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Initial Coin Offering Explained: From Definition to Utilization

18 Aug 2021 updated
11 min

Table of content

Chances are, you are not a random reader who is trying to fill in the evening time by reading random articles. We are pretty sure that you know what virtual money is and how FinTech apps change the world of payments forever here and now. But since your eye caught the reinvented concept of ICOs (Initial Coin Offerings) in the title, you are probably looking for some explanation on what it is, how it works, and why you should or should not dive deeper into the topic of crypto investments. So let us start from the top–the history of the concept–to provide a clear map of how initial coin offerings evolved to their current state.

what is ico

 

ICO in numbers today

The story of ICO numbers should start in 2013 when Mastercoin handled the first token sale. However, the significant year for history was 2014, when Etherum raised $2.3 million in 12 hours with its ICO and put the concept on the map. And while the upcoming years influenced the ICO development as a business model, the exciting peak in earnings appeared only in 2017-2018. The still unsure ICO business that brought only $10 million in Q1 of 2017 grew into $6,880 million in just a year!

The rapid growth of ICOs in the world of cryptocurrencies caused a tremendous buzz those two years. Financial Times noticed the idea only in mid-2017 when it started generating actual revenue. The same attention was paid by the major news media and hence investors throughout the world. 2017-2018 were the golden years of ICOs and helped such giants as Brave, Kik, or Filecoin take a stand. The popularity, however, lessened in the next couple of years. Nonetheless, ICOs still continued generating income for their owners raising $14.8 billion in 2019 alone.

As the trend for cryptocurrencies started to fade among masses, so did the fame and tempo of ICO growth. Many ICOs appeared to be scams (about 75%), and those that were genuine went quiet. Such a market state could not last for long, or we would have already heard that the world of cryptocurrency collapsed. These negative statistics and lack of trust begin to improve today in 2021. Owing to the state changes around the world, the bad reputation of ICOs is getting out of the grey economy sector. USA, Russia, Switzerland, Israel – all these countries have already begun introducing ICOs into their legal systems.

So while the number of ICOs grows and the trust rises, let’s see what ICOs are and how an investor can benefit from interacting with one today.

The core concepts for ICO

Before we can move on to explaining in detail what an ICO is and how it works, there are several core concepts that you need to understand. They are:

  • Blockchain
  • Tokens
  • Smart contracts

What is blockchain?

All virtual data is stored in databases. There is one underneath every application, website, and even software. Blockchain is a type of database that stores data in a particular way – on a chain. Each data piece is transformed into a block of information that connects to the existing chain of previous blocks. In such a system, no chain can be changed, removed, or replaced. This means that once any piece of information about a transaction is recorded on a blockchain, it cannot be erased or altered. And this is probably the most attractive blockchain feature for modern business people.

Another important characteristic of blockchain is its decentralized nature. While traditional databases have only a couple of servers/cloud spaces where all data is stored, blockchain information is stored on thousands of devices participating in the information exchange. Each of the devices is called a node. And since there is no single place for data collection, it is close to impossible to break or tamper with the data stored on a blockchain.

Now when it comes to the blockchain data, the changes are allowed here but only if 51% of the chain nodes accept it. So for any purchase or transaction to happen on the blockchain, 51% of all chain members would have to verify and accept it.

transaction blockchain

Tokens & smart contracts

We haven’t mentioned any tokens or smart contracts before, right? Well, it’s because a token is basically something of value that can be exchanged on a blockchain. So for a transaction to happen, you need to have a valuable item, like a house, a phone, or a sports card. And there is another trick here – tokens cannot enter the blockchain directly because how a physical watch could enter the space of code, right? To do so, tokens need applications, smart contracts. These applications help to operate with tokens on a chain. But this is happening in the code, which is complicated enough as it is. So to make these transactions more understandable and user-friendly, there are applications in common sense – with an intuitive UI available for any end-user. These apps are called dApps (decentralized applications).

Why are these concepts of importance?

Blockchain technology with tokens and smart contracts offers a range of perks that investors can appreciate:

  • Security: each token is encrypted individually on different nodes helping their owners have peace of mind against fraud and thieves.
  • Anonymity: yes, everything in the world of blockchain is based on users’ nicknames. This makes the system safe and keeps the records anonymous.
  • Steadiness: anything recorded on a blockchain stays there forever. And once a transaction is added to the chain, it cannot be changed or deleted.
  • Traceability: every transaction has a timestamp and a chain of transactions by which it can be identified and recovered.

The basics of ICO                                                                    

What is an ICO? Is ICO the same as IPO?

So now it’s time to get to the essence of this article – Initial Coin Offering (ICO). A decade ago, ICOs appeared on the market as an alternative way for companies to raise funds for entrepreneurial ventures–enterprises, such as product development, startup, educational programs, etc., that are created to make money. Owing to the relative similarity, Initial Public Offering (IPO) is frequently mixed up with the Initial Coin Offering by entrepreneurs. But there is a tweak of a difference.

