What is an ICO? Initial Coin Offerings Explained.
Initial Coin Offering, or ICO, is one buzzword you’ve most likely heard flying around the past few years. But what exactly is an ICO?
Put simply; it is a fundraising mechanism where new blockchain projects sell crypto tokens, usually, for BTC or ETH.
ICOs are comparable to traditional Initial Public Offerings (IPOs), but with one big difference, you don’t necessarily purchase shares in the company.
Further, with most ICOs you’ll often hear other terms such as tokens, token standards, and smart contracts. Basic knowledge of these is required to understand how ICOs work.
A cryptocurrency token is used to represent an item of value. You may have heard the term “tokenised” before. A token could represent a share in a company, a gram of gold, or virtual real estate for example. To illustrate this, Polymath (POLY) security tokens represent equity ownership. Tokens are usually applied to a blockchain using smart contracts. Further, most tokens tend to follow a particular coding standard.
The most commonly used standard is the Ethereum Request for Comments 20 (ERC-20) Standard. The ERC-20 standard makes it easy for developers to create their own cryptographic tokens on the Ethereum blockchain. Essentially, it is a set of protocol specifications, behaviours and standards that contracts are built to and is considered an excellent starting point for developers. If you want to learn more, check out this ERC-20 Token Standard page on Github.
Investors send Ether or Bitcoin to a smart contract. This contract then distributes an amount of the ICOs new token at a later stage. Smart contracts automatically process transactions when pre-programmed criteria are met. For example, if a business needs to store a file with NEM (XEM) securely, they transfer the appropriate amount of XEM. THEN, once the smart contract confirms the correct amount is received, the data space becomes available to them.
The first ICO
In 2013, J. R. Willett is credited with launching the first ICO, Mastercoin (now called Omni). Willet described his way of raising funds to start a blockchain project as similar to Kickstarter, a popular crowdfunding platform. He wrote a whitepaper called “The Second Bitcoin Whitepaper”, in which he described his idea of using the Bitcoin network as a protocol layer, building new currencies with new rules on top. He proposed the idea of investors sending BTC to a published wallet address to fund platform development, in return for owning a piece of said protocol. However, Bitcoin had several limiting factors such as its scripting language and the fact that BTC is either spent or unspent.
In 2014, Vitalik Buterin made possible what Bitcoin couldn’t with the publication of his Ethereum whitepaper. The idea gained momentum in the crypto-world, raising over NZD$26 million in late 2014. Buterin introduced a Turing-complete language allowing developers to write smart contracts and develop Dapps (decentralised applications). Thus, the birth of the developer-friendly blockchain platform that now boasts thousands of ICOs.
5 Examples of Successful Ethereum ICOS & Their Market Cap (at time of writing)
- Augur (REP) $577,456,474 NZD
- Golem (GNT) $450,372,501 NZD
- DigixDAO (DGD) $338,043,782 NZD
- EOS (EOS) $13,564,239,318 NZD – Now on their own mainnet
- Tron (TRX) $4,696,152,952 NZD – Launching their own mainnet
Fundraising Flourish or Spiteful Scam?
By mid-2017, ICOs had overtaken venture capital as the primary funding source for blockchain start-ups. Principally, this is because they provide fast access to seed money with fewer restrictions.
One of the most significant benefits to start-ups is that ICOs allow you to fundraise from a global pool of investors without giving up equity. No longer are you geographically limited to seed funds from just one area.
Although, this presents a risk to the investors as (usually) money is raised pre-product making the investment extremely speculative. Additionally, there is currently no regulatory protection in place, and token holders have no guarantee of project development.
In contrast, this level of risk helps prioritise the start-up to incentivise protocol development. Often, users receive rewards for testing the platform or service for bugs themselves. Plus, token holders essentially provide a vote to support innovative business ideas they appreciate through purchasing the new tokens.
If all goes well, it is possible for the initial investment to increase in value if the platform becomes popular.
An example of what is known as a scam coin is The Billion Coin (TBC). Unfortunately, many people fell prey to this scam and lost a lot of money between April and June 2016. What they did was set up a fancy website, offer all sorts of return promises, take people’s money, then disappear. While the site is no longer running, when it was live they made many outlandish claims.
Firstly, TBC claimed to be in fourth place for market cap, yet they weren’t listed on Coin Market Cap or World Coin Index. Next, they claimed to help you “get out of debt fast”. A tell-tale scam sign if ever there was one! Absurdly, they claimed one TBC was worth over 100 BTC. Finally, to purchase TBC, you had to do so on the site’s own exchange, nowhere else.
Avoid Scams by Doing Your OWN Research
If you’re thinking of investing in an ICO make sure you do your homework first. Don’t just assume that all that glitters is digital-gold!
Minimise the risk of falling prey to a scam by reading the projects whitepaper. A promising ICO will have a well-researched, informative whitepaper covering both technical and non-technical aspects of their plan.
Check out the team behind the project. Are they newcomers to the crypto-scene? Have they been involved in other, successful, blockchain projects?
Look into how the team plan on allocating the funds raised from their ICO. Is the majority going into development, or do they not even specify?
What is their token distribution model?
Have they issued a roadmap outlining the development plans and how long it will take?
Guide on Identifying Scam Coins
BitPrime cannot assist you with buying tokens that are in the primary market stage. That is, where you are participating in the first issuance of tokens from a project’s ICO. This article is for informational purposes only. BitPrime does not condone, nor promote, any projects that fall into this first category.
If the tokens in question have been previously issued, they are said to be trading on the secondary market. The only tokens we sell are those that fall into this category. In other words, we only sell POST-ICO tokens.
Future Outlook: regulation and advancement
Many in the cryptocurrency community believe crowdfunding projects to be Ethereum's killer app. Why? Because it has never been easier for a pre-product start-up to raise as much capital in such little time. With the ICO market mostly unregulated at present, this means massive profits are possible for investors, but also, so are substantial losses.
As regulatory guidelines are developed and established, I believe the future of ICOs will be a safer one. Currently, the United States Securities and Exchange Commission (SEC) have subjected several tokens to the Howey Test. If a token passes the Howey Test, it is treated as a security.
“[A security is] a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
Describing the Howey Test warrants a full article on its own, so see this Bitcoin Magazine article if you’d like to know more.
Finally, technology is continually improving, and blockchain and cryptocurrencies are becoming more widely accepted. All in all, the overall quality of blockchain projects is likely to improve with both technological and regulatory advancement.
What do you think of ICOs? Have you invested in any, or do you want to? Let us know in the comments below or read about the difference between ICOs and ICCOs.
Disclaimer: The above references an opinion and is for informational purposes only. It is not intended as personalised financial or investment advice. The opinions expressed by the author do not represent the opinion of BitPrime.
Last updated: 24/06/2018