In a world where digital currencies have transcended the realm of speculation and captured the imagination of investors worldwide, one term stands out as a symbol of entrepreneurial innovation and fundraising prowess: Initial Coin Offerings (ICOs). As the blockchain revolution reshapes traditional financial landscapes, ICOs have emerged as the gateway to a new era of capital raising and project funding.
But what is an ICO or ICOs, and how do they differ from traditional fundraising methods? In this article, we will demystify the captivating world of ICOs, providing you with all the essential knowledge you need to navigate this exhilarating landscape.
What is Initial Coin Offering (ICO)?
An Initial Coin Offering, also known as an ICO, functions as the cryptocurrency realm’s analogous concept to an initial public offering (IPO) in traditional finance, where a company offers its shares to the general public for purchase, serving as a means for a company to raise money or ICO funds while introducing a new coin, application, or service to the market.
Through an ICO, companies can raise funds and support for their innovative ventures within the virtual tokens or cryptocurrency ecosystem.
ICOs are an alternative method for businesses to gather funds by utilizing digital assets. Investors participate in ICOs through trading platforms and receive distinctive digital “tokens” in exchange for their financial contributions.
Essentially, it is a form of crowdfunding that enables project development by creating and selling these digital tokens.
These tokens are unique as they grant investors access to specific project features the issuing company facilitates.
How Does an ICO Work?
The ICO fundraising model enables startups to secure capital by issuing tokens on a blockchain, with these tokens being distributed in exchange for financial contributions. These tokens can be transferred and traded on cryptocurrency exchanges, serving various functions such as granting access to specific services or providing entitlement to company dividends.
When startups embark on an Initial Coin Offering (ICO), they often craft a comprehensive whitepaper that delves into the details of their cryptocurrency project and provides pertinent information about the campaign and product.
The invested funds are returned to the investors if the startup fails to reach the minimum funding target. However, if the ICO proves successful, the raised capital is allocated toward initiating new developments or finalizing the existing product.
Depending on their purpose, tokens can be generally categorized as utility tokens or security tokens.
Utility tokens, also known as “user tokens” or “app coins,” represent future access to a business’s product or service. By offering utility tokens, ICO startups can raise funds to develop their blockchain projects in exchange for users’ anticipated access to the service. Unlike traditional investments in company shares, utility tokens are not intended to be treated as securities, as they are structured to exempt them from federal securities laws.
Startups can create utility tokens to sell “digital coupons” for their forthcoming service, similar to how online retailers accept pre-orders for video games yet to be released. To avoid potential securities offering implications, businesses offering utility tokens often use alternative terms like “token generation events” or “token distribution events.”
In contrast to utility tokens, security tokens derive their value from external tradable assets or the efforts of others. Accordingly, they may fall under the classification of security tokens, subjecting them to federal securities regulations. Compliance with these regulations is crucial to avoid penalties and protect the project’s integrity. Once a token is appropriately classified as a security, it opens up possibilities for various applications, with one promising avenue being the issuance of tokens representing company shares.
ICOs vs. IPOs
When comparing a cryptocurrency initial coin offering (ICO) to a stock initial public offering (IPO), one of the most significant distinctions lies in the level of regulatory oversight. For an IPO, a company is required to register with the regulatory authority and prepare a legally mandated document known as a “prospectus.” This prospectus is a transparent declaration of the company’s intention to issue shares to the public and must meet specific standards to ensure transparency. It provides vital information to potential investors, aiding them in making informed decisions.
In contrast, ICOs, as recently indicated by regulatory actions in the United States, are subject to regulatory requirements primarily if they are classified as security tokens rather than utility tokens, which was further explained above. However, due to the relatively nascent nature of ICO regulations, conducting investor assessments and due diligence can be more challenging, especially compared to the rigorous processes and oversight conducted by accounting firms and investment banks in stock IPOs. Accordingly, stock IPOs typically offer investors more critical information and security.
As a result of the previous two characteristics mentioned above, ICOs have more relaxed requirements.
ICO Pros and Cons
There are important reasons why ICOs are so beneficial for the cryptocurrency ecosystem.
An essential source of funding
They genuinely benefit startups as they are an essential source of the money needed to get the ball rolling that most organizations would fail without. Angel investors and venture capitalists are scarce; the only way a startup would ever reach them is through an ICO.
