What is an Initial Coin Offering? How does Cryptocurrency ICO work?

An ICO, or Initial Coin Offering, is a new way to raise capital for all sorts of projects by selling a cryptocurrency. It’s mostly used by tech startups. Those are the basic facts you should know about ICO. However, if you are not satisfied with an answer what is ICO for beginners, and if you are searching the internet for ‘’everything you need to know about ICO’’ it will take many days until you learn everything in this very dynamic sector.

ICOs provide startups an alternative method of raising capital compared to the traditional process involving banks, private equity, and venture capital firms. These companies, occasionally referred to as crypto projects, issue tokens of their initial coin supply – as opposed to stock in exchange for cash – to investors who have given them capital for their project development.

ICOs routinely take place before a project is even completed because the raised funds help the company scale and cover expenses. Similar to a traditional stock portfolio, the potential for massive future payoffs incentivizes investors to buy tokens, hoping that the tokens originally bought will rise in value.

What is An ICO?

ICO is the abbreviation of Initial Coin Offering. It means that someone offers investors some units of a new cryptocurrency or crypto-token in exchange against cryptocurrencies like Bitcoin or Ethereum. Since 2013 ICOs are often used to fund the development of new cryptocurrencies. The pre-created token can be easily sold and traded on all cryptocurrency exchanges if there is demand for them.

With the success of Ethereum ICO are more and more used to fund the development of a crypto project by releasing token which is somehow integrated into the project. With this turn, ICO has become a tool that could revolutionize not just currency but the whole financial system. ICO token could become the securities and shares of tomorrow.

History of ICOs

It all started with the Mastercoin campaign where people could support the Mastercoin project by burning Bitcoin and getting Mastercoin tokens in exchange. This was conducted entirely P2P and inspired other projects that followed to use the Bitcoin blockchain for P2P crowdfunding purposes.

The Ethereum project used the Bitcoin Blockchain in 2014, successfully raising 18 Mio USD in Bitcoin within a four-week period and breaking all crowdfunding records to date, the Ethereum blockchain has become the platform that simplified the process of issuing tokens, sparking a series of record-breaking ICOs in 2016 and 2017.

Initial Coin Offerings are still a relatively new concept and still represent a small amount of the total crowdfunding capital worldwide. Global crowdfunding volume in 2015 was around $34 Billion, whereas the ICO volume was less than a percent of the total volume with $240m raised. The most notable ICO in the blockchain space happened in 2016 where a project called The “DAO” managed to raise $150 Million.

What is an ICO token

Not a race-car or a shoe. It might look pretty much like Monopoly, though. You buy and sell something that doesn’t really exist, but somebody wins and somebody loses.

The ICO token basically signifies your contribution to the startup investment. The more money you will give, the more tokens you will get in return. With the tokens, you will be able to buy future company services or just sell tokens.

But why would you give the money if you will not own a part of the company as it works in IPO? Right, nobody will. That’s why you have a smart contract.

What is an ICO Smart Contract

The guys with weird genetic trees must promise something worthy to the investors. It can be a free tree for your wife, two percent from the future company revenue or any other value or service. In this case, money definitely might grow on trees.

The smart contract is actually an agreement between the ICO issuing company and the token holder. It is a code that makes a certain “then” happen if a certain “if” happened. For example, it can say that everyone who bought “the genetic tree” token before 2020 can sell it for a fixed price. One a holder will send the token – the price will be adjusted automatically.

How does ICO work?

A project or company specifies its intentions to hold an ICO by publishing a so-called whitepaper. There it explains the project, its goals, how much capital it needs to raise, when the ICO is scheduled, and other information to help investors decide whether to participate.

In exchange for making an investment, an investor gets the project’s cryptocurrency, usually referred to as a token. Depending on the project, tokens may be acquired in exchange for other cryptocurrencies or for fiat money like US dollars, euros, and so on.

ICOs let startups and other companies raise capital much more easily and quickly than, for example by selling shares or bonds or getting loans, since the market is still largely unregulated and they don’t need to deal with venture capitalists or banks. Going forward, however, raising capital via an ICO can be expected to become more and more complicated as the market matures and new regulations are introduced.