IPO is a well-established method of raising funds for a startup or young company. Whenever a private business is ready to let external parties become its stakeholders, it develops stocks and puts them into the public market for investors to buy. By purchasing stocks of such a company, a person can gain influence over the company’s policy, development direction, and overall have an impact on its growth. By selling stocks, a company earns funds for further business development.

When it comes to ICOs, the global idea is the same: investors buy something from a company. But, instead of buying a share and a right to some vote, they purchase the company’s tokens. The latter bring no authority over the company’s plans to the buyer. They only provide funding to the entrepreneurs. Rather than gaining some power, ICOs only give their investors a valuable asset that could be sold at a higher price later on. In a nutshell, ICOs have the global idea of IPOs, but they mostly operate as crowdfunding platforms yet on blockchain and with cryptocurrencies.

how does ico works

Tokens and ICO types

Most often, you could read about the differentiation between utility and security tokens as the sole types of these offerings. However, there is more to this concept than many online resources anticipate. Here is a list of ICO and token types you should be considering.

  • Public and private ICOs. By the definition of ICO, once a company is ready to go public, it can set up the offering. And it is accurate, but the ‘public’ in this context can be limited and unlimited. Whenever the public is limited to a number of pre-vetted investors, it would be a private ICO. Public ICOs, on the contrary, open their doors to anyone interested in buying a token. Most likely, in the beginning, you will be able to participate only in public ICOs.
  • Fiat and crypto ICO fundraising. This is an important point for future investors: most ICOs allow only cryptocurrency-based purchases, and most of the most would agree to BTC (Bitcoin) or ETH (Ethereum). Before you decide to participate in the race, make sure to learn which currencies are accepted so you could be ready with the fiat currency, accepted cryptocurrency, or any cryptocurrency of your choice.

Besides the type of ICOs, one more important element to this kind of investment is the type of token you get after the transaction is complete. Here is what is on the table:

  • Utility token: this is a token that grants the investor access to the startup’s services. When a startup is a public service, a utility token will give investors an early start with the offered service. In simple terms, a utility token is a pre-order deal.
  • Equity token: this token in ICO is close to the IPO’s idea. Here investors pay a hefty sum for a token and hence can get a voice during the entrepreneurial meetings about the startup development.

Asset token: these tokens are rare as they are usually regulated by the local governmental bodies, like the Securities Exchange Commission (SEC) in the US. Asset tokens have a physical representation of their price, such as a golden/platinum bullion.

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Examples of successful ICOs

We have already mentioned Ethereum as one of the top ICOs existing to date. During the ICO stage, one could buy an Etherum token for only $0.31, and today the price is $2,803.67, which stands for a pretty lucrative return on investment (ROI). Once it took over the summit, it’s been around it every year. But enough with Etherum, let’s look at even more successful ICOs and their current state.

Stratis

This company believes that blockchain can transform every business process and streamline operations. They offer a blockchain-as-a-service (BaaS) platform on which companies can develop enterprise blockchain applications.

Stratis initially launched its ICO in June 2016. A STRAT cost was $0.007 per token, and today it is sold at $0.98 per token (but the all-time peak price was $22.66). Over five years, the company raised almost $600,000 worth of digital currency, which stands for 13,202% ROI.

Tezos

Today Tezos is the main competitor for Etherum as it offers investors a decentralized cloud computing platform on which anyone could develop anything. Its ambitious journey with an ICO started in June 2017 at a price of $0.4, and its founders raised $232 million only during these couple of initial weeks. Tezos, with its currency XTZ, is considered the most successful ICO that ever existed.

Even though a class lawsuit shook its positions, the company’s development spiked again after French Central Bank selected XTZ as its digital Euro representation. Today, XTZ costs $3.32 per token with the market capitalization of $3,117,784,860.

Filecoin

Filecoin is the leader of the biggest ICOs existing. Launching its ICO back in 2017, the company’s token was worth only $5, which is already a high price if compared to the previous businesses on our list. Filecoin was promising to develop a decentralized data storage marketplace, and the buzz around its launch promised it the fame of AirBnB. Even though the company raised $257 million in almost a month of the ICO stage, it suffered major launch delays and released its product to the market only in the late fall of 2020.

While today’s token price for Filecoin is lower than the ICO-stage estimate, the company is still doing well, guaranteeing over an exabyte of decentralized storage capacity to its customers.

As you can see, not all companies that thrived during the ICOs stage continue to lead their niches today. Nonetheless, wise investment in the early stages of a business can offer a huge ROI and monetary reward. So let’s move onto the investment part of the ICO business.

Why invest in ICOs?

