What is ICO?
You must have asked yourself that question every single time you read an article about a random blockchain company raising million of dollars in less than 24 hours.
The amount of money that ICOs aka Initial Coin Offerings, have raised over the last two years is truly astonishing. In 2017, ICOs raised a total of $5.6 billion. If that sounds shocking to you then think about this.
ICOs have already raised $6.3 billion, 4.5 months into 2018 alone!
After seeing all these stats, it makes sense as to why more and more people are getting intrigued with ICOs.
So, to clarify all your doubts, we are going to tell you what are initial coin offerings, how they work, and all the nitty-gritties that go along with it. The topics that we will cover are:
ICOs are basically blockchain crowdsales, the cryptocurrency version of crowdfunding. The ICOs have been truly revolutionary and have managed to accomplish many amazing tasks:
- They have provided the simplest path by which DAPP developers can get the required funding for their project.
- Anyone can become invested in a project they are interested in by purchasing the tokens of that particular DAPP and become a part of the project themselves.
The first ever recognized ICO was held by Mastercoin in July 2013. Mastercoin was able to raise about a million dollars. However, it was in July 2014 when ICOs well and truly came into the public’s attention. That was when the ICO Ethereum raised $18.4 million and ushered in a new age of ICOs. However, before we dabble any further, we should look into what tokens are.
Tokens = ICO Cryptocurrency?
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The word “token” gets thrown around a lot, however, more often than not, people simply don’t know what it means. To be honest, it can be extremely difficult to pinpoint an exact definition. Let’s at least start with a very broad definition:
A token is a representation of something in its particular ecosystem. It could value, stake, voting right, or anything. A token is not limited to one particular role; it can fulfill a lot of roles in its native ecosystem
Having said that, there is a difference between cryptocurrency coin and token. Coins like Ethereum, Bitcoin, and Bitcoin Cash are examples of cryptocurrency coin, since they have value outside their native environment.
However, projects like OmiseGO and Golem are tokens because they exist on top of an existing smart contract platform, like Ethereum.
According to the U.S. Securities and Exchange Commission (SEC) there are two kinds of tokens out there:
- Security Tokens
- Utility Tokens
A crypto token that passes the Howey Test is deemed a security token. For a token to pass the Howey Test, it must fulfill the following conditions:
- Is it an investment of money?
- Is the investment in a common enterprise?
- Is there an expectation of profit from the work of the promoters or the third party?
Note: “Common Enterprise” is still open to interpretation. However, majority of the federal courts define it as a horizontal enterprise where investors pool in their
Since most ICOs are investing opportunities in the company itself, the tokens classify as security. Security tokens are subject to federal securities and regulations since they derive their value from external, tradable assets.
On the other hand, if the token doesn’t pass the Howey test, then it classifies as a utility token. These tokens simply provide users with a product and/or service. Think of them like gateway tokens which can:
- Give holders a right to use the network
- Give holders a right to take advantage of the network by voting
So, now we know what an ICO is and what tokens are. Let’s actually look into the mechanism of how an ICO works.
How Does the ICO Crowdsale Work?
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Smart Contract platforms like Ethereum and Neo allow developers to create their Dapps on them. Think of them like a decentralized supercomputer and the Dapps as the applications that one can execute inside.
In order to gain funding for the project, the developer issues a limited amount of tokens (could be utility or security). It is important that the tokens have a limited amount because:
- It makes sure that the ICO has a goal to aim for
- As the demand rises and the supply of token diminishes, it makes sure that the value of the tokens will go up. The tokens have a predetermined price which may go up or down depending on the demand.
ICO trading is pretty simple and straightforward. If you want to buy some tokens, then you send some cryptocurrency (Ether if the platform is Ethereum) to the crowd-sale address. The moment you do that, you get the corresponding amount of tokens sent to your wallet.
Obviously this just a general overview. There is a lot of marketing that goes on leading up to the date of the ICO. In fact, paid advertising used to be so rampant that social media giants like Facebook and Twitter had to ban ICO-related ads on their platforms.
Examples of Successful ICOs
The most successful and (in)famous ICO of all time is the EOS ICO. The project which is spearheaded by crypto rockstar Dan Larimer is hoping to create a scalable smart contract platform. They held their ICO for nearly a year and raised an astounding $4 billion USD.
Bancor took the crypto world by storm when they raised $153 million in 3 hours. Bancor plans to solve one of the biggest investor problems by providing liquidity for tokens which can’t be easily exchanged. The way they are doing that is by utilizing a “smart token” system.