Types of ICOs

As you can see from the examples stated above most token sales so far, have been time capped. However, some startups like Tau-Chain decided to leave their campaign running without a cap and an end date. So before you invest into an ICO make sure you understand how much tokens will be in circulation and what the pricing mechanism will be.

Why will a startup company prefer ICO

The concept is relatively new, and the old IPO might look safer, but some ICO benefits are just unbeatable:

• Retaining control: you are not sharing your company with an investor, you sell him a future service. That’s a huge difference, you will get the money but still control your business.
• Globalization: while some companies go door to door to find an investor, with ICO you can immediately rise money from anybody in any country worldwide.
• No regulation. That means no bureaucracy which could take months. Tech startup success is very much a matter of being first on the market. Otherwise you will be yesterday’s news and somebody else will take the jackpot.

Benefits

To the issuer:

• Access to seed funding, much faster and with fewer restrictions than via the venture capital route
• The opportunity to create new, decentralized business models
• A base of participants incentivized to use and test the service, and a boot-strapped ecosystem
• No loss of equity in the project (unless the tokens stipulated ownership sharing)
• A faster funding process
• More arbitrary limits to the amounts collected

To the token holder:

• Access to an innovative service
• Possible gain through an increase in the token’s price
• Participation in a new concept, a role in developing a new technology

Risks

For the issuer:

• Uncertain regulation (possible post-issue clamp-down, fine or even sentencing)
• Unstable investment (a sell-off by disgruntled users could affect the token price and the viability of the project)
• Little idea of who the token holders are (unlike shareholders)

For the holder:

• No guarantee the project will get developed
• No regulatory protection (investment at risk)
• Often scant information about underlying fundamentals
• Little transparency on token holding structure

The Basics of an ICO

When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for.

During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an IPO-type transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the funds requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.

ICOs are similar to IPOs and crowdfunding. Like IPOs, a stake of the startup or company is sold to raise money for the entity’s operations during an ICO operation. However, while IPOs deal with investors, ICOs deal with supporters that are keen to invest in a new project much like a crowdfunding event. But ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return in their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are referred to as crowdsales.

ICOs also retain at least three important structural differences from IPOs. First, ICOs are decentralized, with no single authority governing them. Second, ICOs are largely unregulated, meaning that government organizations like the U.S. Securities and Exchange Commission (SEC) do not oversee them. Finally, as a result of decentralization and a lack of regulation, ICOs are much freer in terms of structure than IPOs.

ICOs can be structured in a variety of ways. In some cases, a company sets a specific goal or limit for its funding, which means that each token sold in the ICO has a pre-set price and that the total token supply is static. In other cases, there is a static supply of ICO tokens but a dynamic funding goal, which means that the distribution of tokens to investors will be dependent upon the funds received (and that the more total funds received in the ICO, the higher the overall token price). Still other ICOs have a dynamic token supply which is determined according to the amount of funding received. In these cases, the price of a token is static, but there is no limit to the number of total tokens, save for parameters like ICO length. These different types of ICOs are illustrated below:

ICO Benefits: What’s in it for the Investor

In an IPO, an investor receives shares of stock in a company in exchange for her investment. In the case of an ICO, there are no shares to speak of. Instead, companies raising funds via ICO provide a blockchain equivalent to a share: a cryptocurrency token. In most cases, investors pay in a popular existing token like bitcoin or ether and receive a commensurate number of new tokens in exchange.

It’s worth noting just how easy it is for a company launching an ICO to make tokens. There are online services such as Token Factory that allow for the generation of cryptocurrency tokens in a matter of seconds. Investors should keep this in mind when remembering the differences between a share of stock and a token; a token does not have any inherent value. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute them per their plan by transfering them to individual investors.

Early investors in an ICO operation are usually motivated to buy cryptocoins in the hope that the plan becomes successful after it launches. If this comes to pass, the value of the tokens they purchased during the ICO will climb above the price set during the ICO itself, and they will achieve overall gains. This is the primary benefit of an ICO: the potential for amazing returns.

Indeed, ICOs have made many investors into millionaires. Take a look at the figures for 2017: That year, there were 435 successful ICOs, each raising an average of $12.7 million…the total amount raised for 2017 was $5.6 billion, with the 10 largest projects raising 25% of this total. Further, tokens purchased in ICOs returned an average of 12.8x the initial investment in dollar terms.

