ICOs are becoming infamous - and it almost seems like everyone is launching one...
But just what are Initial Coin Offerings and how do they work?
This guide will teach you everything you need to know about them.
Read on or skip to the section you're interested in...
1. ICOs Explained.
1.1. The Definition Of An ICO.
ICO – it's the buzzword of the cryptocurrency industry.
But just what exactly is it?
An initial coin offering (ICO) is when a company raises funds for a new project by selling cryptocurrency coins or tokens to their investors.
Companies run ICOs because it allows them to increase their capital, connect with their community and accelerate their growth.
1.2. What Are ICO Tokens?
ICO tokens are usually tokens built on another blockchain, such as Ethereum’s. These are the tokens that are sold for Bitcoin, Ethereum, and fiat to fund new blockchain or crypto-based projects.
While some ICOs build their own blockchains and cryptocurrencies (also referred to as “coins”), the vast majority of ICOs issue tokens on other blockchains.
Fact: most ICOs take place on the Ethereum platform, but Ethereum itself had an ICO in 2014.
It raised 31.5k BTC or about $18.4 million at the time!
1.3. How Does A Smart Contract Work?
A smart contract is simply a self-executing contract made from computer code.
A programmer writes a smart contract so that once a certain condition or conditions are fulfilled, something happens.
For example, in the case of ICOs, the ICO’s team will code a smart contract to distribute its ICO tokens.
When a user sends a cryptocurrency like Ethereum to the ICO’s smart contract address, the smart contract will automatically send ICO tokens to the user.
So that means there's no need for a lawyer, banker, or any other third party - just you and your smart contract.
2. How Does The ICO Process Work?
2.1. Announcing The Project/Marketing.
Once a company decides to launch an ICO, they have to announce the project and raise awareness to hit their funding goals.
There’s a lot of ways to do this, but the most common way is to run either free or paid (advertising) promotions where cryptocurrency enthusiasts congregate. As of April 2018, here’s what those places are.
6. Wechat (China)
7. QQ (China)
8. Weibo (China)
9. Kakaotalk (Korea)
10. Cryptocurrency-related websites like ICO Alerts, ICO Drops, and news sites.
(This list is not exhaustive but covers the main places on the web where ICOs are announced).
2.2. Releasing The White Paper.
Another key feature of ICOs is the white paper.
The team behind an ICO prepares a white paper to describe details about their project.
Although there isn’t a standardized format for white papers, most cover things investors would care about, such as the following:
- Introduction to the project
- The problem the project is trying to solve
- How the project’s technology works
- The project’s roadmap or plan moving forward
- Details about the project’s token distribution
- How investor funds will be used
- Anticipated outlook for the project’s success
- Information about the project’s team and advisors
- Terms and conditions and other formalities
There might not be a standardized format for white papers… but every ICO needs one!
Most cryptocurrency investors and traders will disregard ICOs without a white paper, calling them scams.
After announcing the ICO and releasing the white paper, the team will gauge public interest and potentially revise their white paper if needed.
2.3. Creating The Tokens.
Once the white paper is released and it looks like there’s a lot of interest in the project, the ICO’s team then has to actually create the ICO tokens.
This is done by writing up the aforementioned ICO smart contract, which will distribute the ICO tokens at a set exchange rate.
For example, an ICO might issue 1,000 of its tokens for every ETH that it receives.
Some ICOs also include bonuses for early investors or people who otherwise show heightened interest in the project.
For example, if you actively promote the project on social media channels or otherwise improve the ICO’s chances for success, you will likely be rewarded with a bonus.
Instead of 1,000 tokens for 1 ETH, you might receive 1,500, and so on.
2.4. The Token Sale.
Once preliminary marketing has been done, the white paper has been written, and the tokens have been created, it’s time for the actual token sale (another term for ICO)!
Usually marketing will be ramped up even more leading up to the token sale so that the project can make sure it meets its funding goals.
ICOs usually happen at a predetermined date and time, and investors have to be ready to go since some of these ICOS sell out FAST!
Once the ICO launches, it’s a race to send ETH or whatever crypto or fiat currency the ICO accepts and receive some new tokens.