Pros and Cons of ICO Explained
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- Most importantly, ICOs give promising projects an opportunity to shine. The prime example of this has to be Ethereum. Look at what it has achieved over the last 3 years. Not only has it become a part of our zeitgeist, they have provided an ideal platform for other projects to develop on top of them.
- Many projects in the “centralized world” never get to do their IPOs (Initial Public Offerings) because of the sheer amount of unnecessary paperwork involved. However, blockchain projects can simply take part in an ICO by presenting a good quality ICO whitepaper.What is ICO whitepaper you ask?It is a concisely written piece of documentation which presents the problem that the project is aiming to solve and the method that they will be following in order to solve it. Upon reading the white paper, the potential investors can choose to invest or not in the project.
- Another brilliant thing that an ICO manages to do is to establish a rapport between the project and their community. Any ICO creator worth their salt will tell you how critical it is for them to develop a healthy community.Quantstamp is a perfect example of this. They were able to raise all their ICO money organically because of their healthy relationship with their community.
- The fact that blockchain crowdfunding was able to collect $6.8 billion in 4.5 months just goes to show how much hype and demand there is behind these projects. Such kind of exposure will do wonders for them.
- In a similar vein, ICO funding provides a huge incentive for developers to go the extra step and come up with more exciting and innovative projects.
- For investors, ICOs provide an opportunity for them to invest and discover the “next big thing.” Let’s give you the perfect example, Ethereum. During the ICO, 1 Ether was trading for 40-50 cents. As of right now, they are trading for $477 each.
- Remember how we told you earlier that one of the biggest pros of ICOs is the lack of paperwork involved? Unfortunately, it is a double-edged sword. Loads of scammers have entered this space hoping to make a quick buck.They simply create a bogus white paper or omit some of the more important details off their whitepaper to make their projects seem more important and intricate than what they actually are.
- When you are investing in a project’s ICO you are not actually investing in the project, you are investing in the idea of the project. As such, it works on pure speculation which is based on the quality of the white paper and the credibility of the team. So, you simply have no idea whether the project is actually going to be a success or not when you invest.This is where certain cold-hard facts should be considered. 90% of the startups fails. Either the product doesn’t work or the developers get lazy. Also, as the DAO attack has shown us, even if everything is in place, a slight mistake in the code could be enough to send a project crashing down.
- During the ICO sale, the presence of “crypto whales” could be problematic. The most infamous example of this is the BAT ICO. The ICO was able to raise a staggering $35 million in 24 seconds! It turned out that majority of the tokens were owned by certain individuals, which simply defeats the purpose of decentralization.These individuals are called “crypto whales” or simply “whales.” These individuals use their significant financial clout to pay exorbitantly high transaction fees to “cut in line” of the waiting queue. During the BAT ICO whales paid as much as $2220 in transaction fees!
- An ICO is an extremely laborious event for the blockchain, at least the way it is designed right now. The fact remains that blockchains are simply not scalable enough to take up heavy duty activity.The $100 million Status ICO clogged up the Ethereum blockchain so badly that a lot of people simply weren’t able to participate because their transactions didn’t come through.This can work in reverse as well.The SophiaTX ICO had to postpone its date because the Cryptokitties game had clogged up and slowed down everything in the Ethereum blockchain.
- Ethereum based ICO tokens are easy to store because they can be stored in any Ethereum wallet. However, things get tricky when it comes to other platforms. More often than not, these tokens may not be compatible with your wallet and storing them may be an extremely tiring and annoying exercise.
- Also, as you may already be aware of, ICOs are increasingly coming under the radar of regulatory bodies like SEC and CFTC. They have already made their presence known by making it compulsory for US based ICOs to declare whether their tokens are securities or not.
- Finally, the next step to increased regulation is government intervention. Because of the vast amount of unregulated money that ICOs are dealing with, the government may consider them unsafe and simply ban them in their countries. China and India are ideal examples of this.
There you have it, hopefully you have understood what ICOs are and how they work. So, is the ICO meaning to change the way crowdfunding has worked so far?
Of course it does, and of course it has. No matter how much of a critic you are, you simply cannot deny the impact that they have had on the financial market.
Plus, when it comes to pure innovation, ICOs have given us extremely innovative projects like Ethereum, OmiseGO, Golem etc. which have the potential of changing the future of finance and technology.
Having said that, there are still plenty of areas that need to be ironed out.
There is a lot of money in this space and unfortunately a lot of scammers have made their presence known here as a result. If you are an investor, then the only way that you can work around this situation is by being more smart and savvy with your investments.
Learn more about the team and read the whitepaper thoroughly. If you think that there is true value in the project then and ONLY THEN should you invest your hard-earned money into it.