23 Oct, 2018
Initial Coin Offering (ICO)
For traditional companies, there are a few ways of going about raising funds necessary for development and expansion. A company can start small and grow as its profits allow, remaining beholden only to company owners but having to wait for funds to build up. Alternately, companies can look to outside investors for early support, providing them a quick influx of cash but typically coming with the trade-off of giving away a portion of ownership stake.
An Initial Coin Offering (ICO) is the cryptocurrency space’s rough equivalent to an IPO in the mainstream investment world. ICOs act as fundraisers of sorts; a company looking to create a new coin, app, or service launches an ICO. Next, interested investors buy in to the offering, either with fiat currency or with preexisting digital tokens like ether. In exchange for their support, investors receive a new cryptocurrency token specific to the ICO. Investors hope that the token will perform exceptionally well into the future, providing them with a stellar return on investment. The company holding the ICO uses the investor funds as a means of furthering its goals, launching its product, or starting its digital currency. ICOs are used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.
This is the most basic definition of an ICO. However, there is much more to the trendy crowdfunding method than this. Indeed, just as ICOs have rapidly come to dominate attention in the cryptocurrency and blockchain industries, so too have they brought along challenges, risks, and unforeseen opportunities. Investors buy into ICOs in the hope of quick and powerful returns on their investments. The most successful ICOs over the past several years give investors reason to maintain this hope, as they have indeed produced tremendous returns. However, this investor enthusiasm also leads people astray. Because they are largely unregulated, ICOs have become a hub of frauds and scam artists, looking to prey on investors who are overzealous and underinformed.
The Basics of an ICO
When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need (s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for. During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an IPO-type transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the funds requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.
ICOs are similar to IPOs and crowdfunding. Like IPOs, a stake of the startup or company is sold to raise money for the entity’s operations during an ICO operation. However, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return in their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are referred to as crowdsales.
ICOs also retain at least three important structural differences from IPOs. First, ICOs are decentralized, with no single authority governing them. Second, ICOs are largely unregulated, meaning that government organizations do not oversee them. Finally, as a result of decentralization and a lack of regulation, ICOs are much freer in terms of structure than IPOs.
ICOs can be structured in a variety of ways. In some cases, a company sets a specific goal or limit for its funding, which means that each token sold in the ICO has a pre-set price and that the total token supply is static. In other cases, there is a static supply of ICO tokens but a dynamic funding goal, which means that the distribution of tokens to investors will be dependent upon the funds received (and that the more total funds received in the ICO, the higher the overall token price). Still other ICOs have a dynamic token supply which is determined according to the amount of funding received. In these cases, the price of a token is static, but there is no limit to the number of total tokens, save for parameters like ICO length. These different types of ICOs are illustrated below:
ICO Benefits: What’s in it for the Investor?
In an IPO, an investor receives shares of stock in a company in exchange for her investment. In the case of an ICO, there are no shares to speak of. Instead, companies raising funds via ICO provide a blockchain equivalent to a share: a cryptocurrency token. In most cases, investors pay in a popular existing token like bitcoin or ether and receive a commensurate number of new tokens in exchange.
It’s worth noting just how easy it is for a company launching an ICO to make tokens. There are online services such as Token Factory that allow for the generation of cryptocurrency tokens in a matter of seconds. Investors should keep this in mind when remembering the differences between a share of stock and a token; a token does not have any inherent value. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute them per their plan by transfering them to individual investors.
Early investors in an ICO operation are usually motivated to buy cryptocoins in the hope that the plan becomes successful after it launches. If this comes to pass, the value of the tokens they purchased during the ICO will climb above the price set during the ICO itself, and they will achieve overall gains. This is the primary benefit of an ICO: the potential for amazing returns.
Indeed, ICOs have made many investors into millionaires. Take a look at the figures for 2017: That year, there were 435 successful ICOs, each raising an average of $12.7 million… the total amount raised for 2017 was $5.6 billion, with the 10 largest projects raising 25% of this total. Further, tokens purchased in ICOs returned an average of 12.8x the initial investment in dollar terms.
The ICO space continues to balloon at a tremendous rate. In the first quarter of 2018, ICOs brought in $6.3 billion in funds, already outpacing the entire 2017 total in just 59% as many distinct ICO projects.
Most Successful ICOs
As the ICO space gets bigger and bigger, so too have the largest ICOs in history. When evaluating ICOs by size, one can consider both the amount of money raised in the ICO as well as the return on investment. Sometimes ICOs with a remarkable return on investment are not among the highest-earning projects, and vice versa. Ethereum’s ICO in 2014 was an early pioneer, raising $18 million over a period of 42 days. Ethereum has proven to be crucial for the ICO space in general, thanks to its innovations with regard to decentralized apps (DApps). When it debuted, ether was priced at around $0.30; as of July 24th, 2018, it trades at $474.62, marking gains of close to 1,600x.
