Beginner Series

Initial Coin Offerings (ICOs)

Shorthand for 'Initial Coin Offering', ICOs are making global headlines -- usually for one of two reasons.

Capable of raising staggering sums of money in zero seconds flat, some ICOs have gone on to handsomely reward early investors. Others, however, have exited the crypto marketplace as fast as the money came in, leaving enthusiasts high and dry.

So, just what is an ICO? And are they legitimate vehicles for your cryptocurrency investment?

What is an ICO?

Headlines and hype aside, an ICO is simply a way of raising funds for a blockchain project.

To say that blockchain technology is one of the greatest technological innovations of the century would not overstate its importance. The technology behind cryptocurrencies absolutely promises to revolutionise the internet, trade and life as we know it.

Developers and entrepreneurs see this as opportunities to create new markets and are busy creating new and innovative blockchain applications -- new ways of using blockchain technology.

However without capital, a good idea is just that: a good idea. Developers and entrepreneurs must raise funds to finance new blockchain applications if they are to ever become reality.

And this is where ICOs come in.

In contrast to traditional fundraising methods i.e. banks and venture capital, ICOs represent a comparatively easy way for blockchain developers to raise the capital needed to kick-start their projects -- without selling out equity or jumping through as many regulatory hoops as IPOs (Initial Public Offerings) entail.

How do ICOs work?

The average ICO campaign looks something like this:

  1. Blockchain project developers invite the public to invest in their idea. This proposal involves the pre-purchase of crypto coins or tokens set to be created by the application. Investors hope that these coins/tokens will appreciate in value over time.
  2. In exchange for the promise of crypto coins/tokens (after the project's development and launch), investors provide fiat or crypto (usually bitcoin or ether) capital to help fund project development.
  3. The blockchain project secures enough capital to kick-start development.
  4. The blockchain application launches and early investors are provided their promised crypto coins/tokens for personal use or investment.

So an ICO looks something like a crowdfunding campaign or initial public offering (IPO). However, unlike a crowdfunding campaign, local laws may not protect contributions (depending on the jurisdiction). And unlike an IPO, ICO investors often do not receive a share of company equity.

Choosing an ICO

ICOs can represent great opportunities for investment, however they can also pose great risks.

ICOs are highly speculative. Investors help to kick-start blockchain development projects in the hope of reaping a good return. Given that the promised crypto coins or tokens have not yet been created and the industry is only loosely regulated, investors also hope that developers make good on their promises. There have unfortunately been many ICO scams that have attracted investor funds, and then disappeared.

So, given that the ICO industry is (for now) largely unregulated -- and there are as many ICOs as there are potential blockchain uses, would-be investors should exercise caution as they consider their options.

Some areas for ICO due diligence include:

  • ICO white paper: This should provide details of the ICO campaign and the blockchain project it plans to fund. A legitimate ICO will seek to encourage investor confidence via an informative white paper. Is the project seeking to address a legitimate need?
  • Development team: Does the team behind the ICO have blockchain development experience? Are they real people who can be contacted and are accountable to their investors?
  • Project code: Does the project already have a working product? Is there an active community on GitHub contributing to the code and troubleshooting issues?
  • ICO campaign transparency: Many an ICO has kept the progress of token sales a secret in order to create a sense of urgency and FOMO (Fear of Missing Out). In such cases, often the opposite is true. Legitimate ICOs will seek to bolster consumer confidence by making the progress of token sales transparent.
  • Structure of the sale: What rights do coin-holders have? What discounts are available to early investors? Some ICOs try to create FOMO by heavily discounting early investors and raising the token price throughout the sale. What will the funds be used for, and how will they be controlled?

The choice is yours

Just like the innovative blockchain projects they fund, ICOs represent innovation in fundraising. A fast, decentralised way to raise capital, ICOs are the new kid on the fundraising block.

Great gains can be made through ICO investments -- as can great losses. Markets will always be unpredictable, however investors can improve their chances of celebrating -- and lessen the likelihood of commiserating -- by choosing carefully between ICO campaigns.

Keep exploring the Cointree Learning Hub for more tips on choosing a smart crypto investment.

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