As cryptocurrencies have grown in prominence over the last few years, the world has been introduced to the Initial Coin Offering, otherwise known as an ICO. These entities are almost the crypto equivalent to an Initial Public Offering, or IPO, and serve as a way to fund up-and-coming cryptocurrencies or crypto projects.
This article will take a look at ICOs. Specifically: what they are, how they work, and their advantages and disadvantages.
What Is An ICO?
As stated above, ICOs are the crypto equivalent of an IPO that exist primarily for startups to fundraise their projects. Any company looking to raise capital to develop and create a service, coin, or application can launch an offering to meet a particular investment goal.
Investors who are interested in providing some of the capital can buy into the offering, and thereafter usually receive tokens from the company in exchange. A token can either be representative of a stake in the crypto company, or it has some form of utility in the company’s service ecosystem.
The first offering was held in 2013 by Mastercoin (now Omni Layer), but the most renowned offering in crypto circles was created by Ethereum in 2014. It shattered the amounts previously earned at the time, eventually culminating in the world’s second-largest cryptocurrency as well as Ethereum’s distributed application network.
How Do They Work?
While the general premise is simple enough, how do these offerings actually work?
Startups seeking to raise capital through an offering usually create what is called a white paper. This white paper provides an outline of the startup’s project. Specifically, it details what the project entails, what need it fulfills within the ecosystem of the marketplace, the investment goal, and how long the public offering will last, amongst a few others.
After the announcement and initiation of the public offering campaign, investors often buy into the project for an exchange of the project’s tokens with either digital or fiat currency. While these tokens can be used within the ecosystem of the company’s services, they are also used as representative of a stake within the company. In other words, they are comparable to owning shares, although tokens don’t have intrinsic value in the same way as shares do.
If the minimum funding goal is not reached, the money is then returned to the would-be investors. If the ICO is successful, the raised capital is then used to fund the goals of the company’s project.
What To Do Before Investing
Needless to say, investors will need a cryptocurrency wallet and account set up to purchase a stake in the startup’s project.
However, potential investors should not simply dive into an offering without first researching it (and what niche the company purports that it will fill). A good investor will research the startup team, as well as the strength of the project in general before investing. It can’t be said enough: research the white paper, the development team, as well as the board members involved before investing.
Finding an offering to invest in is not always simple, but information can be gleaned from online resources. As companies that launch offerings generate much fanfare for their potential product, an investor can go onto numerous discussion forums and the like to find this information. Furthermore, there are sites that aggregate available offerings, which makes research easier due to investors being able to compare and contrast what’s out there.
The Difference Between An ICO and An IPO
Companies that aren’t in the world of cryptocurrency traditionally raise their funds in several ways.
There is the usual gradual growth and development through profit, which keeps the company obligated only to the owners themselves. An alternative is to seek outside investment to jumpstart the company’s projects. Of course, the catch here would be that these outside investors will often hold a stake within these companies proportionate to their investment.
Another way to raise funds is to seek capital through public investment. This is done by selling shares to investors through an IPO.
Contrasting ICOs and IPOs
In contrast to IPOs, which are primarily related to investments, an ICO offers an opportunity for individuals that are interested in a particular project, akin to crowdfunding. Of course, there is always the assumption that there will be a return on investment in some form, usually an offering of tokens. The similarity to crowdfunding is why these offerings are often called a crowdsale.
There are also two other differences to IPOs that ICOs have. As stated above, they are not regulated to the extent that IPOs are, which means that there aren’t organizations that oversee their operations. The second difference lies in their decentralization, due to the nature of the blockchain system, providing different types of structure that the offerings can take.
In the first type of structure, a company can set a specific funding limit that represents the static supply of the available tokens. Another structure is to have a limited supply, but then to have what is called dynamic funding. Dynamic funding simply means that when the tokens are distributed their overall price will be higher in proportion to the final funds received.
Another structure is to have a dynamic supply of tokens that increases according to the amount of received funding. In other words, the token price is static, but the entire total of the tokens is unlimited for as long as the offering runs for.
Advantages and Disadvantages Of ICOs
Now that we have gone over the general characteristics of ICOs, below we’ll go over the main advantages and disadvantages of investing.
We’ll start with the positives. There are obvious advantages for the companies that have created an offering, but what advantages do they hold for investors?
While regular IPO investments confer shares in a particular stock, ICOs don’t provide shares as such. Instead, investors will receive what could be considered the blockchain equivalent, which is a token of the cryptocurrency. It’s easy enough to create these tokens, and they do not have any legal guarantee or intrinsic value as such.
The major reason for investing to receive tokens is for the potentially massive return on investment that some offerings can provide. If it’s successful, the value price of the token will shoot above the set price, creating short-term gains.
In the long term, the continual growth of the cryptocurrency project would confer further gains. Indeed, many investors have transformed into millionaires through these investments. Once successful, there is the potential for massive growth and a high return on investment as a result.
Of course, there is a downside to investing in an ICO, as they’ve brought new issues and challenges to light since their inception. The enthusiasm of investors that have seen the success stories of particular offerings has been the cause of many risky investments.
Due to their unregulated nature, the main issue with offerings is that there are countless scams and instances of fraud to look out for. Investors need to do sufficient research, or they may fall prey to these traps. To make it worse, as governmental organizations do not oversee their operations, an investor will lose the money that they’ve put into the offering if something were to happen.
Due to the sheer number of scams out there, some countries have banned offerings to safeguard the stability of the financial markets. As a result, regulation has come more in the form of banning than actual control of existing offerings.
Often, scams resemble the real thing, with a website and promises of a grand vision. Those who fall prey to them are often asked to deposit their coins into a compromised crypto wallet.
Thereafter, it isn’t long before the scammers “pump and dump” their coins. This is when the scammers create hype for a particular offering in order to create and sustain sufficient interest, thereby inflating the worth of the tokens, before dumping the tokens for a quick and easy profit.
A potential investor never knows for sure whether they’ll lose out after investing. For every Ethereum there are countless others that are seeking to take the money and run. Conversely, there may simply be ill-conceived projects that will never be successful beyond the planning phase due to issues of scaling.
Knowing the potential for scams and fraud is crucial for successful investment.
Take Heed For An Enticing Prospect
This article has detailed the general overview of ICOs. Specifically, it’s taken a look at what they are, how they work, and what a potential investor should do before giving up their money. Thereafter, it contrasted the differences between an ICO and an IPO, before detailing the main advantages and disadvantages of investing in these offerings.
At the end of the day, these offerings are a new way of investing in exciting new crypto projects that could provide a large return on investment. The flipside to this is their unregulated nature, providing the opportunity for scammers and fraudsters to trick unsuspecting investors. Proceed with caution, and always do your due diligence.