This low-hanging fruit opportunity allows startups to reach the investors with the money it takes to get off the ground where otherwise their path would be blocked. It will enable anyone, no matter their geographical location, political views, ethnicity, or religious beliefs, to raise capital. This democratizes the space and allows anyone (theoretically) with the will and the way to create their own cryptocurrency.
Speed and efficiency
Time is always against anyone in the startup mode, and if you don’t have enough momentum, you will die a quick death. ICOs offer speed because all it takes is a whitepaper to start things. The legal paperwork for setting up a corporation, a holding account, or a term sheet is costly. Having investors read all that material before signing on is usually lengthy. With ICOs, there are limits on these necessities, and the amount of time and money it takes to get things accomplished is much easier to deal with.
Community building and investor incentives
ICOs also build communities before they even have a product to invest in. This is important because it incentivizes investors to encourage token growth.
Besides the pros, ICOs also have a lot of weaknesses.
High potential for scams
There are a lot of scammers in the space that have made use of ICOs to scam many people out of money. Anything can look good on paper. It isn’t hard to see why scammers take advantage of these easy prey when they only need an attractive whitepaper to get people interested in risking their money. Fancy names, multiple “advisory boards,” and professional-looking websites can suck in the unwary investor and bleed them dry if they allow it.
Speculative value without tangible products
Conceptualized products that have no value without speculation give much power to the whimsical opinions of those who may or may not have a vested interest in seeing the project succeed or fail. Conflict of interest must always be considered before giving value to any speculation.
Manipulation by wealthy investors (“whales”)
People with the most money in the space tend to manipulate it like other markets. These people, known as “whales,” can push the market with bots, GAS, and scripts that set things up to their advantage. They can afford to pay more transaction fees to get ahead of you and buy up the tokens within the ICO.
Lack of proper leadership and sustainability
Organizations offering ICOs with no authentic leadership (like a regular corporation would have) that don’t understand how to create a good, sustainable company that will stand the test of time are in trouble. This has often happened involving new startups because their teams are decentralized, unfocused, and need intelligent decision-makers that can drive the company into a successful existence.
High failure rate
The cold, hard reality is that 90% of these ICOs will fail for whatever reason, and the number of failures vs. the number of successes makes it hard to legitimize ICOs for those who do their due diligence. However, most people invest in ICOs with blinders on. They don’t learn how to trade cryptocurrency the right way. Instead, they rush in and invest their capital without knowing all the ICO’s pros and cons, hoping to hit it big like playing the lottery.
As ICOs have become a system that has lost trust, investors are looking for new ways of securely putting their money into both the token and the company. However, in recent times, there has been an increase in interest in “STO,” which stands for security token offerings.
The STO merges the flexibility and democratizing of the ICO with the traditional security and regulations applied to securities, which would help restore investors’ trust in decentralized financing.
STOs are more practical from a regulatory point of view, as know your client (KYC) and anti-money-laundering (AML) requirements are implemented to provide transparency within security token contracts.
When ICOs first launched, they had no regulatory framework, so naturally, the issuing companies or developers did whatever they wanted in their token sales.
But then, in 2018, various world governments and financial regulators started cracking down on how projects and companies conducted their ICOs. As a result, many scammy initial coin offerings decided to relocate to countries with laxer regulations or leave the space entirely.
Also, the repercussions of not complying with the law are harsh, so many ICOs might have just been discouraged from entering the market.
As more and more scam ICOs are being exposed and taken to court, the regulations for ICOs will continue to solidify. Even if these new securities laws might not scare away all projects, they will make launching an initial coin offering more difficult.
In almost every country, some institutions should be responsible for regulating ICOs. For instance, The United States Securities and Exchange Commission (SEC) regulates Initial Coin Offerings (ICOs) in the United States (ICOs are under SEC’s jurisdiction). The Securities and Exchange Commission plays a vital role in enforcing securities laws and protecting investors from fraudulent or unregistered securities offerings, including ICOs. The SEC evaluates whether a particular ICO falls under the security category and, if so, requires compliance with applicable regulations, such as registration or exemptions.
How to Spot and Avoid ICO Scams
Investing in an ICO can potentially lead to big returns, just like most Ethereum, NEO, and Ripple early investors can tell you. However, not all ICOs are legitimate. In fact, so many ICO scams have made their way into the digital trading ecosystem that it’s somewhat understandable why most investors are extremely reluctant towards or are bluntly against ICOs.
