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ICO (Initial Coin Offering): What Is It And How Does It Work?

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ICO (Initial Coin Offering): What Is It And How Does It Work?

What is an ICO? If you know anything about cryptocurrency, you’ve probably heard of an Initial Coin Offering. Today, ICOs are an increasingly popular fundraising method attracting attention outside of the cryptocurrency community. Here’s your guide to understanding what an initial coin offering is, how to invest in one, and what you need to watch out for.

The following article is not investment advice and should not be read as such.

What Is an ICO?

ICO (Initial Coin Offering): What Is It And How Does It Work?

An initial coin offering is a new way for businesses to fundraise. It’s a cross between crowdfunding an IPO, but for a cryptocurrency. This can mean exclusive access to services offered by a cryptocurrency company, an asset to buy and trade and much more.

Typically, an ICO functions as an alternative to traditional fundraising methods such as private investment offerings or IPOs.

Why Are They So Popular?

Since 2017, ICOs are exploding in popularity. And that popularity includes investors and entrepreneurs alike. To give you a sense of just how big an initial coin offering can become, check out some of the most successful ICOs to date. These include:

  • Filecoin: $257 million
  • Tezos: $232 million
  • EOS: $180 million
  • SIRIN LABS: $157.9 million
  • Bancor: $153 million

So why are ICOs so popular? In essence, because they represent a whole new asset class for investors. Not only can investors make money off of trading cryptocurrency, but the currency itself can represent something besides money.

Since cryptocurrency can represent a lot of different things, so can ICOs. Crypto can represent energy, attention or fuel within a network and an offering is a way to access that early on and at a lower fee.

For example, a utility token gives investors access to products or services within a company. Without holding the coin, they might not have access to the same services or might pay a higher fee. If they want to buy the cryptocurrency after the company has met its fundraising goals, they could pay a much higher premium.

For security tokens, ICOs give qualified investors a way to hold a tokenized asset. Keep in mind that these are more regulated because the SEC considers them to be securities. This means that they’re available to a smaller investor pool.

How ICOs Work

  • When a new company carries out an initial coin offering, they begin by creating their own new cryptocurrency. These early-stage currencies are typically called “tokens.”
  • They set the number of tokens and establish their initial value.
  • Additionally, they define all parameter of the initial coin offering. These usually include answering the following questions:
    • How much would they like to raise?
    • What will they use the funds for?
    • How will they distribute the tokens?
    • What currencies can be used to purchase the new tokens?

If it meets their funding goals, it’s a success. If not, the funds are returned to the purchasers, in theory.

How to Invest

Since cryptocurrency in ICO is not listed on a secure cryptocurrency exchange yet, it’s a little more complicated. Heres how to invest in cryptocurrency in the fundraising stage.

Keep in mind that the following is for educational purposes only. Do not treat it as investment advice.

1. Do a Lot of Research

If you want to invest in an ICO, you need to keep track of the market. This means paying attention to qualifications and dates.

For example, some ICOs have a whitelist, which means that you have to pre-register in order to buy. Others only release a certain percentage of their cryptocurrency, which can sell out in minutes.

Social media is a good resource for ICO tracking, especially Reddit, which has individual channels for specific tokens.

Otherwise, there are a lot of initial coin offering websites. Here are a few examples:

  • Top ICO List
  • ICO Panic
  • ICO Watchlist
  • ICO Alert

There are a lot of ways to do in-depth market research, too. ICO Market Reports publishes weekly reports on trends, including specific projects to which platforms have the most initial coin offerings. InWara has research to over 3,000 ICOs for investors willing to pay for market data.

Think you’ve decided on a specific token? Look into the company offering the initial coin offering and their whitepaper.

2. Invest in Leading Cryptocurrencies

If you want to invest, you sometimes have to buy cryptocurrency first. To do this, you have to know how to buy Ethereum (ETH) or how to buy Bitcoin (BTC).

Keep in mind that most ICO tokens exist on the Ethereum blockchain so ETH is the most common coin for this purpose.

3. Get a Cryptocurrency Wallet

Next, you have to transfer that cryptocurrency from your private wallet (if the ICO doesn’t accept fiat). Ethereum (ETH) compatible wallets are the best because most ICOs exist on the Ethereum blockchain. Here are a few of the best cryptocurrency wallets currently available.

You cannot transfer funds from an exchange to a non-existent token as it won’t be listed on the exchange yet. This is one of the key differences between a wallet vs exchange.

4. Join the Community

Each investment will have its own guidelines, which you can typically access via their Telegram. Some also use Slack and Reddit forums. This is how you’ll figure it where to send your cryptocurrency and how you’ll receive your tokens.

Investment Approaches

If the ICO you invested in succeeds, the token will eventually get listed on a cryptocurrency exchange. At this point, you have a couple main options:

  • You can trade them on a cryptocurrency exchange. Many investors participate in initial coin offerings with the goal of selling off their tokens as soon as they’re listed.
  • You can hold your tokens and use their product or services once the company behind the offering becomes operational.

What Happens if It Fails?

Not every ICO succeeds. In fact, many of them fail to ever get off the ground. For example, fewer than half of all initial coin offerings survive longer than four months. Similarly, nearly 50% of all initial coin offerings in 2017 failed by February 2018.

Legitimate ICOs will explain in their whitepaper then they will return investor funds if they do not reach their cap. If it’s fraudulent, you will most likely never see those funds again.

For these reasons, potential investors should do a lot of research and look for key indicators of an ICO’s legitimacy.

How to Spot an ICO Scam

Because the world of crypto is relatively unregulated and because it’s so new, there is a lot of room for scams, like the $100 million Envion scam. Many of these receive a lot of publicity.

Here are a few things to do to prevent buying into a scam:

  • Research the company behind the initial coin offering. A real one will always include a white paper outlining all aspects of the offering. Go to the company’s website and thoroughly read the whitepaper.
  • When you read the whitepaper, pay close attention to the legal language it uses. Initial coin offerings are not often regulated the way IPOs or security tokens are.
  • Research its developers. A legitimate one will be transparent. It should be easy to find information about the developers’ plans, how they’re using funds and their project timelines.
  • Look for financial protections. Most importantly, the best initial coin offerings will usually use an escrow wallet to ensure that funds are secure. Ideally, the escrow wallet will require multiple keys to unlock funds. Even better, those keys should be held by a neutral third party.

A New Way to Fundraise

Like investing in any startup, ICOs offer both risk and reward. Above all, make sure you do plenty of your own research before making any financial decisions. There is an incredible amount of innovation coming from cryptocurrency and blockchain startups, but there is also room for fraud.

Either way, initial coin offerings represent a novel way of fundraising. Though SEC ICO regulations are still in flux, it’s one of the most democratic ways of fundraising the investment community has seen before.