What Is ICO?
Initial Currency Offering or ICO is a way in which funds can be raised for a cryptocurrency process. It is completely unregulated and is similar to a crowdsourcing or crowd funding tool. Typically, it is used by new startup companies to avoid the regulative authority often involved in the capital-raising process that is typically controlled by banks.
During an ICO campaign, early endorsers of the project can actually gain a percent of the cryptocurrency, often in exchange for bitcoin. To encourage investors to buy into the project, entrepreneurs usually present a white paper, explaining what the companies plans are, how it will grow and other information such as a target budget. It is at this time that investors purchase tokens and the crowdfunding campaign for the project begins.
The hope for investors is that once the launch is successful and the company reaches a level of profitability, their tokens or coins become more valuable. Since the ICO project begins before the actual project is initiated, investors always take the risk that the startup fails once it launches and their investment becomes worthless. However, there have been several noteworthy cases where investors have gained massive returns on their investment through ICO projects.
It is important to understand that while it is often referred to as crowdfunding, it is not the same. During crowdfunding campaigns, investors are making donations. Through an ICO, investors are completing the action for the potential of an ROI. As such, ICOs can more accurately be described as crowd sales.
The History Of ICO
ICO is still a relatively fresh tool for entrepreneurs, but over the years it has grown in popularity. It began with the Mastercoin campaign in 2013. During this time, investors could support the company and get Mastercoin tokens as a reward. It was one of the first ventures of this kind to be completed entirely through peer to peer lending.
Many other startups were inspired by the idea and followed suited. In 2014 the Ethereum project used the blockchain for its own ICO, raising $18 million in bitcoin. This was a project that opened the process of ICOs to the masses, and since then there have been a number of record breaking ventures in both 2016 and 2017.
Although ICO is still a fresh idea and only takes a small percentages of the crowdfunding capital globally, it continues to evolve. Despite being less than one percent of the total crowdfunding volume, one project, entitled “DAO” was able to make one hundred and fifty million in bitcoin. Other projects include Status with $100 million and EOS which has thus far raised $185 million and is ongoing.
Types Of ICOs
Since there is a lack of regulation for ICOs, there has been a lot of freedom on how to run the projects. This has lead to the development of various different processes and strategies that entrepreneurs have used to run an ICO. There are currently a total of four different price mechanisms for an ICO.
- No Fixed Price
It’s possible for developers to choose to sell their tokens without a fixed exchange rate. Instead, investors are encouraged to buy into the startup, and then each investor is given a number of tokens that matches up to the percentage of investment that they injected into the project. During this process, the price of each token can be determined by how many people actually invest. In cases like this, if only one investor funded the company they would receive all the tokens.
- Fixed Pricing
If the price of the tokens is fixed at a certain exchange rate, investors can buy as many as they like. This means that larger investors won’t have to worry about altering the price of tokens by purchasing more. There will often be a cooling off period after purchase where tokens can not be sold before they are available to transfer at the market price.
- Rising Prices
In this case, the ICO is still run with a fixed exchange rate. However, the price can rise over time, and this will be beneficial to investors that jumped in early, taking the biggest risks. They stand to make the greatest gains per coin.
- Decreasing Prices
Or finally, other projects have encouraged people to invest early by lowering the price of tokens throughout an auction up until the point where the auction ends. This again encourages people to invest early but for a different reason.
There is more than 3500 tokens on Ethereum blockchain network!
The Risk For Investors
It is worth mentioning again that ICOs have virtually no regulation, as shown by the various ways that they can be sold. This fact alone makes the situation risky for investors. Many experts have suggested that the process favors those who understand the processes involved in the investments and puts new people interested in buying into a project at a distinct disadvantage.
Before investors buy into an ICO, it is important for them to understand what tokens will be worth once they are in circulation and which of the four pricing mechanisms above will be used. Many critics have further argued that there is no kind of protection for investors and that is based on FOMO instead of rational decision making. Essentially, buyers invest out of fear of missing out on what has the potential to be a great opportunity.
Most countries around the world have no form of government regulation for these types of sales. This increases the risk for both investors and entrepreneurs. That said, this may soon change with the recent statement released by the SEC. The U.S. Securities and Exchange Commission has cautioned that the sales of Initial Coin Offerings are subject to federal security laws. As such, there may soon be protections for investors looking gain a stake in these kinds of projects.
At this time, however, ICOs are still not regulated, and due to this, they can be used for fraudulent activities. Due again to the lack of regulation, any money lost through these projects may not be recoverable, and this is a serious risk for potential investors.
Is this only first step towards legalisation? “China bans all ICOs and digital currency launches as ‘illegal public financing’”
This is why investors should always research the project carefully before investing in an ICO, ensuring that it can be trusted.