What are initial coin offerings (ICOs) and should I participate?
There’s a great deal of interest in cryptocurrency now that familiar coins like Bitcoin and Ethereum have skyrocketed in value since their initial launch. Their success has spawned thousands of other cryptocurrencies and blockchain-based projects that are all competing for the public’s interest.
Initial coin offerings (ICOs) are very similar to initial public offerings (IPOs) of a company stock, and are used to raise capital for a cryptocurrency project by offering the public early access to new types of digital tokens.
What Are Initial Coin Offerings (ICOs)?
An initial coin offering (ICO) is a way for cryptocurrency projects to raise money to fund the project development. Investors are issued a cryptocurrency token linked to the project, which may offer some utility, or simply represent a stake in the project.
ICOs typically raise money in the form of a more established cryptocurrency, such as bitcoin (BTC) or ether (ETH). Participants will also need a basic understanding of how blockchain applications and digital wallets work to participate, which makes it a more advanced investing strategy.
Overall, ICOs continue to be one of the most popular fundraising options for cryptocurrency companies, but come with a higher level of risk than most other crypto investment options.
How Do Initial Coin Offerings Work?
The idea for an initial coin offering is typically presented in a white paper on the website of a new cryptocurrency project. This white paper outlines the project goals and roadmap, as well as the structure of the ICO for investors to review.
Project marketing teams use this white paper to promote the project, teach potential investors about the project team and token, and increase interest in the ICO launch.
There are many ways to structure an ICO, but the most common way is to create a funding goal and sell tokens at a fixed price — typically denominated in a national currency, such as U.S. dollars). This is similar to an IPO in that investors will pre-purchase tokens before they are listed on any exchange to be sold.
For example, a crypto project may have a $500,000 funding goal, and will issue new tokens at $0.25 per token. If it reaches the funding goal, it will have issued 2 million tokens to investors.
Some projects may consider varying the price of each token depending on the amount of funds raised as well. For example, if a project sets a $1 million fundraising goal, issuing 1 million tokens, but instead it raises $1.5 million, the tokens may be valued at $1.50 instead. This way, the project can still cap the supply of tokens released during the ICO but raise more funds.
The cryptocurrency industry is becoming increasingly regulated, and many ICOs now require a process called “whitelisting,” which requires participants to provide proof of identity and residence to get added to a project whitelist. This ensures the participants are legally allowed to participate in the token sale, and anyone from a restricted jurisdiction is blocked from participating.
U.S. residents are often unable to participate in many ICOs due to SEC crackdowns on ICO projects, classifying them as securities sales.
Once a project decides to launch an ICO, here are the steps involved:
- White paper released
- ICO start and end date determined
- Fundraising goal determined
- Whitelist created (if applicable)
- ICO launched
- ICO closed (when funding goal met)
- Tokens Issued
Although there are many variations, ICO fundraising typically follows this process.
To invest in an ICO, you need to obtain the required cryptocurrency (or fiat currency) specified by the project to buy in. In many cases, this will be Bitcoin or Ethereum, although other cryptocurrency may be used.
You will also need a basic understanding of how to use a digital wallet to connect to blockchain applications. To participate in an ICO, you will need to have a digital wallet that holds the cryptocurrency required to buy in, be able to connect it to the ICO platform, and transfer funds over the blockchain to the ICO platform.
Pros and Cons of ICOs
ICOs are an effective way to raise money for a new crypto project, but there are inherent risks involved for investors and project owners alike. Here are a few factors that make ICOs a good investment opportunity, but also a few things to watch out for.
Pros of ICOs
ICOs are a quick way for crypto projects to get funded and off the ground without needing to pool their own capital. They also present a great investment opportunity for those who believe in the capabilities of the team and the roadmap for the project.
Here are a few reasons ICOs are so popular:
- Raise Money Quickly. With an abundance of cryptocurrency projects launching every month, finding a funding source is critical for the success of any project. ICOs are a way to quickly spread the word about a project, onboard new investors, and quickly raise the initial capital needed to launch a project.
- Possibility for Huge Profits. Getting in on the ground floor of a new crypto project with the possibility for outsize returns is why investors participate. Some of the most popular ICOs saw tokens rise in value by 1,000% or more.
- Available to Anyone. ICOs do not require any special licensing or government approval to launch. Any startup crypto company can launch an ICO to raise money for their project, as long as they have the technical know-how and marketing acumen to get investors to participate.
Cons of ICOs
Although ICOs give companies quick access to capital and investors the opportunity to participate in a project they believe in, there are many risks to investing in ICOs. From regulatory challenges to outright fraud, ICOs are a high-risk, high-reward investment. Here are a few negatives to watch out for with ICOs:
- High Risk (“Rug Pulls”). Due to the unregulated nature of ICOs, there is a decent risk of losing your money. Worse yet, many ICOs prove to be outright scams, raising money only for the team to disappear with the funds without ever completing the project. These “rug pulls” defraud investors and make the value of any related token essentially worthless.
- Regulatory Challenges. ICOs have come under scrutiny of regulators around the globe, with the People’s Republic of China outright banning the use of ICOs. The U.S government also has gone after ICO launches that defraud investors, and the SEC warns citizens against participating.
- DIfficult to Participate for Beginners. Participating in an ICO requires knowledge of cryptocurrency digital wallets, connecting to blockchain applications, and an understanding of how to transfer funds on the blockchain. This creates a technological barrier to entry for many participants.
Examples of Cryptocurrency ICOs
Some of the largest ICOs in cryptocurrency history have lost a lot of value, if not all of it. Although Ethereum is one of the original ICO projects, there have been thousands of ICOs since 2013, and many of them are no longer around. Here are some examples of the largest ICOs and how they have performed.