Well, the answer is pretty obvious – to earn money. ICO is the first stage of the blockchain development business, the time when its tokens are sold at a very low price; hence they are available to anyone interested. Once the ICO period ends, the cost of the company’s tokens rises slowly but steadily, offering investors the opportunity to sell to a higher bidder and return the investment.

A rarer case for investment reasoning is participation in the company’s business on a daily basis. This is a feature of IPOs which is uncommon in the ICO market. Nonetheless, it still can be a valid point if you consider investing in something.

But while everyone knows that ICOs bring money, there is the same massive fuss around their untrustworthiness and a large number of scams due to the lack of regulations. We have to admit – this happens. But the more the market develops, the lower get the risks in this investment niche. So rather than explaining what is good or bad with ICOs, we’d like to focus on the top risks an investor may face and the ways one can prevent them.

ICO risks

Top risks & How to avoid them

The main risk that one may hear is that the market of cryptocurrencies is unstable and that one never knows when it might crash. While it is correct, the business of making money on investing in startups is generally a risky job, so let us put this one aside. Below is a list of risks related explicitly to the ICOs and their way of running things.

Projects untrustworthiness. We don’t mean here that every ICO is not reliable but only that the information provided in their project description (white paper) might not be correct or complete. And considering that white paper is the primary document for investors to read about ICOs, it is a big risk.

How to avoid it? At the back of your head, always remember that anyone (literally) can create a white paper and publish it. Just recollect on the story when SEC wanted to teach investors a lesson by publishing a fake white paper. In the meantime, carefully read the white paper you found for the ICO and pay attention to:

  • the details on what the funds will be used for
  • the current market state and prospective/expected ROI
  • the strategy behind the initial release and expansion plans
  • the conditions for buying and releasing tokens
  • the list of involved parties (team members, partners, investors, project advisors)
  • the system architecture and technical specifications
  • existing users and prospective target audience

Keep in mind that a reliable white paper is about 25-35 pages long and consists of pure facts, not marketing slogans.

Inexperienced team. Startup people are great visionaries, but they often lack experience and knowledge to complete the project and bring it to financial success.

How to avoid it? Always vet the ICO team. Perform small research on the development team as well as its advisors, understand their background and efficiency of the previous projects and experience.

Insufficient details on project progress and issues. As an ICO investor, you are not likely to get any deep insights into the project (as opposed to the IPO business). This is frustrating and frequently very annoying but this is a risk every ICO investor accepts.

How to avoid it? Well, there is no way to avoid this one. But you can always negotiate your position or simply select an ICO that provides its stakeholders with updates on the project’s development, issue management, and risk assessment.

Fraudulent companies. ICO is sort of a gamble where investors stake on returns. It can and should be a well-informed gamble, but the process of startup development usually has many unknown and uncontrollable factors. So any promise on a high return or assurance of the bright future is mere speculation.

How to avoid it? Do not invest in ICOs that promise the moon. Stick to the verified facts and hard data when making a decision about any investment.

Lack of legal regulations. This point has been raised in this article a couple of times, and unfortunately, it still remains one of the biggest complications when it comes to ICO investment. Lack of legal support in most countries is a risk that is already being mitigated by many states, yet, the systems are still far from perfection.

How to avoid it? It is highly advised to invest locally and in the countries that started legal support for the ICO investors. Besides that, do your due diligence on the legal aspects of the prospective ICO (verify their anti-money laundering and know-your-customer policies, follow tokens distribution in pre and public sales, see their fundraising goals, etc.)

The truth is, risks will always be in investment; you just need to be morally ready for them. But instead of worrying, just arm yourself with information and facts to make a deliberate investment decision.

The bottom line and 4IRE tips for smart investments

Initial Coin Offering is a new way for startups and established businesses to raise money for their ideas. It is a relatively new and trendy way to invest and a perfect opportunity to get the missing funding in the 21st century.  Based on blockchain, ICOs offer both participating sides a wide range of perks like traceability of every transaction or complete anonymity of the investor. Nonetheless, the whole process is not flawless. We have raised six top concerns investors have about spending money on ambitious ICOs and making their investments count. But besides reaction to risks, here are two essential pro-active pieces of advice from the 4IRE team:

  • Follow the ICO trail online. You have read all the materials provided by the team (their white paper, team composition, the money trail, etc.), but you did not look at the project from a different angle. Check forums where the ICO and its team participate in conversations/make announcements and evaluate their responses. What sentiments people have about the company, how the team reacts to critics, how well they can answer questions, or maybe they just ignore the hard truth.

  • Consult field experts. This might not be an obvious step, but you need to find a field expert who understands what the prospective ICO is planning to solve. The search will require an investment of your time, but an independent peer review of the project can shed light on its dark corners or potential downsides. Our team members are always open to such consultations so drop us a line if you need help.

Now breathe out. You have just received a large amount of information on making a smart ICO investment. So it is high time to begin researching for the options on the table and making a smart move into the lucrative world of crypto investment. 

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