Introduction
As of April 2018, Initial Coin Offerings (“ICOs”) – an industry analysts believe can eventually become a multi-trillion dollar space – raised a staggering USD $5,014,952,132. With a total market capitalization of over $100 billion, the cryptocurrency market has attracted the attention of many, including traders looking for quick cash with few regulations.
What are Initial Coin Offerings?
ICOs are another form of cryptocurrency that businesses use in order to raise capital. Through ICO trading platforms, investors receive unique cryptocurrency “tokens” in exchange for their monetary investment in the business. It is a means of crowdfunding through the creation and sale of a digital token to fund project development.
This unique token functions like a unit of currency that gives investors access to certain features of a project run by the issuing company. These tokens are unique because they help fund open-source software projects that would otherwise be tough to finance with traditional structures.
What are White Papers? And What Purpose Do They Serve?
When a cryptocurrency startup firm wants to raise money through an ICO, it usually puts its plans on a “white paper” to provide investors with important information. This information will include, but is not limited to: what the project is about; what objectives the project will aim to fulfill upon completion; how much money is necessary to undertake the venture; how many virtual tokens the issuers will keep for themselves; what type of currency is accepted; how long the ICO campaign will run for; and who the team is behind the white paper. The company issuing the ICO prepares the white paper prior to launching the currency. It is a pivotal component of ICOs, as many investors ask for a whitepaper draft before deciding whether to invest.
Cryptocurrency ICO vs. Stock IPO
The biggest difference between a cryptocurrency ICO and a stock initial public offering (“IPO”) is the regulatory oversight. First, as part of the mandatory requirement to register with the regulatory authority, any company looking to issue an IPO must create a legal document called a “prospectus.” The prospectus represents a legal declaration of its intention to issue its shares to the public, and it must meet certain standards of transparency. Among other things, it must include key information about the company and its upcoming IPO to assist potential investors in making an informed decision.
On the contrary, as stated in recent US regulatory action, ICOs only have regulation requirements if they are issued as security tokens rather than utility tokens, which are described in more detail below. However, because such regulatory activity has only recently been developed, investor assessments and due diligence are more difficult to accomplish, especially in comparison to evaluating stock IPOs, which are regulated through strict processes and overseen by accounting firms and investment banks, thereby providing investors with more information and security.
How do ICO’s Work?
Through the ICO fundraising model, startups can raise capital by issuing tokens on a blockchain (a list of records secured using cryptography) and then distributing tokens in exchange for a financial contribution. These tokens, which can be transferred across the network and traded on cryptocurrency exchanges, can serve an array of different functions, from granting the holder access to a particular service, to entitling them to company dividends. Depending on its function, tokens may be classified as either utility tokens or security tokens.
Utility Tokens
Utility tokens, called “user tokens” or “app coins,” represent future access to the business’s product or service. Through utility tokens, ICO startups can raise capital to fund the development of their blockchain projects in exchange for users’ future access to the service. Utility tokens are not designed to be a standard investment for a share of the company, and, if properly structured, this feature exempts utility tokens from federal laws governing securities.
By creating utility tokens, a startup can sell “digital coupons” for the service in development, similar to how electronic retailers accept pre-orders for video games that might not be released for several months. One example of a utility token is “Filecoin,” which raised $257 million by selling tokens that provide users with access to its decentralized cloud storage program. Businesses that offer these utility tokens are trending to avoid using the term “ICO,” and favor terms such as “token generation events” and “token distribution events,” to ensure they are not appearing to engage in a securities offering.
Security Tokens
Contrary to utility tokens, if a token derives its value from an external, tradable asset or it can increase in value based upon the efforts of others, it may be classified as a security token and become subject to federal securities regulations. Failure to abide by these regulations could result in costly penalties and may threaten to derail a project. Therefore, a business must meet all of its regulatory obligations. Once the token is properly classified, a wide variety of applications are permitted, the most promising being the ability to issue tokens that represent shares of company stock. Online retailer Overstock.com (“Overstock”) is currently involved in this practice. Overstock announced that tZERO, one of its portfolio companies, would hold an ICO to fund the development of a licensed security token trading platform. The tZERO tokens are issued in accordance with SEC regulations, and Overstock’s CEO, Patrick Byrne, stated that token holders would be entitled to quarterly dividends derived from the profits of the tZERO platform.
Many industry observers, including Mr. Byrne, believe that mainstream companies will one day issue shares through ICOs, either in place of or in addition to, traditional public offerings.
Concerns
Joichi Ito, Director of the MIT Media Lab and professor of the practice of media arts and sciences, has raised some concerns with the “gold-rush” mentality that is fueling the success of ICOs. He believes that cryptocurrencies are being deployed in irresponsible ways that are causing harm to individuals and damaging the ecosystem of developers and organizations.
Mr. Ito is concerned that regulators of IPOs have not yet caught up with ICOs, thereby allowing issuers to get rich by taking advantage of unwitting investors who are buying tokens of questionable value. Ultimately, Mr. Ito believes the regulatory intervention will need to be much more sophisticated and technically informed. In the meantime, a long list of people will read about skyrocketing prices of Bitcoin and decide to buy into one of the myriad ICOs being introduced to the public, perhaps without fully understanding the risks associated with such an investment.
