CNBC put out an article in May 2018 entitled ‘a blockchain start-up just raised $4 billion, without a live product.’ Similar stories have been commonplace in the world of cryptocurrencies through ICOs or initial coin offerings,
The project CNBC referred to was EOS, a well-known cryptocurrency for creating decentralized applications and smart contracts. To date, it remains the coin with the most successful ICO of all time in monetary value.
While stock IPOs (initial public offerings), which are the loose equivalent of ICOs in crypto, raise substantially more yearly, it’s impressive how many billions are invested in coins, considering many often do not have a working product yet.
Initial coin offerings have laid the foundation for many of the tokens we know today, with varying degrees of success. 2017 was perhaps the busiest and most lucrative time for ICOs because of the mania surrounding cryptocurrencies.
Of course, we could argue the frenzy keeps increasing as more people have become aware of blockchain technology, meaning investors are peeping at their ICO calendar for the next unicorn.
This article will cover initial coin offerings, how they work, and their benefits and drawbacks.
What is an initial coin offering?
An ICO is a type of crowdfunding for launching a new cryptocurrency. While most initial coin offerings are publicly promoted and rely on heavy public investment, some are privately funded.
In many cases, developers have a distribution plan to allocate some tokens to private investors and the general public. The main objective is for developers to sell a large number of their coins to investors who purchase those typically in BTC, ETH, or even fiat currency.
It’s key to note that the investment doesn’t denote some ownership of the company issuing the coin, like how buying stocks during an IPO means owning a stake of the firm. Instead, the point of investors buying the coin is their belief in the potential future appreciation.
Crypto creators will often have a funding goal and a rough time for when they plan to launch the project into the mainstream successfully. Should these groups not reach their targets, they would need to return the money to the backers, concluding the ICO as a failure.
Most literature frequently makes comparisons between ICOs and the IPOs in equities. Indeed, these share several similarities of companies making a fundraising campaign to pursue expansive growth plans. However, numerous distinctions exist which make for interesting analysis.
While brands that ‘go IPO’ already have a tested and working service/product with massive market share, considerable influence, and substantial profits, most ICOs occur purely based on a detailed whitepaper.
So, let’s explore more about how initial coin offerings work.
How an initial coin offering works
The archetypal ICO begins with an established or start-up blockchain developer/company publishing a lengthy whitepaper. This paper describes in elaborate detail how the said cryptocurrency works and the main problems it aims to solve.
Other key information in these include (but not limited to):
- The amount of money needed to pursue the venture
- The number of tokens to be sold to buyers and kept by the founders
- Exchange currencies accepted
- How long the campaign will run
- The sales cap
- The team behind the cryptocurrency
At this point, the developers will have already created the cryptocurrency to be put on sale and ensure the price per token covers their operating costs. Most coins sold in ICOs to investors are utility tokens, meaning we use them to access some product or service within the blockchain’s network.
In some cases, we have equity tokens affording holders a share in the future profits of the blockchain firm. The second-last step in launching an ICO is the promotion aspect. As expected, companies embark on substantial marketing to attract plentiful investors, primarily through online channels.
Lastly, the ICO would occur in a few rounds lasting for several months. After the campaign has run its course, it may take even longer for the cryptocurrency to publicly launch as developers work on their expansion plans from the proceeds received.
Part of the money is used to list the token on several exchanges, which can cost millions. In the meanwhile, holders of the coin may still benefit (in the case of utility tokens) from a service or product related to the cryptocurrency or simply buy and hold for the long haul.
Investing in ICOs: good or bad idea?
For blockchain developers, ICOs present a much lower barrier to entry to investor funding than going through a traditional investment bank. Of course, investors stand a chance to profit from a potentially lucrative investment if the cryptocurrency performs well in the markets, a case of the ‘early bird gets the worm.’
However, ICOs probably present far more red flags than the upside. Perhaps the biggest concern even today is the largely unregulated and anonymous nature of cryptocurrencies.
Hence, initial coin offerings can become the breeding ground for a host of scams like pump-and-dump schemes and other fraudulent activities. It is one of the reasons why many countries have banned ICOs and most crypto dealings. These are not the only motivations contributing to the high failure rate of such offerings.
In some cases, projects may simply be immature and not present a unique enough proposition to substantially influence the industry. Moreover, because of the decentralized and anonymous nature of cryptocurrencies, sending money to the wrong address or hacking make transactions irreversible in many cases.
Therefore, these are some of the reasons investing in ICOs remains highly speculative and risky, perhaps even more than buying any ordinary cryptocurrency from an exchange.
Despite the many uncertainties in the ICO space, these offerings are responsible for some of the most well-known cryptocurrencies like Ethereum, EOS, Tezos, TRON, Aave, Solana, and many more. Without ICOs, perhaps most of these projects may not have seen the light of day.
However, many investments in cryptocurrencies need a highly knowledgeable investor who has mitigated all the risks as best as possible. It starts with investigating the team behind the coin in question as anonymous developers are commonplace.
The investor will need to perform backed research providing evidence on the usefulness of the technology behind the coin and the feasibility of the long-term vision. Other critical factors also include understanding the supply/demand dynamics and thoroughly reading the Ts & Cs.
Overall, as the cryptocurrency industry grows in leaps and bounds, it won’t be too long to hear of another successful ICO that eventually performs beyond market expectations.