A complete guide to understanding ICOs and working with them
Previously, when a start-up planned to raise capital, it largely depended on IPOs, venture capitalists or other early investors, and its own pockets. However, this was before blockchains, smart contracts, and initial coin offerings (ICOs) were developed. ICOs are a form of crowdfunding where the fundraising business creates and releases tokens — the native cryptocurrency — for investors to buy. By doing so, the business will eventually raise the funds needed for developing a project or carrying forward its vision.
The concept of ICOs is somewhat similar to that of IPOs — both of these crowdfunding techniques allow the speculators to earn monetary rewards in the future. However, there seems to be a lot of confusion around ICOs and their nature; that’s why we have created this guide to help navigate the powerful, lucrative ICO landscape with confidence and efficiency.
What’s an ICO?
An initial coin offering, or ICO, is a relatively new phenomenon that emerged with the innovations of cryptocurrency, crowdfunding, and blockchains. Also known as a “crowd sale”, an ICO is the event where a business releases its native cryptocoin for the purpose of financing. Since 2013, initial coin offerings have been frequently used for funding the development of a new crypto project or native cryptocurrencies. If the native cryptocurrency is in demand, then it may be traded and sold on leading crypto exchanges as well.
While an ICO is live, a business exchanges its native cryptocurrency for Bitcoins, Ether, and other popular digital currencies. Sometimes, a business may even exchange its coins for fiat currencies. The completion of an ICO is similar to the completion of an IPO — the business receives the capital that can be used for growing or continuing its innovation; at the same time, the general public receives tokens/native cryptocurrency. This way, both the involved parties — the business and the investors — profit from the ultimate incentive, which is to witness the rise and growth of a business with new cryptocurrency token.
The investors will back a native cryptocurrency if the project has a rock-solid development team, transparent business model, and strong technological structure. The idea of launching a presale of a bunch of cryptocoins or tokens belonging to a blockchain project has easily evolved into a super-successful instrument of fundraising.
The evolution and history of ICOs
Perhaps the first-ever fully-fledged ICO campaign was launched by Mastercoin. In 2013, Mastercoin promised to develop a layer over Bitcoins to tokenize their transactions and execute smart contracts. In order to complete this project, the development team sold close to 1 million Mastercoin tokens against Bitcoins and raised nearly USD1 million.
In the same year, Ripple Labs also started developing a robust payment system that was known as Ripple. To raise money to kick the platform development into high gear, the team created nearly 100 billion XRP tokens and sold them through a crowd sale.
Similarly, there are many other cryptocurrencies that were initially funded through a well-planned ICO campaign. For instance, Lisk sold coins worth nearly USD5 million in 2016. However, to date, the most notable ICO campaign was associated with Ethereum. In mid-2014, Ether was sold against Bitcoin by the Ethereum Foundation — and the company managed to raise a whopping sum of close to USD20 million. As a result, this ICO campaign has become known as one of the biggest crowd sales in the history of ICO.
With Ethereum came the benefits of smart contracts — the technology that ushered in the next generation of initial coin offerings.
Top terms that ICO investors should know
A blockchain is a type of distributed ledger that has a lot of digitally recorded, unchangeable data stored in packages; these packages are called blocks. Instead of storing the data on a single sheet of paper, it’s located on different blocks — hence, it’s called a distributed ledger. Every single block is then chained to the very next block using a special cryptographic signature. All of this allows the blockchain to be used as a distributed ledger. The blockchain can be easily accessed and shared by anyone with the appropriate permissions.
During every ICO sale, the company issues cryptographic tokens to the investors. These tokens can be transferred or traded across a number of cryptocurrency exchanges once the project becomes successful. These tokens can even be used for performing specific functions such as entitling the token holders to company dividends or to granting them access to an ecosystem’s services. There are a number of tokens made available by a company during the ICO sale; some of the popular ones include equity tokens, securities tokens, and utility tokens.
ICOs are the events where a company sells its digital tokens to all those who believe in the seller’s vision and project. These events are called ICO sales. These sales are further divided into two varieties including presale and public sale or crowd sale.
Also known as pre–ICO, the ICO presale is an event that lets the blockchain enterprise sell the tokens before the ICO campaign or the crowd sale goes officially live. The fundraising targets for the pre–ICOs are lower when compared with those set for the main crowd sale. Usually, the tokens that are sold during this phase are cheaper than the ones sold during the main ICO event.
Unlike an ICO presale, a crowd sale is a public sale that’ll let all the investors take part in the process of buying tokens. During crowd sales, businesses will sell the tokens at a price that’ll be a tad higher than what it was during the presale.
How are ICOs created?
Initially, the concept of ICOs wasn’t mature — but, today, initial coin offerings have become more methodical than before. The success of an initial coin offering in the already-crowded cryptocurrency landscape depends on the way a business presents its tokens, earns community trust, and gives value to the investors.
