What is an ICO and How Does it Work?
Prepared to finally understand what is an ICO? Get ready for this post, then!
The rise in the price of Bitcoin grabbed most of the headlines in 2017, mostly because it is the first and best-known cryptocurrency.
Starting out at just over $1,000 in January, 2017, Bitcoin’s price surged to over $17,000 in December.
However, other cryptocurrencies have also shown significant gains during the same period.
These include Quark with a return of over 8,000 percent, Cryptonite with more than 75,000 percent, and DubaiCoin with an astounding gain of almost 824,000 percent.
These kinds of returns have attracted the attention of many investors and venture capitalists seeking a piece of the action.
They have also spawned an increase in the number of startups in the cryptocurrency space that intend to raise capital through Initial Coin Offerings (ICOs) to fund their ventures.
What are ICOs and how can they be Compared to IPOs?
An ICO is the cryptocurrency equivalent of a traditional Initial Public Offering (IPO).
With IPOs, investors exchange money for equity in a public company.
Cryptocurrency startups use ICOs to raise funds for their new ventures, selling their own cryptocurrency in exchange for legal tender or other cryptocurrencies, such as Bitcoin or Ether.
Whereas IPOs are tightly regulated by banks and the Securities and Exchange Commission (SEC), ICOs are currently unregulated, with no oversight by the SEC.
An ICO is like crowdfunding, except backers expect a return on their investment rather than donating money for a startup.
ICOs exchange virtual coins or tokens instead of shares to raise capital.
IPOs are normally only accessible to high net worth investors, while anyone can invest in an ICO.
How do ICOs Work?
Startups launch an ICO by publishing a white paper or website giving a detailed description of the project and key team members, the budget for the venture, the types of currency accepted for investment, and the timeline for the ICO campaign.
Early ICO investors are often given bonuses.
Most ICOs set a limit on the number of tokens or coins on offer prior to the campaign launch.
Early investors may be given preferential terms, which often include a lower price per coin or token.
While some ICOs may keep the price steady throughout the campaign, others adjust the price according to demand in order to raise as much capital as possible.
There have been valid concerns about the risks associated with ICO investment.
In order to mitigate the risk, ICOs may facilitate their offerings through an exchange or escrow service.
An escrow provides investors with some degree of security against scammers and a means of verifying how funds are spent after an ICO campaign has run its course.
Advantages of ICOs
ICOs offer a number of advantages for both entrepreneurs and investors:
- They provide a platform for startups to raise money faster than conventional fundraising mechanisms. Unlike IPOs or regulated crowdfunding campaigns, ICOs don’t have to go through red tape and documentation to get started. All that is needed to launch an ICO and attract investors is a white paper or a website outlining the venture. This makes fundraising much cheaper
- Investors are given early access to a potentially profitable venture. Some ICO projects can turn out to be highly profitable for early investors. The Ethereum ICO launch in 2014 is a case in point. Its offering of Ether cryptocurrency turned out to be the most successful ICO venture to date. Ether was offered at 35 to 40 cents at launch and is now priced at over $1,100
- Heightened exposure for projects. The creation of a website to support an ICO gives startups the opportunity to showcase influential team members and early investors in the project. This helps to build credibility and trust, and attract further investment
- They facilitate community building. ICOs give entrepreneurs the opportunity to build a strong community around their projects. They also give the community a valuable say in the direction of future projects, enabling investors to keep creators and team members accountable. A strong community also improves credibility and attracts more investors
- Potential for high reward. Although high risk, ICO investments can offer high rewards. To a large extent, investments are not affected by changes in the stock market and the economy
Risks Associated with ICO Investments
Investors need to be aware of the potential risks and disadvantages of investing in ICOs:
- They attract scammers. The unregulated nature of the cryptocurrency industry is something which attracts scammers. The creation of a white paper or website to launch an ICO is no guarantee that it is genuine. These can be full of untruths and inaccuracies which scammers may use to entice investors
- ICOs are speculative by nature. When investing in an ICO project, investors are backing an idea or concept, with no guarantee of success. Statistics show that over 90 percent of startup enterprises in all industries fail, and cryptocurrency projects are no exception
- Prone to investment by whales. Whales are people who have a lot of money to invest in an ICO. They invest early to buy up a large portion of tokens and then sell them later at a premium to get a short-term profit. They basically rig the game in their favor, leaving smaller investors to purchase coins or tokens at elevated prices
- ICOs may not facilitate secure storage of tokens or coins. This will make wallets prone to hacking and fraud, or lead to tokens being lost
- New cryptocurrencies may not be accepted by exchanges. Tokens or new digital currencies lose their liquidity if they are not accepted by cryptocurrency exchanges
How to Avoid an ICO Scam
Investors should look out for signs that an ICO may be a scam and take evasive action.
Check the signs that tell you an ICO may be a scam:
- Weak ICO promotion. If a white paper or website promoting an ICO does not have detail on the project or information about the creators and team members behind the venture, it could be a scam. Investors should conduct a thorough research on all aspects of the project, as well as the company and team involved before committing to the investment
- Unclear roadmap. An ICO launched without adequate detail on development and funding goals may be a scam. It could be an indication that the creators are just looking to make a quick profit
- No cap on fundraising. Legitimate ICOs usually publish their fundraising goals before launching. An ICO without a funding cap may indicate that creators are only in it for short-term profit
- Biased mining structure. A mining structure rewarding pre-launch investors with a significant number of pre-mined tokens may be evidence that the venture is driven by the prospect of short-term gain
ICO Affiliate Marketing
For ICO startups, affiliate marketing presents a way to generate capital faster and without the regulatory funding restrictions imposed by banks and venture capitalists.
Affiliates reach new customer bases and bring in more web traffic for exposure to the project.
ICOs may present an exciting opportunity for affiliate marketers to make money.
However, ICO scams have the capability of destroying a network and causing significant damage to an affiliate marketer’s credibility.
Affiliate marketers have an added responsibility to safeguard the investment of every member of their affiliate network.
This demands meticulous screening of ICOs to determine legitimacy.
It may be easy to be caught up in the emotion and hype surrounding cryptocurrency investment.
Make no mistake:
There are opportunities in ICO investments to make a lot of money.
However, investors and affiliate marketers need to conduct due diligence on ICOs to assess their legitimacy and potential for profit before committing to any project.