One of the biggest trend in cryptocurrency today is Initial Coin Offering (ICO).

The idea of pre-selling cryptocurrency coins or tokens for a blockchain project is becoming a successful instrument for raising funds.

An ICO is when a new cryptocurrency project sells a part of its cryptocurrency tokens to the intended followers or anyone who believes in its cause – in exchange for money today. Project creators can raise money for their operations with ICOs. It’s sort of an Initial Public Offering with a crypto base and without the usual financial regulations.

The first ICO took place in 2013 when Mastercoin performed a crowdsale of its token on Bitcointalk.org forum. The ICO starts before a project is completed, and helps fund the projected expenses before launching. Some larger projects choose to keep the money in a foundation that will provide continued support for the project.

How do ICOs Work?

You can declare ICOs on different cryptocurrency forums such as Bitcointalk. The declaration should contain key information about the project. They include whitepaper, project goals, timelines for the ICO, project development, personnel involved, the experience of team members and features of the project.

ICO funds are collected in Bitcoin via a global or public address. Best practice demand all funds be held in a multi-sig address that is public. Specific movements of an ICO may differ. It takes a few weeks of trying to raise as many funds as possible subject to demand. Some ICOs can cap the total amount raised such as DigixDAO which capped their fundraising at $.5.5 million. Most companies will keep a few tokens for early promotion bounties. They include forum social media and newsletter campaigns.

After the conclusion of the IPO and the project launches, the ICO tokens are listed on crypto currency exchanges to trade against other cryptocurrencies. The price of the token is a reflection of the cryptocurrency market mood, project-specific news, and extra new features. Currently, the largest exchange by volume is Poloniex.

History of ICOs

In 2013, several projects begun using a crowdsale model to fund their development. Ripple was the first cryptocurrency to be distributed by an ICO. In early 2013, Ripple pre-mined 1 billion XRP tokens which were sold to investors in exchange for fiat currencies or Bitcoin. The funds raised were used to develop the Ripple platform.

In early 2014, Ethereum Foundation sold ETH against 0.0005 bitcoins earning over $18 million. It was the largest ICO raised at the time and serves as the foundation for the development of Ethereum.

Another early adopter for ICOs for cryptocurrency projects is Mastercoin, which crowd funded on Bitcointalk forums. The developer received $1 million after developing Mastercoin tokens against Bitcoin. Mastercoin managed to raise approximately 5,000 bitcoins at the rate of 100 Mastercoin (MSC) per BTC. Other popular cryptocurrencies that have been developed through an ICO include Lisk, Bitshares, NXT, Maidsafecoin, NEM, Synereo, DigixDAO, Waves and Factom.  

Evolution of ICOs

ICOs are a blend between donations and investments. Due to various scams in the industry, the community chose to self-govern best practices and principles in relation to ICOs. Platforms such as the now closed Koinify promised due-diligence of projects before listing and releasing the funds to project teams. This was done after achieving some pre-defined goals. Community members also requested projects to use multi-signature wallets to enhance security. Some ICOs use one public Bitcoin address to raise funds. Though it lacks privacy, it allows the community to audit the health of the ICO and the money raised.

Legality

The legality of ICO is vague. The token is sold as a digital good and not as a financial asset. This is why ICO is often referred to as “crowd sale”. As a result, most jurisdictions do not regulate it. This simplifies the process making it paperless. But some jurisdictions are aware of ICO and thus regulates them similar to the sale of shares and securities. The dramatic collapse of DigixDAO caught the attention of some regulators. Most ICOs today take place in a gray area, though that may change in future. This could, in turn, expose investors to financial and legal risks. Additionally, the cost and effort to abide by the regulations could lower the advantages of ICO in comparison with traditional funding methods.

Should You Invest?

Any investor will be excited by the returns and increase in market capitalization of crypto currencies. Despite the great opportunities, there are also risks that need to be factored before venturing into the blockchain world. This is true for investments that can give investors more than 100% profits within a short period. But investors should first consider the pros and cons.

Pros

  • Despite the increasing competition from new entrants, many companies have succeeded in raising capital through ICOs
  • The high ROI provides an opportunity for risk takers. When returns are high so are the risks
  • ICO tokens are liquid making it easy for investors to cash in and out anytime. You can convert ICO tokens into Bitcoin and other cryptocurrencies
  • ICOs don’t have fees similar to those investors in IPOs face.

Cons

  • ICO is littered with failures, with copycat projects or projects failing to achieve their goals. This has driven the value of some initial coins to zero
  • The lack of regulations and due diligence can expose investors to Ponzi schemes and scams
  • You are unlikely to recover any investment lost in scams and frauds.

How to Spot a Potential ICO Scam

The cryptocurrency community has had its fair share of scam ICO campaigns in the past. Some red flags to look out for are:

  • Anonymity – If the brains behind an ICO don’t disclose the identity and reputation, they can easily get away with a scam
  • No escrow wallet for contribution: If the owners of a project have exclusive access to donations, nothing would stop them from disappearing with your money
  • Unrealistic goals: A project that lacks a clear roadmap means the owners don’t know what they’re doing or don’t intend to deliver
  • Lack of transparency: Showing work-in-progress of your project is the industry standard in crypto. If the developers don’t release relevant demos, it could be they’ve done nothing.