Considered one of the original ICOs, Ethereum raised $16 million to launch the Ethereum network, with ETH tokens originally valued at $0.311 per token. Since then, Ethereum has risen to a value ot over $2,500 per token, giving ICO investors an incredible 800,000% return on investment.
EOS launched the largest ICO in the history of cryptocurrency, raising over $4 billion in support of its project in 2017. The ICO lasted for one year — much longer than most ICOs, which typically last about a week. EOS tokens were sold for about $0.925 per token, and EOS currently trades just above $2.00, which is a 216% return on investment.
Telegram is a popular messaging platform that launched a pre-ICO for its TON token in 2018 for qualified investors. After raising over $1.5 billion, investors were put on hold while Telegram promised to build out its blockchain network.
After battling allegations from the U.S. Securities and Exchange Commission (SEC), the plug was pulled on the project, and investors were promised a refund. Although some of the investors received refunds, about $500 million was never refunded. The TON token we removed from exchanges and the project was scrapped.
PETRO coin is a cryptocurrency that was launched by the Venezualean government supposedly backed by oil reserves.
The ICO was launched in 2018 and raised over $700 million, but the SEC banned U.S. investors from partaking in the ICO fundraising due to existing sanctions against Venezuela.
PETRO is used in Venezuela as a currency, but because there is no public market available for PETRO (it is not listed on exchanges), investors cannot exchange it for an equivalent cryptocurrency or fiat currency.
Initial Coin Offerings (ICOs) vs. Initial Public Offerings (IPOs)
Initial coin offerings (ICOs) and initial public offerings (IPOs) both allow companies to raise capital for launching or expanding the company. Both provide value in offering company stock or tokens in return for the investment, and both are viewed by investors as a way to get in early in an investment.
Although ICOs are commonly compared to initial public offerings (IPOs), they do have some differences. IPOs offer stock in return for your investment, which represents an ownership share in the company. ICOs on the other hand offer the native token for the cryptocurrency project, which does not typically represent ownership in the project, but simply access to the blockchain’s cryptocurrency.
IPOs are also regulated by the Securities and Exchange Commission (SEC) in the United States to help protect investors, whereas ICOs are unregulated, and anyone can create and launch one. This leads to more fraud in ICOs than in IPOs because regulators have little to no control over the crypto companies.
Initial Coin Offering FAQs
Although ICOs can be a great way for projects to raise money and investors to make money, there are also major risks associated with these offerings. If you have ever thought about investing in an ICO, you can review some of the more frequently asked questions to understand whether ICOs are a good idea for you.
Should I Invest in an ICO?
Investing in an ICO is a speculative investment that carries the risk of loss, including total loss of capital invested. If you are thinking of participating in an ICO, do your research — understand the risks involved and learn about the team, the project, and about any other investors involved before participating.
You also need to know whether your country or jurisdiction allows ICO participation. Many projects now whitelist participants and will not allow residents of certain places to participate.
How Do I Buy an ICO?
To participate in an ICO, you typically need to sign up for access and go through a whitelisting process, which includes verifying your identity and residence. Because many ICOs are not offered in certain jurisdictions, projects use whitelisting to ensure you are able to participate.
When the ICO launches, you connect your digital wallet to the platform and purchase tokens using a predetermined cryptocurrency (or fiat currency). Although many ICOs prefer Bitcoin and Ethereum, other cryptocurrencies may be used.
After purchasing tokens, you hold them in your digital wallet. Once the project is added to an exchange, you may be able to trade your tokens for other cryptocurrency.
Are ICOs Regulated?
One of the hallmarks of cryptocurrency is its decentralized and unregulated nature. But while ICOs are not regulated in most countries, there are some countries that have limited or banned crypto projects from participating in ICOs.
For example, China has made it illegal for any companies to launch an ICO as a fundraising platform. The United States also warns against ICO participation, and although it is not illegal to launch an ICO, many projects exclude U.S. residents from participating.
What is a “Rug Pull?”
Although ICOs are a popular way to raise money for a cryptocurrency app or service, it comes with the investment risk that a project could fail and investors could lose money. In the worst cases, the projects prove to be outright scams, with the founding team never intending to launch a completed project.
Fraudsters sometimes roll out what looks like a new altcoin with great fanfare. Then they simply pocket any money eager investors put into it.
When the issuers of an ICO disappear with the investment money, the result is called a “rug pull,” and the tokens issued become worthless. Unfortunately, this is a common scam in the ICO space, so buyer beware when evaluating new token offerings.
How Do I Invest in an ICO?
To invest in an ICO, you will need to join an ICO launch, connect your digital wallet, and purchase tokens in exchange for a more established cryptocurrency, such as Ethereum. You may need to be whitelisted to join or be selected by the project to participate.
After you purchase the tokens, you will need to hold them until they are listed on an exchange for trading. Once they are listed, you can trade them away or purchase more, depending on availability.
ICOs help new crypto companies quickly raise funds to launch their cryptocurrency, and can be a great opportunity for investors to get in on a promising project early. But ICOs are also wrought with fraud, and even successful ICOs could turn out to be a poor investment. Some of the best ICOs have created a massive ROI for investors, but just as many (if not more) of them end up being a loss.
If you are looking to invest in an ICO, you should consider it a speculative investment, with the risk of total loss. ICOs are also banned in certain jurisdictions, and the SEC cautions U.S. residents against participating in them.
Overall, ICOs have their place in the cryptocurrency market, but with high potential rewards comes a much higher risk.