The ICO space continues to balloon at a tremendous rate. In the first quarter of 2018, ICOs brought in $6.3 billion in funds, already outpacing the entire 2017 total in just 59% as many distinct ICO projects.

Is Someone Going To Regulate ICOs

The SEC classified tokens from ICOs as securities in December of 2017, with SEC Chairman Jay Clayton saying at the time that they had proved that “a token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”

This means the SEC is gearing up to crack down on ICOs that they deem to be misleading investors. The first strike came on December 11, 2017 when the SEC halted Munchee, a California company with a food review app. Munchee was attempting to raise money to create a cryptocurrency that would work within the app to order food. This is the first instance of the SEC issuing a cease and desist for an ICO for unregistered securities. Does this mean the hammer is about to drop? We’ll see.

How to Find ICOs

Investors looking to buy into ICOs should first familiarize themselves with the cryptocurrency space more broadly. In the case of most ICOs, investors must purchase tokens with pre-existing cryptocurrencies; this means that an ICO investor will need to already have a cryptocurrency wallet set up as well as some digital token holdings. Below, we’ll walk through the steps necessary to invest in a theoretical ICO modeled after KIN, an existing digital currency. The steps may be different, however, depending upon the type of ICO.

• Sign up for Coinbase or another digital currency exchange. There are hundreds of different exchanges and wallets, so you have a multitude of options here.
• Stock up on the currency you’ll need in order to buy into the ICO.
• Transfer your holdings to a digital wallet which supports them. The most important thing in this case is to make sure that your wallet will hold cryptocurrency compatible with the ICO (i.e. if the ICO requires payments in ether, your wallet must hold ether).
• Be certain that you have the official page for the ICO itself. Read through the whitepaper, the terms of the ICO, and any other information that you can. When you’re ready to begin, look for buttons to “enter the token sale” or “participate now.”
• Register for the ICO. In order to do this, you’ll need to provide your public wallet address as well as some other information according to the ICO site.
• On launch day, follow the site’s instructions for buying into the ICO. In most cases, this will involve transferring ether from your wallet to the ICO’s public address. In return, you’ll receive some of the ICO’s cryptocurrency at a rate specified by the terms of the offering. Be sure to keep in mind that there are small fees associated with transfering cryptocurrencies like ether, so you’ll have to keep a bit of the original token in reserve to cover these costs.
• The ICO will send the new token to your cryptocurrency wallet. Depending on the wallet, you may need to add the token to the wallet itself so that you can send and receive transfers.
• Either hold onto the new token or exchange it for USD or other digital currencies. The company which provided the ICO may offer a service allowing you to transfer the token back to the previous cryptocurrency, or you may need to go to another digital currency exchange in order to make the transfer. In some cases, you may need to hold the token until it becomes listed on an exchange which you can access based on your region.

How does one go about finding ICOs in which to participate? There is no recipe for staying aprised of the latest ICOs. The best thing that an interested investor can do is read up about new projects online. ICOs generate a substantial amount of hype, and there are numerous places online in which investors gather to discuss new opportunities. Online communities like Reddit offer these kinds of conversations. Further, there are dedicated sites which aggregate ICOs for investors.

Risks and Criticisms of the ICO

Although there are successful ICO transactions on record and ICOs are poised to be disruptive innovative tools in the digital era, investors are cautioned to be wary as some ICO or crowdsale campaigns are actually fraudulent. Because these fundraising operatives are not regulated by financial authorities such as the SEC, funds that are lost due to fraudulent initiatives may never be recovered.

The rapid ICO surge in 2017 incurred regulations from a series of governmental and nongovernmental In early September, 2017, the People’s Bank of China officially banned ICOs, citing it as disruptive to economic and financial stability. The central bank said tokens cannot be used as currency on the market and banks cannot offer services relating to ICOs. As a result, both Bitcoin and Ethereum tumbled, and it was viewed as a sign that regulations of cryptocurrencies are coming. The ban also penalizes offerings already completed. In early 2018, Facebook, Twitter, and Google all banned ICO advertisements.