The process begins with preannouncing the cryptocurrency project. After making the preannouncement, the development team releases the whitepaper that’ll include the project’s summary and other details. These details are related to the development roadmap, business models, integration of different currencies within the project, development team, and how the project will benefit the community.
Such preannouncements are usually done on different core community platforms including Bitcoin Talk and Reddit. Generally, the community quickly gives feedback on these preannouncements; such feedback gives the development team enough time to implement improvements. Ultimately, these improvements will make the project gain more traction among different investors.
The offering phase comes right after the preannouncement stage. In this phase, the development team offers a well-defined contract that describes the transactions’ terms, the project’s lifecycle, target investment amount, and related deadlines. This phase will even include the financial instruments, or digital tokens that are to be traded.
The offer will further define every single rule that governs investors’ rights and token usage. In this phase, the core development team announces the starting and ending dates of the ICO. Always note that a crowd sale can be divided into multiple sub-stages as well.
Marketing and sale
Also known as a PR campaign, a marketing roadmap can make or break an ICO campaign. In the past few years, investors have witnessed a lot of ICO programs conducted annually; all of this has made marketing very challenging. Right now, businesses may hire agencies that are specialized in developing and deploying marketing strategies especially for the cryptocurrency landscape.
Whenever the marketing phase is completed, the actual sale of tokens or native coins begins. Two of the most popular sale channels picked by many businesses consist of special project sites that are organized by an investor’s office and cryptocurrency exchanges. Many companies launching their ICO campaigns even offer early-bird discounts of close to 25%, but these discounts or bonuses gradually decrease if the sale is divided into multiple stages.
The basic difference between ICOs and IPOs
At face value, IPOs and ICOs may sound similar; their familiarity is obvious in the way both of them raise capital. Nevertheless, these two crowdfunding strategies are different with regard to their regulatory frameworks and mechanics. In this section, we’ll cover the basic aspects that set these two crowdfunding techniques apart from one another.
It’s a mandatory requirement for a company to register itself with a regulatory authority if its wants to roll out an IPO. Before issuing its IPO, a business will even have to submit a legal document that’s known as a prospectus. The prospectus represents a complete legal declaration of the business’s intention to issue the shares to the investors; the legal document needs to meet specific transparency standards. Furthermore, the document must include key details about the company and its IPO so that the investors can make an informed decision.
ICOs, on the other hand, are never bound by any such legal requirement; that is, the companies issuing ICOs do not have to register themselves with a regulatory authority. Such businesses, however, just need to submit a document in the form of a whitepaper—this is a document conceived by the core development team, and it outlines key details about the project, its purpose, team, and working. Nevertheless, there isn’t any specific standard or protocol followed while writing an ICO whitepaper. Because of this, a team can decide what information to include (or exclude) in their whitepaper.
Credibility and track record
There are a lot of requirements a business needs to meet before using an IPO to list its shares. For example, a business planning to launch its IPO needs to show a specific minimum earnings’ threshold and an excellent track record. To show its credibility, a business needs to have different professional accounting firms verify its accounts; also, the firm’s investment banks must act as its underwriter for the deal. These processes become a natural filter and will only let the most credible businesses list their shares. Also, most businesses that have thought of going public have also been funded by different institutional investors including private equity firms, angel investors, and venture capitalists, to name a few. All in all, if a business wants to take part in an IPO, it should complete a rigorous due diligence process.
However, since many ICOs need not conform to legal protocols or specific regulatory framework, a majority of them don’t necessarily have a track record; only a simple whitepaper backs a crypto project. While there may be some projects with a fully functional prototype (in either alpha or beta stage), many projects only have a conceptual framework that is detailed in a whitepaper. This is one reason that makes investments in ICOs risky. However, it’s definitely true that speculators may gain a sense of satisfaction by going through the development team’s experience and the project’s concept.
All the stocks acquired via an IPO signify an ownership stake on all the future earnings of a business. Furthermore, the stock can be divided into a variety of classes such as preferred stocks, hybrid stocks, or common stocks. The holding stock’s utility, however, will be the entitlement of different shareholders to receive dividends and have a clearly defined vote at the shareholders’ meeting.
Unlike an IPO, acquiring a bunch of ICO coins doesn’t grant any sort of ownership in the project. There are countless ways an investor of a coin may earn future benefits, but that’ll actually depend on how the coin is structured. In general, a cryptocoin’s value will directly correlate with the perceived utility. A few coins may generate value by letting the token holders have a stake in the project’s future revenue; while there’ll be some coins that’ll equate their values to the ecosystem’s usage. Put simply, if a coin has more adoption, its value will be higher.
How should a speculator invest in an ICO?