In 2015, a two-phase ICO began for the company Antshares, which later rebranded to become NEO. The first phase of the ICO ended in October of 2015, and the second continued all the way until September of 2016. During this time, NEO earned about $4.5 million. While it is not one of the largest ICOs in terms of money raised, it has provided exceptional ROI for many eary investors. The price of NEO at the time of the ICO was about 3 cents, and at its peak it traded at roughly $50, marking an increase in price of about 150,000%.
More recently, ICOs have generated significantly larger amounts in terms of total funds raised. The largest ICO by this metric is filecoin, a decentralized cloud storage project. During a one-month ICO ending in September of 2017, filecoin managed to raise about $257 million.
How to Find ICOs
Investors looking to buy into ICOs should first familiarize themselves with the cryptocurrency space more broadly. In the case of most ICOs, investors must purchase tokens with pre-existing cryptocurrencies; this means that an ICO investor will need to already have a cryptocurrency wallet set up as well as some digital token holdings. Below, we’ll walk through the steps necessary to invest in a theoretical ICO modeled after KIN, an existing digital currency. The steps may be different, however, depending upon the type of ICO.
1) Sign up for Coinbase or another digital currency exchange. There are hundreds of different exchanges and wallets, so you have a multitude of options here.
2) Stock up on the currency you’ll need in order to buy into the ICO.
3) Transfer your holdings to a digital wallet which supports them. The most important thing in this case is to make sure that your wallet will hold cryptocurrency compatible with the ICO (i.e. if the ICO requires payments in ether, your wallet must hold ether).
4) Be certain that you have the official page for the ICO itself. Read through the whitepaper, the terms of the ICO, and any other information that you can. When you’re ready to begin, look for buttons to «enter the token sale» or «participate now.»
5) Register for the ICO. In order to do this, you’ll need to provide your public wallet address as well as some other information according to the ICO site.
6) On launch day, follow the site’s instructions for buying into the ICO. In most cases, this will involve transferring ether from your wallet to the ICO’s public address. In return, you’ll receive some of the ICO’s cryptocurrency at a rate specified by the terms of the offering. Be sure to keep in mind that there are small fees associated with transfering cryptocurrencies like ether, so you’ll have to keep a bit of the original token in reserve to cover these costs.
7) The ICO will send the new token to your cryptocurrency wallet. Depending on the wallet, you may need to add the token to the wallet itself so that you can send and receive transfers.
8) Either hold onto the new token or exchange it for USD or other digital currencies. The company which provided the ICO may offer a service allowing you to transfer the token back to the previous cryptocurrency, or you may need to go to another digital currency exchange in order to make the transfer. In some cases, you may need to hold the token until it becomes listed on an exchange which you can access based on your region.
How does one go about finding ICOs in which to participate? There is no recipe for staying aprised of the latest ICOs. The best thing that an interested investor can do is read up about new projects online. ICOs generate a substantial amount of hype, and there are numerous places online in which investors gather to discuss new opportunities.
Risks and Criticisms of the ICO Space
Although there are successful ICO transactions on record and ICOs are poised to be disruptive innovative tools in the digital era, investors are cautioned to be wary as some ICO or crowdsale campaigns are actually fraudulent. Because these fundraising operatives are not regulated by financial authorities such as the SEC, funds that are lost due to fraudulent initiatives may never be recovered.
The rapid ICO surge in 2017 incurred regulations from a series of governmental and nongovernmental In early September, 2017, the People’s Bank of China officially banned ICOs, citing it as disruptive to economic and financial stability. The central bank said tokens cannot be used as currency on the market and banks cannot offer services relating to ICOs. As a result, both Bitcoin and Ethereum tumbled, and it was viewed as a sign that regulations of cryptocurrencies are coming. The ban also penalizes offerings already completed. In early 2018, Facebook, Twitter, and Google all banned ICO advertisements.
To make sure you don’t get scammed when you invest in an ICO, follow these steps:
1) Make sure that project developrs can clearly define what their goals are. Successful ICOs typically have straightforward, understandable whitepapers with clear, concise goals.
2) Know your developers. Investors should expect 100% transparency from a company launching an ICO. This means that you should know who is involved in the project, what their business plans are, where they are located, what the timeline for the project is, and so on.
3) Look for legal terms and conditions set for the ICO. Because outside regulators generally do not oversee this space, it is up to you as an investor to ensure that any ICO you buy into is legitimate.
4) Make sure that ICO funds are being stored in an escrow wallet. This is a wallet which requires multiple keys in order to be accessed. This is a useful protection against scams, particularly when a neutral third party is a holder of one of the keys.
There is no way to guarantee that you won’t be on the losing end of a scam when you invest in an ICO. That is a risk that you must be willing to take. On the other hand, ICOs can offer tremendous rewards as well. The key for investors is to take necessary precautions to avoid making irrational or uneducated decisions, and to learn as much as possible about the ICO world in order to best capitalize on its excellent potential.