An ICO is often referred to as a crowdsale or a donation but essentially is a tool that trades future cryptocoins for current cryptocurrencies that already have a value.
The final point that should be made about ICOs is that they are unregulated. This has its benefits – companies can move faster, but also has its drawbacks – the emergence of fraudulent ICOs.
ICOs, like the crypto world in general, have exploded in 2017. According to coindesk.com, between 2014 and the end of 2016 $295 million was raised through ICOs. In 2017, we have seen that number multiplied by 7, over $2 billion has been raised in ICOs this year.
What is the intention of a company behind an ICO?
Before we delve into why people are getting excited about ICOs, we need to cover the fact that there are two different types of ICO:
- As highlighted, it is to create a digital currency, similar to Bitcoin. With the intention that you can buy products and services with it. This solves the initial problem of distributing the coins.
- The second is to fund a project or piece of technology that requires the transfer of cryptocoins across a blockchain. This is designed as a crowdfunder, like any start-up company, they often require investment to further their project. Investing in these ICOs is similar to owning a stake in a business that you see longevity and scalability in.
ICO Project funding example
To give you a better idea of these types of projects, we will take the Golem token as an example, ‘the worldwide supercomputer’. It is a project that aims to be the ‘AirBnB of the computing world’. They want to rent your idle computing power to another user anywhere in the world. This means other users who require an increased power supply can rent from you and others to fulfil their computing needs.
This is all done using blockchain technology, with Golem tokens being used in exchange. As you can see, this is an extremely ambitious project. Those who are investing in it early on, are investing in a project for the long term because this is project in its current state is worthless, but in 5 years might be worth a fortune.
Golem is very much in the development phase and all the funding that it received during its ICO is to be put towards developing this technology and ideally bringing it to the general public.
Despite this huge increase in ICO investment, according to CNBC, it is only recently that ICO fundraising has surpassed Venture Capitalists funding. The majority of the funding in the past has been by venture capitalists or other private investment, however the tide appears to be changing and leaning towards ICOs.
How does an ICO crowdfund work?
Before you get coins from a new project or cryptocurrency, you need a platform in order to receive the coins.
A project or new cryptocurrency will either develop their own blockchain or, and what is happening more and more, new coins and companies are using the Ethereum platform. The Ethereum platform allows any developer to add applications to the platform, otherwise known as side blockchains. If developers think that the Ethereum platform can fulfil all their needs, it means that development is quicker and integration with other coins is very easy. Once a coin has been distributed, they are much more likely to be available on well-known exchanges and easier to trade for other cryptocurrencies.
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The procedure of an ICO is as follows:
- Those who intend to buy at the initial coin offering will be required to register to the platform in question. This is normally found on the company’s website.
- Assuming they use the Ethereum platform, the user will be required to get an Ethereum wallet or a specific one the ICO requests. For an Ethereum wallet, the following is regarded as secure and very user friendly – myetherewallet.com.
- They must then send Ether to this wallet. This is sent from another wallet containing Ether. The amount of Ether you send to this wallet will determine how much of the coins you are entitled to.
- Coins can either be distributed immediately on Ether deposit or once the ICO comes to an end, the coins are distributed dependant on quantity of Ether in each wallet. Depending on the ICO, a time bonus is often applicable.
ICOs are often carried out in stages and offer bonuses to those who invest at different points during the ICO. An example of this type of bonus is if the ICO was held over three weeks, then those who invest in the first week would receive a 3% bonus on their investment. Investors who get involved in week two would receive a 2% bonus and those who invest in the final week would receive a 1% bonus.
Another way companies tempt investors is by offering bonuses on amount invested. Simply put, the more you invest the higher percentage of bonus you will receive. This method was used by Cash Poker Pro during their ICO, see below.
ICOs sole intention is to generate money for their projects. Some ICOs will have a funding target and a funding cap, whilst others will simply attempt to generate as much money as possible.
Each ICO differs in the amount of coins on offer. They will likely offer a certain percentage and keep the remaining for the developers, owners and early investors.
There are some projects that do not have a cap to the amount of coins that will be available on the market and so do not offer a certain amount.
The proud owner of a new coin! Now what?
You essentially have two options now. Trade your fresh new coin or hold on it.
Once a coin goes live to the market, there are lots of exchanges that will give you exposure to the new coin. You can trade it for any cryptocurrency of your choice, assuming you have a wallet for the one in question.
Each exchange will give you a different price, so make sure to shop around to see which exchange offers the best price. The price is determined by supply and demand forces that each exchange handles. As there is no regulation, price differences often occur between exchanges, which in fact can be used to your advantage if you are an arbitrage trader. Normally the largest exchanges are the most reliable, the likes of Poloniex, Bittrex etc.
Drawbacks to ICOs
ICOs have plenty of advantages, just to name a few:
- Anyone can participate in an ICO.
- The more investors, the more decentralised the cryptocurrency is.
- Tokens can be bought at a low price.
- Efficient way to raise capital.
- Allows ICOs to move quickly.
But it also has its drawbacks. The big one is being scammed. Scam artists can take advantage of an unregulated industry. They can develop a very much believable front to a new coin, drawing in investors. Taking the Ether or Bitcoin that has been invested and then not producing any coins once the ICO ends and then disappear. These can often be referred to as ‘pump and dump’ coins.
Another risk is that criminals can hack into an ICO project and change wallet addresses, resulting in coins being sent to the hackers.
There are ways you can reduce your risk. The main is being extra vigilant about the ICO you are investing in. Often looking to see who advises on the projects will give you a good idea about how trustworthy the project is.
As you can see there is certainly a risk when getting involved with ICOs, but there is also a huge amount of upside potential. Like any investment there is risk attached and whether you get involved will depend on your risk appetite.
As long as you don’t risk more than you can afford, then I would suggest on a small scale it is worth the risk.