Well, as we’ve covered the benefits, now it is time to know the steps that’ll help speculators invest in an ICO and experience the related advantages. Today, speculators are investing their capital in ICOs. Joining an ICO sale is not rocket science — an investor needs to have funds, an internet connection, and an Ethereum wallet. But we’ve seen a lot of investors who become confused when it comes to buying tokens during an ICO sale. That’s why this section will be dedicated to demystifying the process of buying ICO coins.
Get a crypto wallet
Investors, first, need to get access to a wallet that’ll store their crypto assets such as tokens and digital coins. Some of the top crypto wallets for an investor include MyEtherWallet, Cipher Wallet, Parity Wallet, and imToken Wallet. We suggest getting MyEtherWallet as it’s ideal for storing the tokens based on the Ethereum blockchain. (Most of the tokens today are ERC20 compatible and are based on this blockchain.) Once the wallet is set up, the investors will register on a cryptocurrency exchange so that they can buy Ether or other cryptocoins.
Register on a cryptocurrency exchange
Before participating in any ICO sale, the investors will need Ether or any other cryptocurrency that’s accepted for buying tokens. Fiat currencies may also be used for buying tokens, but that is not always the case. Right now, there are many prominent crypto exchanges used for buying coins; some of the top ones include CEX.io, Poloniex, and Kraken.
Own cryptocoins and transfer them to the wallet
Buying Ether, or other cryptocurrencies, becomes simple and quick once investors have registered on an exchange. On the crypto exchange, the investors need to buy cryptocurrency. Once the cryptocoin is bought, it’ll be stored only on the exchange’s account. At this time, the investors should transfer the purchased digital coins into their respective crypto wallet.
Buy the tokens with cryptocoins
Once the coins are stored in the wallet, they’re set to be used for buying tokens. However, before buying the tokens, the investors need to find a credible ICO sale. After finding an ICO campaign of a well-reputed company, an investor should buy its tokens by sending a specific amount of cryptocoins to the crowd sale’s wallet address.
The steps to evaluate an ICO campaign
In order to evaluate an ICO campaign, an investor should analyze every single aspect of the crypto project ranging from its overarching concept to the execution strategy. While analyzing any ICO project, the investors need to consider the following factors.
Identify all the weak links and strong points of the business model of the company backing the project. The investors need to ask some questions such as:
- Does the company need an ICO?
- How does the company integrate crypto tokens along with its existing business model?
- Is it possible to use the crypto tokens outside the company’s proprietary ecosystem?
- Is the project’s technology feasible?
After analyzing the business model, the investors should lay their hands on every single detail available about the project’s team and its advisory board. It’s better to invest in only those ICOs whose teams have experience in managing crypto assets in the blockchain space.
ICOs are mostly announced on leading community forums; afterward, the marketing and promotional parts kick in. First, the investors need to check the community feedback about the ICOs. The investors need to visit the Twitter, Facebook, or Reddit pages of the project and sense the community’s mood about the ICO campaign. However, the investors need to be aware of different bounty posts or paid reviews where the participants are paid for propagating positive information and opinions on the project.
Current product state
Every ICO has a product that’s near completion or at least halfway down the total development track. If the project’s product status is something like that, then it makes complete financial sense to join the ICO sale. It is then essential for investors to find out whether the project is on the right development track or not.
Understanding the market niche
Last but not least, investors need to understand the intensity of the competition that the project/product is facing or will face. Investors need to do a lot of research to understand whether or not any other business is working on a similar project.
Differentiating a reliable ICO from a scam
Right now, the ICO frenzy is taking the entire crypto ecosystem by storm. It’s true that nearly one ICO sale is happening daily — that’s why it becomes all the more important for an investor to separate a great ICO opportunity from a scam. In this section, we provide important information that will help speculators identify an ICO scam.
Lack of well-defined team profiles
If an ICO campaign doesn’t provide social profiles of every team member, it’s most probably a scam. Basically, there should be at least one member who may represent the entire team and who should have rich crypto-related experience under his belt.
Missing or compromised escrow
The absence of a well-defined escrow account is one of the brightest red flags that the investors need to identify. Likewise, if an escrow is programmed to release 100% funds to the core development team right after the ICO sale is finished, then it’s definitely a bad arrangement. An ideal escrow will make sure that the fund release should happen pretty gradually — for instance, 20% of the funds should be dispensed after token distribution, 40% right after the beta release, and other similar milestones must be met.
If the whitepaper lacks technical detail, then it’s not worth reading. For example, if an ICO has been developed with an aim to disrupt an entire industry and it’s not providing any concrete details (both operational and technical) about how will it do it, the ICO isn’t trustworthy.
If an ICO makes bold claims but doesn’t have a specific roadmap that has realistic milestones/goals, then it’s better to avoid investing in this project. Furthermore, if the team has provided its own roadmap, then it also makes complete sense to make sure to judge the project’s operational and economic feasibility.