ICOs are used to raise capital, with almost all of this being done via crowdfunding online.
Websites like Indiegogo are some of the most popular for ICO fundraising. These basically allow investors from around the globe to check out new ICO projects, invest and purchase tokens online.
3. The History Of ICOs.
3.1. When Was The First ICO?
Although ICOs rose to fame in 2017, the first ICO actually took place back in July 2013 with Mastercoin, which sought to create a smart contract system for Bitcoin.
Mastercoin raised about half a million dollars and was historic being the first ICO. However, the project and its continuation, OMNI, are largely irrelevant today.
It wasn’t until Ethereum’s ICO in July 2014 that more ICOs started to pop up.
3.2. Are ICOs Always Successful?
While ICOs have become a great new way for projects to receive funding, they have been largely unsuccessful in achieving any post-ICO success.
A study of ICOs in March 2018 found that 81% of ICOs were scams, 6% of ICOs failed, 5% had gone MIA, and only 8% actually made it to an exchange for trading.
(Of those 8%, 1.9% were successful, 1.8% were promising, and 4.4% were dwindling).
In other words, only about 4% of ICOs are successful or show signs of potential.
3.3. Examples Of Successful ICOs.
Here’s some examples of successful ICOs:
1) Ethereum – In less than 4 years, Ethereum has become the #2 cryptocurrency by market capitalization. It has even become the main platform for OTHER ICOs to build upon.
2) NEO – known as the “Chinese Ethereum”, NEO, too, has seen its market capitalization rise dramatically. Recently more and more ICOs are launching on the NEO platform.
3) Stratis – Stratis created a platform that allows businesses to build blockchain-based applications using familiar languages C# and .NET. ICO investors have seen an ROI of 56,000% as of March 12, 2018.
4) Ark – With so many cryptocurrencies sprouting up, it can be frustrating trying to choose one or a few, or getting two cryptocurrencies to work together. This is where Ark comes in. Ark is designed to integrate other cryptos into its blockchain. Interest in this project has led to a 35,400% ROI as of March 12, 2018.
3.4. Examples Of ICO Scams.
Of the dizzying 81% of ICOs that ended up being scams, here's a couple of notable ones.
1)Pincoin/Ifan – perhaps the biggest crypto scam of all time, Modern Tech, a Vietnam-based company, released two Ethereum-based tokens, Pincoin and Ifan. It’s believed that they ran off with $660 million in investor funds.
2)Onecoin – not far behind is Onecoin. Onecoin somehow swindled investors out of $350 million even though they had no working prototype and their site was riddled with spelling and technical errors.
3.5. The Future Of ICOs.
People are now beginning to realise that there’s a lot ICO scams in the industry.
In fact, 2017 was a big year and learning period for both ICOs and investors.
While scam ICOs still trick many investors, a lot of investors have smartened up and are on the lookout for potential scams.
4. The Benefits Of ICOs For Investors.
So why do people invest in ICOs?
Here's a few of the potential benefits for investors...
4.1. Potential For High Growth Returns.
Many investors are attracted to ICOs because of the high growth returns they 'promise'.
For example, Stratis had a 56,000% ROI. That is more or less unheard of outside of the ICO and larger crypto sphere. And even then, it's still extremely rare.
Plus this comes with risk:
The truth is, most ICOs fail...
So never invest in an ICO for quick returns or purely because of marketing hype - you should at least research the foundations, team and business model of a project first.
4.2. Low Barriers To Entry.
ICOs also have low barriers to entry. For example, some investment opportunities in the US require investors to be accredited investors.
Accredited investors need a net worth of $1 million (not including primary residence) or $200,000 income for each of the past 2 years.
On the other hand, more or less anyone can jump into ICO investing. The barriers to entry are much lower.
4.3. You Get To Invest In Projects You're Passionate About.
With ICOs on a tear, there are many projects to choose from. With so much choice, you have the power to invest in the projects you're truly passionate about.
4.4. Potential Discounts.
ICOs also usually offer tokens at a discounted price as a reward for investing early...
However, the token price could easily drop post-ICO too, and this 'discounted price' is only based on speculation.