Conclusion
An ICO is similar to a mix between an IPO and online crowdfunding, but for cryptocurrency. One can contribute “X” amount of an existing token and receive in return “Y” amount of a new token (at a set conversion rate) at a date set by the issuer of the token.
This token can be used in two ways, either with a utility function or a security function. A utility token is generally unregulated and used by startups to gain capital to fund their projects in exchange for future access to the service in development. On the other hand, a security token is generally treated like a stock, a tradable asset with ownership qualities, and is regulated by the SEC. ICOs are a new concept and some raise concerns with the actual value of the tokens and how easy it is for the issuer to get rich. Ultimately, time will tell whether this becomes the future of funding businesses or merely a “get rich” scheme by issuers.
Even if you’re the kind of person that only spends a few minutes a day online reading news articles, chances are you’ve heard of ICOs. They’re the new Internet craze, and much like everything else people go crazy for, ICOs promise big and easy profits.
At the time of writing, coinmarketcap.com listed 1,530 cryptocurrencies. In this article, published on Sept. 3rd, 2017, the figure was 848. That is, on average, five new coins appearing every single day.
Investors really are spoiled for choice. There are a lot of serious ICOs raising funds for important and useful projects. At the same time, many startups are trying to gain investors’ attention through rather unconventional methods, such as choosing a Shiba Inu as a mascot and calling the token Dogecoin. Those wishing to invest and make a political statement at the same time might be attracted by something like Putincoin or Trumpcoin. There is even a Useless Ethereum Token (yes, that’s its actual name), which criticises the very concept of ICOs on its website. And yes, they’ve raised quite a bit of money.
As you can see in the picture below, some of the most successful ICOs are capable of bringing massive returns for the early investors.
Notably, they bring even bigger dividends to companies, startups and individuals organizing them. According to this recent WSJ report, the overall amount of funds raised through initial coin offerings around the world has exceeded $4 bln. Most of that was raised in 2017, as at the end of 2016 that figure stood at only $225 mln.
How to buy tokens during an ICO
1. Register for an ICO through the project’s website
Every legitimate project that sources funds through an ICO has a website, where they specify what the project is all about, its goals, the amount of money needed, how long the funding campaign will go on for and so forth. This website is where you can register for the ICO.
Beware of ICO campaigns that don’t require any registration whatsoever. Of course, there is still a chance that it is a fully legitimate operation, but as of late most trusted and high-profile ICOs require investors to register.
2. Get Bitcoin or Ether
Yes, you will need one of the two major cryptocurrencies in your possession in order to be able to participate in an ICO. Check out our dedicated guides on buying Bitcoin and Ether.
Bitcoin, still being the single most dominant cryptocurrency, is accepted pretty much anywhere in the crypto world. However, as Ethereum offers a stable and convenient Blockchain platform for developers to set up their projects, it became a platform of choice for ICOs. So, Ether, being the native token of the Ethereum platform, is widely used for purchasing tokens during ICOs.
The minimal amount that you can invest depends on a particular ICO. It can be anywhere between $10 to $100, or 0.02 ETH to 1 ETH. The minimal investment amount is usually stated in the project’s white paper, which can be found on its website.
3. Move your Bitcoins or Ether to a wallet you control
We have said this countless times already: refrain from keeping your cryptocurrency in a wallet provided to you by an exchange. It jeopardizes the security of your funds, as you are essentially not in control of that wallet. Instead, move your tokens to a software wallet that keeps your passwords on the device of your choice. Alternatively, you can invest in a hardware wallet for added security. You can read more about Bitcoin and Ethereum wallets in our dedicated guides.
There are a lot of wallet options out there, but one characteristic that you absolutely have to keep in mind when choosing a wallet is that it supports the ERC20 token standard.
It is the most wide-spread token standard to date. Moreover, it is the official standard for the Ethereum network. Thus, virtually any wallet that supports Ether will be ERC20-compatible.
4. Buy ICO tokens
Once you’re registered for an ICO and have your funds available and ready, all you need to do is send your cryptocurrency to the campaign’s address.
5. Participate in an ICO by sending your crypto to their address
The primary goal of every single ICO campaign out there is to get your money. For that reason, they do try to make the process as trivial as possible. Most of the time, the project’s website will provide you with thorough guidelines on how to invest.
But, you have to be extremely careful when sending your funds.
First of all, check the website’s address as many times as you feel is necessary. There might be fake ICO websites listed as ads on top of your Google search results. Those will look identical to actual websites, with one or two symbols of the address being slightly different.
Secondly, check the project’s wallet address as many times as you can. There will be fraudsters and phishers posting fake addresses online, so you need to be extremely careful not to end up sending your money to a wrong place. If that happens, you will never be able to get it back.