To make sure you don’t get scammed when you invest in an ICO, follow these steps:

• Make sure that project developrs can clearly define what their goals are. Successful ICOs typically have straightforward, understandable whitepapers with clear, concise goals.
• Know your developers. Investors should expect 100% transparency from a company launching an ICO. This means that you should know who is involved in the project, what their business plans are, where they are located, what the timeline for the project is, and so on.
• Look for legal terms and conditions set for the ICO. Because outside regulators generally do not oversee this space, it is up to you as an investor to ensure that any ICO you buy into is legitimate.
• Make sure that ICO funds are being stored in an escrow wallet. This is a wallet which requires multiple keys in order to be accessed. This is a useful protection against scams, particularly when a neutral third party is a holder of one of the keys.

There is no way to guarantee that you won’t be on the losing end of a scam when you invest in an ICO. That is a risk that you must be willing to take. On the other hand, ICOs can offer tremendous rewards as well. The key for investors is to take necessary precautions to avoid making irrational or uneducated decisions, and to learn as much as possible about the ICO world in order to best capitalize on its excellent potential.

Who Can Launch an ICO?

Literally anyone! Currently, there’s very little regulation on ICOs in America, meaning as long as you can get the tech set up you’re free to try and get your currency funded. Right now cryptocurrency as a whole is kind of like the wild west; there’s gold in the hills and relatively little law to speak of. This can work in your favor or it can lead to getting swindled. Of all avenues of funding, an ICO is probably one of the easiest to set up as a scam. Since there’s no regulation there’s nothing stopping someone from doing all the work to make you believe they have a great idea, and then absconding with the money. 

This means that if you’re really set on getting in on that new ICO that your friend Aiden from work told you about, make sure you do your homework. The first thing to do is make sure that the people putting up the ICO are real and accountable. In the internet age its beyond easy to find a stock photo and put together a convincing website, so going the extra mile is important. Some things to look for: What history do the product’s leads have with crypto or blockchain? If it looks like they don’t have anyone with relevant experience that can be easily verified, that’s a bad sign. 

I want to start my own ICO. How do I do that?

The most important thing you want to do is make sure that either you or someone (probably multiple people) involved have worked in and understand cryptocurrency and blockchain. Even if anyone can make an ICO, it doesn’t mean that everyone should. You need to be able to answer questions on the spot about every little detail pertaining to your ICO.

You should also ask yourself if you really think that your business will actively benefit from an ICO. Basically, after reading this article, you should consult someone who can take a look at your specific idea and tell you if its a slam dunk or not. If it’s not, you might be better off going through safer avenues of funding. 

If you’re determined to move forward, you need a white paper, which is a document that should identify exactly what your currency can offer that has never been done before, or how you’ll do an established idea better than anyone else has. This document should be engaging, informative, and very, very detailed. You can find the white paper for Ethereum, one of the most successful ICOs yet.

Like any business, you need to hook your buyer by the end of the first page. Ethereum’s white paper takes the time to explain what blockchain is, and then goes on to detail how they intend to build on the progress that Satoshi Nakamoto made and create something exciting. They do all of this by the end of the first page. Now, does every single white paper need to include an unabridged history of blockchain including the time that guy paid 10,000 bitcoins for a pizza? Probably not, but it should be understandable to someone without any knowledge of how these systems work. 

Now that you’ve got your white paper, you need to advertise. You have two targets that you’ll be trying to reach out to: those with knowledge of how cryptocurrency and ICOs work and people with basically no idea. You’ll want to identify the people that would be most excited by your new venture, since they’ll be more eager to give you money if it means a deal for them. In the case of BabyCoin (again, hypothetical) maybe we’d reach out to some popular mommy bloggers/vloggers and see if they would be interested in producing some content to showcase why BabyCoin is the biggest innovation in babysitting since The Babysitter’s Club. Just make sure they disclose the nature of the deal to advertise for you: The SEC released a warning to investors stating that it is illegal for celebrities to use social media to endorse ICOs without disclosing what  compensation they received.

You’re also going to want to make your programmers and leads available to answer questions on social media like Reddit and Twitter. You should also consider submitting your ICO to some listings that run databases of what they perceive to be quality ICOs. This is how you get people involved in the crypto-community excited about your product, which will hopefully trickle through the internet. 

Great! So the word is out about BabyCoin and people are psyched, all that’s left to do is determine the token pricing and distribution. You also might want to have a prototype in order just to prove you know what you’re doing. Get your website and exchange set up and good luck!