What is an Initial Coin Offering?

What is an Initial Coin Offering?

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Cryptocurrency initial coin offerings (ICOs) represent a radical change worldwide in terms of business financing thanks to the use of blockchain technology. This new model has made it possible to obtain the necessary resources to finance large projects without having to go through the administrative and legal bureaucracy that other financing channels entail.

However, like any other tool of this type, ICOs have their pros and cons, and for all those enthusiasts in the crypto world, knowing all the cards in play is what makes the difference between making a good and a bad move.

In this new post, we’ll talk in-depth about the world of cryptocurrency ICOs, so that you’re in a better position to decide whether or not this new investment trend is right for you.

What is an Initial Coin Offering?

An Initial Coin Offering or ICO, is a term that has a certain similarity to the term IPO or Initial Public Offering, which is when a company goes public and offers shares to potential investors for a certain price to obtain financing. Well, something almost identical happens with ICOs, only that they’re used to finance the launch of new cryptocurrencies.

And how do you put this into operation?

When a group of people or a company decide to create a new cryptocurrency, they must follow these two steps:

  1. Design and develop the base software of the new cryptocurrency
  2. Make the software available to volunteer miners allowing them to maintain the network

But of course, this comes at a cost and requires funding. For this reason, many developers offer a certain amount of their new cryptocurrency to potential investors, in exchange for money, either in the form of other currencies such as Bitcoin or fiat money.

In this sense, ICOs are very similar to crowdfunding, which is when a community of users finance projects directly, without intermediaries. A good example of a successful ICO is Ethereum, which managed to raise $18 million through an ICO before its official launch.

On the one hand, the advantage is that the project creators secure funding to move forward with the development of the cryptocurrency, while the initial investors have a greater chance of obtaining large returns if the project is a success.

Are initial coin offerings legal?

The answer to this question depends a lot on the country where you live. While in some countries some type of regulation may already exist, in most countries, reulaton is still lacking. Also, take into account that cryptocurrencies are still a relatively new technology, and even after over 10 years of existence of Bitcoin, look at how long it took governments to start regulating them.

It’s also important to consider that there are two factors that require regulation, the part that creates the ICO, and the users who participate in it.

Naturally, this doesn’t please governments, since it doesn’t allow them to have control over the money that flows in and out of these projects, not to mention it stops them from receiving taxes. In addition that, there could be criminal activities involved. Although some countries are trying to develop favorable legislation for ICOs – such is the case of Gibraltar – in most cases the opposite is true.

In fact, some countries are already developing plans to start heavily regulating ICOs, and even in some cases, these instruments could end up being very similar to IPOs in terms of paying taxes.

On the other hand, it’d also not be surprising if some countries began to announce that they’ll ban these ICOs – something that has already happened in China, for example.

How to buy initial coin offerings?

To answer this question properly, it’s appropriate to first explain how ICOs work.

Usually, and as I explained above, when someone creates a new ICO and seeks funding, they issue a certain amount of tokens on top of an already established blockchain platform, with Ethereum being the most popular for this. This event is previously announced on social networks, forums, and websites related to the crypto world.

When the project finally manages to get interested investors, it gives the tokens to those investors in exchange for cryptocurrencies or in some cases, fiat money such as dollars. This last process is carried out through smart contracts, which allow to automate the distribution of the tokens based on the conditions established by the issuer of the ICO.

In this way, when the payment condition is met, the smart contract sends the amount of tokens corresponding to the investor’s wallet, thus completing the exchange.

Typically, these smart contracts are developed and audited by specialized companies using high-level quality and security standards to avoid potential software failures.

The steps required to participate in an ICO are variable, so in some cases, it may be necessary to previously register on a website, or go directly to the site to buy the desired tokens.

Today, ICOs typically consist of two phases:

  • Pre-ICO or pre-sale – the objective here is to attract the attention of the largest possible number of private investors – more investors, more money – by offering them some type of incentive.
  • ICO or sale – The token distribution process as such, where the number of investors willing to take the risk of giving money in exchange for X number of tokens has already been established.

As I already mentioned, the most used platform to carry out ICOs is Ethereum, since it allows the creation and issuance of compatible ERC-20 tokens and the automation of the distribution process of such tokens through smart contracts with relative ease.

Also, being a standard use protocol, ERC-20 guarantees interoperability between tokens, which means that all these crypto assets will be interchangeable and compatible with decentralized applications (dApps) that use ERC-20.