Missing code repository
This is yet another shot at determining whether an ICO is a scam or not. The investor should look for the code repository — if it’s missing, then the speculator should avoid the ICO campaign altogether. Every reliable ICO will plan to release its project code to different public repositories.
A disproportionate mining structure
To identify whether an ICO is a scam or not, investors should check the mining structure of the tokens; this information must be available in the ICO whitepaper. For instance, an investor can simply check the number of tokens that are premined and reserved for the developers or early investors. If the value of the premined tokens is high when compared with the value of the total mineable tokens, then the ICO project isn’t worth trying.
Where to store the purchased tokens?
All the purchased token will be stored inside a digital wallet; storing tokens is similar to storing the cryptocurrencies such as Bitcoins. However, the wallet you pick to store the tokens will depend on which blockchain the tokens are issued on. For example, all the ERC20 tokens are issued on the Ethereum blockchain. So, if investors are buying ERC20 tokens, they should store them in any of the available Ethereum wallets.
However, if the investors are concerned about their crypto wallet getting hacked, then they should choose an offline wallet. For instance, there are many paper wallets available that can be used for storing tokens offline. The best thing to do in this regard will be to follow all the instructions given by the ICO organizer.
The investors may even ask the organizers questions related to storing the tokens; these questions can be asked on an organizer’s social media channels — always remember that an ICO organizer will be the best guide to understanding which wallet will be best for storing their tokens.
The benefits of investing in ICOs
The fact that ICOs are open to the public means that nearly anyone can join the crowd sale if they can transfer the funds on time. In addition, this means that the projects can raise the funds in a purely decentralized way. As more and more investors take part in an ICO sale, the less centralized the entire project becomes — and that’s precisely what the concept of cryptocurrency is all about.
By joining an ICO campaign, investors can shape the future of different industries and can disrupt the entire commercial ecosystem. Right now, there a lot of projects raising funds using ICOs; every crypto project plans to bring something innovative to the table. A large selection of crypto projects raise a lot of money while their ICOs are live and that’s because during crowd sales, speculators can buy the tokens at really rock-bottom prices.
Also, ICOs always follow a defined and limited demand-supply principle. As a result, cryptocoins gain immense value with time. The initial investors of an ICO could simply leverage this principle’s economic prominence — that’s what improves their chances of gaining exponential profit in the future.
In the existing cryptocurrency landscape, investors can simply use crypto tokens for buying services that are offered by the ICO organizer. If the token manages to gain traction and market trust with time, the chances are that it’ll eventually also be used for making a number of third-party purchases — similar to what investors can do with Bitcoin.
Eventually, many exchanges will begin trading these tokens if the project becomes successful in the future. From a purely speculative viewpoint, ICO campaigns are worth the risk and that’s why more and more investors are making a beeline for these projects.
The regulations governing the ICO world
In terms of regulations governing the bold world of ICOs, there are no rigorous laws or regulations managing these crowd sales. Instead of legal regulations, most of the ICOs are governed by public vigilance and other promoting practices such as the blockchain technology which provides complete transparency.
Industry experts are expecting some of the top national governments to step in and introduce new regulations governing the ICO world. One of the top regulatory developments for governing the ICOs has been introduced by the US Securities and Exchange Commission (SEC).
In its recent ruling that was passed on July 25, 2017, the SEC described a few of the “coins” that are offered during ICOs as securities and has applied its own regulations to them. The SEC has even released its ICO investigation, which was conducted last year; the DAO has been addressing some chief issues that involve ICOs. A few key findings of that investigation report are given below.
The report states that all the fundamental principles governing the US federal securities law are becoming applicable to a whole new paradigm. This paradigm includes the virtual capital-raising entities, or organizations, leveraging blockchain technology to facilitate the investment and/or capital-raising exercises and other related sale and offer of securities.
Furthermore, one noteworthy declaration made by the ICO report was related to smart contracts. By automating certain functions of a contract through the technology of smart contracts or a computer code, a party does not essentially remove its conduct from the purview or scope of other US federal securities laws.
Nevertheless, the SEC stated that whether or not an issued coin qualifies as a legal security will depend on the definite “facts and circumstances” of different individual ICOs.
The future of ICOs
It’s evident that most ICOs have seen success, and some of these projects are based on a robust foundation. However, the entire ICO market is still evolving, and it’ll experience some radical transformations in the near future. Right now, one of the top factors fueling the existing ICO frenzy is the lack of regulation — but that, too, is changing gradually.
As the ICO–related regulations are becoming more mature, we can expect some sort of red tape to happen around ICOs in the future. However, applying some strict regulatory frameworks isn’t necessarily bad news because it will help separate the good ICOs from the bad ones and the potential scammers. For every regular investor it’s important that the risks, benefits, and legal upswings of the ICOs are factored in, well before investing.