd-sale stage is very similar to fundraising and crowdfunding. Many startups fail here as they are unable to raise enough funds to bring their ideas to life. If that is the case, the collected funds should be returned to the investors.

If the investors manage to raise the target sum, however, they enter the third stage of the ICO process where they have to bring their ideas to fruition. Or in other words – to fulfil everything they have promised to their investors.

The problems surrounding ICOs

Although the concept of ICOs sounds very promising and transparent, in reality, it is quite different. In recent years, there were some highly successful ICOs like Ether and Neo but the majority of all initial coin offerings turned out to be a scam. In fact, statistics point out that as of now, there are more than 1600 failed crypto startups. In addition, research by the ICO advisory firm, Satis Group, points out that for 2017, only 8% of all projects with a market cap of over $50 million have ended up trading on a designated exchange, while the rest 92% failed or proved to be a scam. Here are the main reasons for that.

ICOs are unregulated

Unlike the stellar requirements that projects seeking funding has to answer to in order to qualify for banking loans or venture capital investments, initial coin offerings allow a fast and unregulated way to raise funds. There is no Securities or Exchange Commission (SEC) to monitor the actions of these ventures and take the necessary prevention. This means that investors are unprotected and should rely only on their own analysis to be able to avoid potentially shady schemes.

The oversight authorities will, at some point, catch up the ICO niche and will set strict regulations to mitigate the risk for investors. In fact, Singapore has already issued a guide, defining digital token offerings but it remains to be seen how many countries will follow and when.

Investors fall for the big profits

Many crypto investors seeking to find the “golden mine” or the “next Bitcoin” fall in the trap of shady entrepreneurs. The hunt for the next big thing often makes investors underestimate the credibility of the information presented in the project’s whitepaper and forget to perform the necessary initial due-diligence analysis. Recent research shows that investors in fraudulent ICOs have lost more than $1.36 billion just in the first two months of 2018.

Investors who are willing to back ICOs should be aware that they are basically backing an idea (just like crowdfunding works), rather than a real-life working solution. This comes with high risks and potentially high rewards.

Institutions and corporations against ICOs

Some governments and local regulators, such as the People’s Bank of China, stated that ICOs are capable of disrupting the financial stability and banned them officially. Today, even the banks there are prohibited from offering services, related to ICOs.

The same was the case with leading social networks and search engines. As of 2018, Google, Facebook and Twitter banned all ICO advertisements to avoid potential scam schemes reaching their audience.

Tips for avoiding shady ICOs

For those willing to dive in the ICO world, there are a few tips that you should follow in order to mitigate the risk of losing your funds:

  • Evaluate the idea – the decentralized application scene is booming and new projects are born on a daily basis. Try to evaluate how promising the idea of the particular project is and whether it has an edge over the competition
  • Inspect the whitepaper in detail – check all information presented in the whitepaper and research the team behind the project to make sure everything is transparent
  • Analyze how realistic the plan is – make sure to find out whether there is a long-term plan and how realistic it is. If the roadmap is unclear, stay away from the project
  • Define your investment horizon – like each investment, it is necessary to come up with a timeline in accordance with your investment goals. That way you will know when to leave the project

Key Takeaways

  • Investors can take part in an ICO by purchasing tokens
  • ICOs are unregulated and investments in them are not protected
  • ICOs have the potential to be highly profitable, but at the same time bear enormous amounts of risk
  • If you decide to invest in an ICO, don’t fall for the hype and make sure to evaluate the idea and analyse the credibility of the information you are presented with