Now that you have a clearer understanding of how ICOs work, it’s easier to detail the steps to participate in one:

  1. Visit crypto communities and websites frequently for announcements of new ICOs
  2. Select a project of your interest and thoroughly analyze all the details
  3. Register with a wallet or exchange that is compatible with the project’s token
  4. If you’re going to use a hardware or software wallet, configure it appropriately
  5. Go to the ICO website, make the respective payment, and receive your tokens directly into your wallet

Are ICOs a good investment?

As with any investment, participating in an ICO involves taking risks, but in this particular case, the risks are higher.

In the first place, it could happen that the project doesn’t work and the respective tokens end up being worthless. However, this is something that can happen with any new business project.

On top of that, ICOs have the added risk of possible bad programming that makes it easier for someone to steal all the money. Something like this happened in the DAO case, a project in which hackers managed to steal more than 150 million dollars from investors.

Another latent risk is that, in the absence of regulation and being outside the conventional financial system, ICOs are not liked by governments, since they are not able to control the ICO process nor collect on possible taxes, not to mention the possibility of the ICO being used to finance criminal activities.

To be honest, ICOs are more appropriate for those investors who are not afraid of participating in new cryptocurrency markets and take on the high level of implied volatility. This high volatility makes ICOs ideal for those traders who usually carry out many operations on a daily basis and don’t keep a large number of these tokens for long.

So I wouldn’t recommend it to investors who are more passive and conservative with their money. In this case, the most appropriate action would be keeping the investment to a minimum level – 1% or 2% – and calmly assume the HUGE possibility of losing money.

How can I tell if an ICO is good?

If you are looking forward to investing in a new cryptocurrency ICO in the hope that the project will be successful and the price of your tokens will skyrocket, you can, but be VERY, VERY careful, today more than ever.

A few years ago when ICOs appeared for the first time, only people with extensive knowledge of computer science, blockchain, and cryptocurrencies were investing. They knew what they were doing.

But now, everyone wants to participate, even those who don’t even know how to turn on a PC.

So when it comes to ICOs, it’s important to remember that there is no secret formula that can help someone avoid falling for a scam. The most important thing is to be very critical and cautious when investing our money. If you still want to invest, take into account the following tips to know how to identify an ICO with the potential to be legitimate and successful and if it sounds too good to be true, it probably is.

Here are some things to look for when researching an ICO project to invest in:

  • They should show you the project’s whitepaper, where all the details of the project are explained.
  • If the whitepaper is too technical and you don’t understand a lick of it, then maybe it’s because they want it to be that way.
  • The ICO should have a legitimate development team behind it.
  • The team behind the initiative should have a presence on the internet. Look for references of its members in social networks and pages of other projects where they have participated.
  • And those who are going to escrow the portfolio where the funds will be, should also be real people.
  • If there are some renowned companies behind the project such as Microsoft, Amazon, etc., even better.
  • Verify that the “official” website of the project is not a Telegram group, Facebook page or similar.
  • The project should have a community of followers with a positive opinion of the project in general.

Unfortunately, the world of cryptocurrencies has become a very attractive place for all kinds of scammers and there are already many ICOs that have disappeared overnight, without a trace, after obtaining the desired money.

On top of that, many other projects end up involved in all kinds of controversies due to the misuse of funds, as has been the case with Tezos. So, always proceed with caution and have an eagle’s eye!

Advantages and disadvantages of Initial Coin Offerings

Advantages for the investor

  1. The opportunity to get a new cryptocurrency with growth “potential” at a very low price
  2. Possible additional benefits that may be included when buying the tokens, such as products or services
  3. You can support groups of developers you know and trust

Advantages for the ICO issuer

  1. They are a quick way to obtain financing without going through all the red tape
  2. Funds don’t pay taxes if there is no regulation for ICOs in the issuer’s country
  3. They can experiment with new blockchain-based business models
  4. They get a good user base even before the cryptocurrency hits the market

Disadvantages for the investor

  1. The possibility of running into an inexperienced development team that ruins a good project
  2. No guarantees of return on investment
  3. No laws to protect them
  4. Little transparency during project development

Disadvantages for the ICO issuer

  1. Possibility of a sudden government regulation
  2. Initial investment in development that may not be recovered if not enough investors are found
  3. Ignorance of the identity of the token buyers

Conclusion

Now you know what ICOs are, where they come from, and what their possibilities and risks are, as well as the measures you should take to reduce the risk of being scammed.

Even though investing in an ICO is synonymous with “great risk,” if you take the proper precautions and NEVER invest more money than you can lose – the golden rule – it’s feasible to venture and invest in an ICO from time to time.

If so, it is best to look for interesting projects that you understand well and that you are passionate about. Don’t just go in for profitability, as this is very difficult to predict.

And in the end, Allah knows best,

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