What is an Initial Coin Offering (ICO)?

What is an ICO?

An Initial Coin Offering, also commonly referred to as an ICO, acts as a means of raising funds. An ICO is launched by a company looking to raise money to create a new coin, app, or service. An Initial Coin Offering (ICO) is similar to an Initial Public Offering ( IPO) of the crypto-currency industry. Potential investors will buy into the offering and obtain a new cryptocurrency token issued by the company. This token may have some functionality in using the product or service that the company provides, or it may simply represent a stake in the business or project.

Getting to know how an Initial Coin Offering (ICO) works

When a cryptocurrency company tries to raise capital via ICO, it typically produces a whitepaper and will outline the following:

  • Overview of the ICO project and its objective 
  • Background and professional experience of the entrepreneur
  • The project to be completed through this ICO fundraising
  • how much money is needed
  • how many virtual tokens the founders will hold
  • what kind of money will be accepted
  • Period of the ICO campaign

During the ICO campaign, project enthusiasts and backers purchase some fiat or digital currency project tokens. These coins are referred to as tokens and are identical to the shares of a business sold to an IPO investor. If the money received does not exceed the minimum funds needed by the company, the money may be returned to the backers and the ICO is considered unsuccessful. If the funding requirements are met within the specified timeframe, the money raised will be used to achieve the objectives of the project.

General considerations

Investors looking to buy into ICOs should first learn more about the cryptocurrency. For most ICOs, investors must buy tokens with pre-existing cryptocurrencies. This means that an ICO user would need to have a cryptocurrency wallet set up for a currency like Bitcoin or Ethereum, as well as a wallet capable of carrying whatever token or currency they choose to buy.

Is ICO being regulated?

In early Sept. 2017, the meteoric rise of ICOs led to a backlash between a series of government and non-government bodies. 

The SEC defined ICOs tokens as securities by SEC President Jay Clayton in December 2017 and said at the time that “token was an investment contract and hence was a security under our federal securities law. We concluded, in particular, that the token offer represents an investment in a common business with fair expectations of professionalism.

This means that the SEC is prepared to take action on ICOs that they consider misleading investors. The first strike occurred on 11 December 2017, when the SEC prevented the California food review app from Munchee. Munchee was trying to raise money to build a cryptocurrency to order food in the app. This is also the first time that the SEC has issued a cease and desist for an ICO for unregistered securities.

More recently, the Securities and Exchange Commission on 19 February 2020 announced settled charges against blockchain technology startup Enigma MPC for conducting an unregistered offering of securities in the form of an initial coin offering (ICO). Enigma, based in San Francisco and Israel, has agreed to return funds to harmed investors via a claims process, register its tokens as securities, file periodic reports with the SEC, and pay a $500,000 penalty.

In 2017, The People’s Bank of China has formally banned ICOs and slammed them into economic and financial stability as counterproductive.

As a currency, the Chinese central bank prohibited the use of tokens and prevented banks from providing ICO-related services. As a result, both Bitcoin and Ethereum prices tumbled in what many considered to be a sign of more regulation in cryptocurrency. The ban also penalized offers already finalized. In early 2018, ICO ads were removed from Facebook, Twitter, and Google as they were deemed risky financial products.

Where to find ICO to participate in? 

ICOs generate a significant amount of excitement, and there are numerous online sites where investors gather to discuss new opportunities. There are dedicated sites that aggregate ICOs, allowing investors to discover new ICOs and compare different offerings to one another. One of such site is ICObench a free ICO rating platform.

Advantages and Disadvantages of Initial Coin Offerings (ICO)

Advantages

In the IPO, the investor receives shareholdings in the company in exchange for his investment. In the case of an ICO, there are no shares per se. Instead, businesses raising funds via ICO have 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 corresponding number of new tokens in exchange.

It’s worth remembering how easy it is for an ICO company to set up these tokens. There are online services that allow cryptocurrency tokens to be generated in a matter of seconds. Investors should keep this in mind when understanding the differences between shares and tokens. A token has no inherent value or legal guarantees. These digital tokens created under the terms of the ICO are distributed to individual investors.

Early investors in an ICO project are typically encouraged to purchase tokens hoping that the venture will succeed after it is launched. If this occurs, the value of the tokens they bought during the ICO will increase above the price set during the ICO itself, and they will achieve total profits. This is the primary advantage of the ICO: the ability for very big returns.

In July 2014, the Ethereum Foundation raised more than 31,000 bitcoin worth around $18.3 million when it sold the first 60 million etherium for the first time. It work out to be about $0.31 per etherium, currently ethereum coin is worth a lot more.

Disadvantages

Since ICOs have taken the lead in cryptocurrency and blockchain industries, they have also created challenges, risks, and unexpected opportunities. Digital tokens are typically highly speculative, not transparent. In a short time, the exchanged price can fluctuate significantly and can become worthless overnight. 

Because they are largely unregulated, ICOs are brimming with fraud and scam artists trying to prey on overzealous and poorly informed investors. And as they are not controlled by financial authorities such as the SEC, funds that are lost due to fraud or negligence may never be recovered.

Lack of secondary market liquidity.

 Even if the tokens can be exchanged in a secondary market, if not enough successful buyers and sellers, you can be stuck with them. 


Things to look out for before investing in an ICO

If an opportunity sounds too good to be true, or if you are forced to purchase quickly, please exercise extreme caution. Be mindful of the possibility of losing your investment.

  • Make sure project developers can clearly define their objectives. Successful ICOs generally have straightforward, understandable white papers with simple, concise objectives.
  • Established company Investors should aim for 100% transparency from the launch of an ICO by a company.
  • Find out if there are any prominent backers for the ICO, a prominent financial investor backer would be more credible. In the case of an influencer or celebrity backing the ICO, do check if they are endorsed by the company.
  • Look out for coverage on media for ICO
  • Look for legal terms and conditions set for the ICO. As outside regulators do not normally regulate this area, it is up to an investor to ensure that any ICO is legitimate.
  • Make sure ICO funds are deposited in a wallet of escrow. This is a wallet that takes many keys to open. This protects against scams, especially if a neutral third party holds one of the keys.

Conclusion

ICOs provide an attractive alternative to raising capital , particularly for small and medium-sized businesses, as quicker, lower-cost funding with a more diverse investor base is possible. Most countries still do not have clear ICO regulations in effect, blockchain technology does not relieve users of the need to comply with the current regulatory structure. 

While some ICOs may be attempts at honest investment opportunities, many may be frauds, separating you from your hard-earned money with guaranteed returns guarantees and potential fortunes. These digital assets and their technologies can provide a modern and efficient medium for carrying out financial transactions, the risks of fraud and abuse have also increased because their markets are less regulated than the conventional capital markets.