Some of the most popular and attractive ICOs will have thousands and thousands of people sending Ether all at the same time, which may result in the network being ongested, which means that your transaction might take a while to go through. You can always check the status of your transaction here by simply putting your wallet’s address into the search bar.
Finally, make sure to include a little bit of extra Ether into your transaction. This extra Ether will go on “gas,” which enables transactions within the Ethereum network. Basically, in this particular case gas serves as a transaction fee. The required amount of gas is usually laid out on the project’s website.
6. You get ICO tokens to your address
You should receive your newly purchased tokens to your wallet’s address. If this doesn’t happen straight away- don’t worry and be patient. Depending on a particular campaign, your tokens can arrive immediately, but sometimes it might take weeks, months or even longer. Moreover, during a busy ICO, a lot of things can get delayed, some deadlines can be moved an so on. So, make sure to stay up-to-date and consider communicating with other investors on dedicated platforms and forums.
Sometimes, when you receive the tokens, you might not be able to trade them straight away. This depends on rules of a particular ICO. This information, as well as the time you’ll need to wait before receiving the tokens, is usually laid out on the project’s website.
7. Once you have your ICO tokens, figure out how to store them
Again, always make sure your funds are safe and secure.
Most major ICOs will take the necessary steps for their token to be supported by major wallet services, especially by Ethereum’s official wallet service MyEtherWallet. Even if a particular token is not supported by it yet, the service enables you to add a custom ERC20 token.
If you’re using a hardware wallet, any ERC20 token can be transferred to the device and managed through MyEtherWallet. Moreover, the hardware wallet manufacturers constantly update their lists of supported cryptocurrencies. If the token you invested in is getting that support, all you need to do is download and install the latest version of the official manufacturers’ firmware.
How to buy tokens after an ICO
Once the ICO period is over, and if it was successful enough, the token will eventually be listed on an exchange. Which particular exchange depends on a project. To find out which exchange will list the token, you can either follow the announcements from the project itself, or check the Bitcoin Forum’s Altcoin section, and find a topic about the particular token. Alternatively, CoinMarketCap lists most cryptocurrencies in existence as well as exchanges where they can be traded.
When a token gets listed on an exchange, most of the time it will be trading against Bitcoin and Ether. We have extensive guides on how to sell both Bitcoin and Ether, which include sections about trading on exchanges.
I’ve bought my first tokens, what now?
Well, there is no straight answer to that question. It’s an investment, so once you acquired your tokens, you basically have two options: hold and receive dividends or trade the tokens.
Carry dividends
There are plenty of successful and profitable ICOs out there. Once the company successfully goes past the ICO stage, its value should start getting higher, as the company itself becomes more trusted and well-established in the marketplace. At the same time, the token’s value will go up as well, enabling investors to gain bigger profits.
Moreover, tokens usually provide investors with future access to the product or service as well as certain perks. In this respect, ICOs are very similar to traditional crowdfunding methods, where participants receive rewards for investing.
For instance, some projects offer a token bonus for early investors, in this case, 100-300 percent. Others, like SCCEX, a startup that hopes to build a Scandinavian cryptocurrency exchange, offers free trading, money deposits and withdrawal as well as an Aurora debit card, which can be used worldwide completely free of charge and it’s an exclusive item for the ICO participants.
Finally, if the ICO was held by a DAO- a Decentralized Autonomous Organisation, which can be set up on the Ethereum platform, then the token holder also receives voting rights in proposals which shape the organization and the direction it’s taking.
Trade tokens
Once the token gets listed on one of the cryptocurrency exchanges, you will be able to trade it. Bitcoin and Ether are going to be the only trading options for quite some time after it gets listed, with other trading pairs being supported later on, provided the token will be in demand. But keep in mind that some tokens will never get listed.
Chances are, you will need to sit on your investment for a while. You might incur a massive loss straight away, or see no gains for a long time. And then, a quick and massive spike might happen, which can either mean that the token’s value will keep rising steadily or it could be a one-off event, after which the value will return to virtually nothing.
Those spikes can happen within just minutes, and you need to be able to catch them. Many exchanges have alerts or “set a stop loss” options, so take full advantage of those.
There are a lot of “ifs” and “buts” in cryptocurrency trading, but if you play your cards right, it can bring massive returns. The best example here would be that of Ethereum, which debuted in 2014 with an ICO price of around $0.30. At the time of writing, less than four years later, it trades at $940 per token. You do the math.
Who can participate in ICO?
You don’t need much to invest in an ICO. Essentially, the starter pack includes active Internet access and some Bitcoins or Ether. The Blockchain technology allows for investments to flow from virtually anywhere in the world, with minuscule fees and usually within several minutes.
But, and this is a very important “but,” make sure that it’s legal in your jurisdiction. ICOs are probably the one aspect of cryptocurrencies that authorities all over the world are striving to regulate the most. ICOs are explicitly banned in some countries, such as China and South Korea, while others have either introduced certain regulations or are about to do so. For instance, regulatory bodies in Russia are strongly considering introducing hard caps for both the overall amount of money that a project can receive through an ICO as well as the amount that an individual can invest.