Blockchain technology has opened us up to a whole new world of opportunities. I can’t think of anything more disruptive since the internet and smartphones. Apart from birthing innovative new tools, it is triggering a revolution in the financial services sector with ICO as the vehicle. So what is an initial coin offering?
The phenomenon is literally changing the concept of fundraising – and it’s been successful so far.
Thanks partly to media hype, the last 18 months has seen ICOs raise billions of dollars making some overnight millionaires. But what exactly is it? How does it work and how can you participate in it?
What’s an ICO?
You can think of an ICO as the crypto world’s equivalence of an Initial Public Offering (IPO) with which companies sell stocks to raise funds and get a public valuation.
In an initial coin offering, a blockchain startup offers investors units of a new cryptocurrency or tokens in exchange for another cryptocurrency like Bitcoins or Ethereum.
Unlike an IPO where investors are offered ownership of stocks in a company, an ICO offers tokens whose use case is solely based on a promise the platform will be useful in a proposed network when it is built.
Investors Buying into Ideas
In other words, entities that sell tokens in initial coin offerings mostly have not even developed alpha product. This calls to question the legitimacy and appropriateness of this form of fundraising.
An offshoot of this is that the ecosystem has attracted all sorts of teams that are mainly interested in making money even though they have no plans of building something worthwhile that the society could use.
Like selling stocks to grow a company, ICOs are usually used to fund the development of new cryptocurrencies or digital assets. Investors buy mostly for quick profit. Those who obtain the early token of successful projects could enjoy the exponential growth when the coin is listed especially if the project team follows through with its roadmap.
Days of Massive Profits Over
This was the trend in the past but rarely happens these days because ICOs mostly have lost the goodwill it once had. As at 2017 and part of 2018, token buyers routinely gained 1000 percent.
The frenzy over ICOs is usually high as series of activities are lined up. Just being a part of it could be daunting because it is an unregulated space with no clear legal status. Consequently, participation could be premised mainly on trust.
This is where there is a problem. 70 percent of most ICOs launched since 2017 has been shown to be fraudulent. These were launched by scammers that take advantage of the crypto wild west to defraud investors.
This is why you should be extremely careful while participating in initial coin offerings. To participate safely, due diligence is essential, otherwise you’d be donating your cryptocurrencies to scammers.
How does ICOs work?
Initial coin offerings are crowd-funding based on anticipation. The concept is that the investor ideally believes that the proposed project will be a success. The view of the investors ordinarily reflects confidence in the team and the project so they willingly buy the tokens of a specific ICO.
Under an ideal condition, a token should be priced less than $1 based on cryptoeconomics. If things go as planned, a $0.1 token should be worth something higher as the project progresses in development. This way everyone is a winner because the founders have their project funded while the investor makes profit.
ICO teams are usually crypto geeks with exciting new ideas of how to build systems and applications on blockchain such as new dApps. The concept after being internally validated is made public to the crypto community through an announcement.
Whitepapers and Publicity Material
This is accompanied with web publications, whitepaper and social publicity. The whitepaper is the marketing document that argues in favor of the project backing facts and figures with technical feasibility.
As the project gains public attention, the objective of the team in the interim would be to form a community around the project. These would be the core supporters of the project in terms of adoption and testing.
Airdrops Are Free Tokens
For instance, many ICOs commence token distribution through an airdrop which aims to ensure wide circulation of the token. Circulation is also enhanced by encouraging the community use of the token by paying supporters such as marketers and developers with the new token.
Prior to the foregoing, details like future plans or roadmap, number and price of tokens to be distributed are accurately fixed.
The ICO date is announced which is a window period for the sale of the token. The success of the token sale will depend on a number of factors but evinced by the number of investors that actually purchased the token making payments with bitcoin, ether or any other monetary instrument specified by the founders and promoters of the project.
There’s usually a fixed period for offering tokens, after which sales are closed. This is usually detailed down to the exact time, start day and duration. This window period of token sale is what man y refer to as the initial coin offering.
Some of the most successful ICOs have raised millions in hours such as seen with Bancor and Tezor. Although these early ICO were unable to translate their financial success to overall project success.
How can you participate?
For some ICOs, participation can be straightforward while others are a bit more complex. The fact that SEC and other regulators have been trying to classify tokens means that not every token sale is approved in all jurisdictions.
If you’re in the United States, you will do well to crosscheck that the ICO is approved by your government. The same is applicable to Chinese, Korean and to some extent Indian and Pakistanis.
The biggest ICO of 2018 was the Telegram Open Network which was not even open to public but was sold to qualified investors. The report of the sale shows that 68 entities raised $1.7 billion.
Private Sales and Pre-ICOs
Private sale and pre-sales are strategies that teams have employed to sell to institutional and high net-worth individual foreclosing the possibility of having a crowd. However, only very capable and confident teams that have built high reputation such as telegram can limit their ICOs in this manner.
During the crowd-sale, you are expected to transfer your funds to the specified wallet address. There are specified wallets that can hold your token such as MyEtherWallet. This is the wallet of choice for ERC-20 based project and others hosted on the Ethereum smart contract.
Other platforms that are used for smart contract are Waves, Cardano, EOS, Ethereum Classic and Tron. Depending on the specification of the project, the wallet you specify is the one that receives your token during distribution.
Token distribution usually commences after the end of the token sale debar unforeseen circumstances. If all things work well, you should receive your tokens in your token wallet in weeks or months.
What you do with your token depends on your objective of buying it. Tokens are classified as low or high velocity. A high velocity token is one that investors sell immediately it is approved for trading on exchanges.
A low velocity token is one that people will hold longer because they are of the opinion that it has high potentials. For instance people will keep coins like bitcoin, ether and XMR longer than they would keep XTZ and lesser known coins that they do not believe in.
Your token can now be sold and traded on cryptocurrency exchanges if there is demand for them. The start-up usually announces where the token will be listed. You can sell it for some Bitcoins after it gains more value.
Who Can Participate in ICOs
Having known what an initial coin offering is, we should know that anyone that is interested in the coin market can join a token sale.
However, it is important that you research the ICO to know if it is worthwhile. As mentioned earlier, there are many fraudulent ICOs. It is your responsibility to research before you invest.
You’ll at least need to have a moderate understanding of how things work in the crypto world. Read the accompanying whitepaper, join relevant communities and make informed decisions.