ICOs are a concept similar to crowdfunding. Someone presents an idea for a project and advertises it in an attempt to attract investors. If you like their idea, you can buy the coins or tokens in advance, paying with already-established cryptocurrencies or (less commonly) with traditional currencies. This funds the project and enables the team to develop their design. If it is successful, the coins rise in value and the original investors make a profit.
- An alternative method of raising funds for a start-up.
- The team presents their project in a whitepaper.
- The ICO is launched and coins are sold to the public.
- Gathered funds allow the project to enter its main development stage.
- Development is complete and the coins become useful and potentially valuable.
The idea of crowdfunding
It’s difficult for a startup company to make a breakthrough in any market, and the cryptocurrency market is no exception. Many clever ideas and innovations never see the light of day. The people behind them don’t have the funds necessary to develop the technology on their own and can’t find an investor who would support them.
Instead of one major investor, this system provides numerous smaller-scale investors.
Crowdfunding is an alternative to the traditional financing of start-ups. It bypasses large investors and markets the project straight to the general public. Whoever believes in the potential of what the company is offering can invest money to help the team develop their idea.
The ICO spin on crowdfunding
The concept of initial coin offerings is similar to crowdfunding. A team comes up with an idea for a cryptocurrency-related project. Then they need to get enough money to develop their idea. Instead of (or alongside) trying to court investment from a venture capital fund (as most traditional start-ups do), these teams publicly announce their idea and allow almost anyone to invest.
During an ICO, it is possible to buy coins of the new cryptocurrency at a predetermined price. This is the first time anyone can buy the new currency. The idea is that the price of the coins will increase as time passes and the investors, or backers, will profit from that.
However, the coins don’t exist yet or are distributed in a locked-down state, so the backers can’t use them immediately. The coins only become usable after the development process is over. In case the ICO fails to gather enough funds, the new cryptocurrency is usually not created (or completed) at all and backers get their money returned to them.
The details of an ICO are normally specified in a whitepaper, a document that outlines the idea and the plans of the developers. The whitepaper can contain everything from the type and the amount of funds necessary to complete the project, and the technical details on what their product strives to achieve, to the conditions under which the funds can be returned if the ICO fails.
The stages of an ICO
ICOs have several stages, not all of which are fully open to the public.
An ICO begins with a private sale. This usually takes place behind closed doors, a few months before the ICO is open to the public. During this stage, the team tries to collect money to be spent for marketing and funding the next stages of the ICO. Since the project is not yet on its feet and many things have to be handled manually, they try to avoid a multitude of small investors and usually create an investment threshold (say, 1000 USD).
The next stage is the presale. By this stage, the funding process has been somewhat automated and manual work reduced. The ICO is now open to the public, but investing is still not available to everyone. The team makes a selection, usually based on know-your-customer filters, or even a random selection, in order to prevent overcrowding. The presale itself can be split into multiple phases. The price of the coins increases with every phase.
After that, it is finally time for the crowdsale. During the crowdsale, investors may need to be whitelisted and can be required to submit a KYC form. This is necessary to comply with regulations (such as anti-money-laundering policies and anti-terrorist prevention measures).
Avoiding ICO dangers and scams
Not all ICOs are stories of success, neither for the developers, nor for the investors. One of the biggest advantages and, at the same time, the main drawback of an ICO is its unregulated status in many countries around the world. This means that the team behind it enjoys the freedom to develop their project as they see fit. On the other hand, it gives no guarantees to those funding it.
Unfortunately, there have been numerous occasions when developers did not follow through with the vision presented in the whitepaper, or entirely failed to deliver the product. The backers were left with worthless and useless coins or, worse yet, nothing at all. Some fraudulent “developers” never planned to release the product in the first place and vanished when the ICO was completed.
To avoid these problems, contemporary ICOs are based on blockchains that support smart contracts. These contracts function as a hard-coded safety mechanism. They make it possible to specify the conditions under which investments will be returned, should the development team fail to deliver.
Thinking about investing in an ICO?
In the modern cryptocurrency environment, most startups raise money through ICOs. If you want to invest in fresh businesses, you can become an ICO backer. But most ICOs only accept investments in other cryptocurrencies. Established coins like ether (Ethereum) or bitcoins are usually used for this purpose.
To get BTC or ETH, you’ll have to buy them at an exchange that will allow you to trade traditional money for cryptocurrencies, such as Bitstamp. You can register your account for free.
This webpage has been approved as a financial promotion by Bitstamp UK Limited which is registered with the UK’s Financial Conduct Authority. Please read the Risk Warning Statement before investing. Cryptoassets and cryptoasset services are not regulated by the Financial Conduct Authority. You are unlikely to be protected if something goes wrong. Your investment may go down as well as up. You may be liable to pay Capital Gains Tax on any profits you earn.