5. The Disadvantages Of ICOs.
Before you invest in any ICO, you need to really understand that there are serious risks.
Let's run through a few of them...
5.1. Investments Are Pure Speculation.
First of all, it’s hard to know which ICOs will do well since ICO investing is such a new space.
Plus, the project idea may sound great...but is it really going to be practical?
Unless there's a solid working platform or Beta product in place, you're essentially investing based on speculation.
5.2. Most ICOs Fail.
As mentioned, 81% of ICOs have turned out to be scams!
With the lack of regulations, the buzz of cryptocurrency and the amount of money that's flooding the market, this has led to an influx in fraudsters.
I'll come onto some tips for avoiding ICO scams later...
5.3. You Might Be Waiting A While.
While some ICOs have been incredibly successful, this often isn't the case!
You should be ready to take a long-term perspective when it comes to investing, and if you can't then that's a sign that you don't truly believe in the value of that project.
6. How Is An ICO Different From An IPO?
So in terms of definitions, the difference between ICOs and IPOs is that:
ICO = Initial Coin Offering
IPO = Initial Public Offering
But what does that mean for you?
Well, an IPO is for stocks and shares - whereas an ICO is for blockchain related projects.
Here's a few of the key differences between both...
6.1. You Don't Own Shares, You Own Tokens.
ICOs are very different from IPOs in that investors don’t purchase shares of a company.
They merely purchase the ICO tokens and hope that the tokens appreciate in value.
6.2. Less Regulations.
ICOs are also much less regulated than IPOs, which makes it easier for companies to raise funds for their projects.
The biggest problem with this is that almost anyone can launch an ICO, which leads to scams and poorly run projects.
(We'll come onto that later.)
6.3. How To Find The Latest ICOs?
7. The Legalities Of ICOs.
Although ICOs are still fairly unregulated, government bodies are increasingly coming out with legislations addressing ICO launches.For example, the SEC has announced they're cracking down on ICOs scams and requiring that ICOs offering security (equity) tokens register with them or seek an exemption.
8. How To Avoid ICO Scams.
Unfortunately, with the meteoric rise of ICOs comes a new problem:
Fraudsters and scammers.
It's therefore essential to always do your research, before you invest in an ICO.
So here's a few things to watch for, to keep yourself protected from ICO scams...
8.1. Check The Use Case Of An ICO Token.
If the ICO doesn't really require a token, you have to question the validity of their business model.
So make sure you check if the ICO is actually beneficial and necessary for that business.
ICOs aren’t always necessary to get a cryptocurrency project off the ground. So it's important to understand the agenda behind the ICO sale - and whether that project really needs funding.
8.2. Research The Team And Their Experience.
Do they look like a professional team? Do they have experience? Does their leadership team have a strong track record of success?
Although some ICOs are run by professionals with plenty of experience, many aren’t. There have even been cases of 'fake personas' listed on an ICO website.
So it's important to do your research here:
A website and their team may look like the real deal - but you can't take that for granted.
8.3. Read The White Paper.
Though white papers can be very detailed (30+ pages), some are very poorly written, which can be another telltale sign of a scam.
If an ICO isn't willing to invest their time and due diligence into a whitepaper, you have to question how serious they are about the project.
8.4. Do They Have A Working Product?
Also known as “white paper ICOs”, ICOs that don’t have a working product or platform are a huge gamble. Basically, you want to see more than just a 'nice concept'.
For example, a platform running in Beta mode is a good sign that your potential investment is working to deliver on their promises.
8.5. Is Your Investment Deposited Via A Third Party?
If you're sending BTC or ETH directly to an ICO, it's a red flag.
Instead, you should only purchase token sales via a third party. One of the most popular payment processors is Coinpayments.net.
8.6. Bias Influencer Marketing.
You have to be aware that some social media influencers are paid to promote ICOs, which means they'll leverage their audience to drive more token sales...
Quite often, they already know the ICO isn't going to be a hit. But they'll promote it anyway because they're getting paid to do so.
The majority of social media influencers won't promote a shady ICO - but there's still some that do.
And although investors are catching on to this, Facebook Groups and YouTube channels are still prime targets for bias influencer marketing.