Right off the bat, it’s important to note that there is no perfect recipe or guide for determining the legitimacy of an ICO. However, the key to determining if an ICO is legit or a scam is research, lots and lots of diligent research. There’s always the option of using a renowned ICO rating website to determine the legitimacy of an ICO. However, even these websites may prove to be untrustworthy or reliable. In short, the best way to ensure you won’t get scammed is to do your own research.
Without further ado, here are some red flags and vital aspects one should consider before enrolling in an ICO:
Poorly Made, Unmaintained, or Copied Website
A website is one of the first things you should analyze to ensure an ICO is legitimate. Most fraudsters don’t invest in high-end websites. Hence, a poorly made website is a huge red flag. Of course, a website is not an entirely reliable indicator that an ICO might be a scam, but you should be very careful if the website seems to be a “generic” one.
Shady/Anonymous/Fraudulent Team Members or Advisors
Since ICOs are public “events,” it’s common sense that the developers and team members behind the project should also be listed. By holding an ICO, a startup company is basically asking its potential token holders to trust that the developers will deliver a working or potentially useful product (instead of running off with the money).
Therefore, it’s only natural that the team behind the ICO should be able and willing to back up these “promises” and claims with verifiable and publicly available identities. To put it as simply as possible, if a team refuses to identify itself, then investors should be very wary about the project. There have been ICOs where the hackers used basic images and the names of ordinary people to pass off as legit team members.
The Token Doesn’t Have a Specific Use Case
Here’s one aspect that’s also extremely important. For starters, it’s important to know exactly how the company intends to use the token as well as the blockchain technology behind the project. The token should be used almost exclusively to boost the platform’s development. An excellent example of shady tokens is simple digital currencies without bringing forth any real innovations or improvements upon the existing blockchain and crypto technology.
Another big red flag is if the token distribution structure does not make sense. For example, having a majority of tokens reserved for the team members and advisors can be considered a clear sign that the team favours gain over development.
Right from the start, a whitepaper is one of the most important, if not the prior, aspect of any ICO, as it’s basically the project’s profile.
Be on the lookout for overly-optimistic roadmaps. For example, if a whitepaper sets an unrealistic development schedule, that’s a bad sign. Furthermore, investors should ensure that the whitepaper is unique, that the grammar is good, and all the information is authentic. If an ICO promises fixed dividends and profits, there’s a good chance it’s a scam, as the market is too volatile.
Simply put, if the whitepaper is not done correctly and lacks information, research, and vital references, you better avoid the ICO altogether.
This might be the hardest one to spot so far. There have been multiple past examples in which new fraudulent ICOs have copied the content from other ICOs in its entirety, including logos and pictures. Once again, diligence, focused research, and the community can all help you in this regard to discover a fraud.
Other Noteworthy Aspects Worth Checking
Usually, all ICOs should go through a pre-ICO stage. Therefore, it might be a good idea to check if the number of advertised tokens is respected during the actual ICO.
Behind every ICO, there needs to be a company. If no legitimate company is incorporated in the ICO information, then this is yet another red flag. As a potential future investor, you should be able to check the company based on the registries from its specific country. It should be considered a plus if a company is registered in a country that has clear regulations and guidelines for ICOs (Switzerland, Malta, Gibraltar, etc.). In short, you should be able to cross-check information to see if the company exists.
An unmaintained code repository, or an empty GitHub or BitBucket repo, for instance, is something that should be enough to put off any serious investor. For example, say a project is listed or advertised as open source but has an empty repository page; it’s a fairly clear indication that something is not right.
The Most Outstanding ICOs of All Time by Amount Raised
EOS (EOS) – $4.2 billion
EOS achieved a remarkable feat during its year-long initial coin offering (ICO) by raising an impressive $4.2 billion, surpassing the combined funding of the top three venture funding rounds in 2018, which included industry giants such as Epic Games, Uber, and e-cigarette developer Juul.
The visionary behind this project is Dan Larimer, the chief technology officer of Block.One and an esteemed pioneer in the cryptocurrency realm. Larimer had previously introduced groundbreaking initiatives like the social media network Steemit and the decentralized exchange BitShares, among other ventures that sparked enthusiasm and controversy in the crypto community.
As of May 12, 2023, EOS traded at just $0.86.
Filecoin (FIL) – $257 million
Filecoin’s ICO took place for only two days in September 2017. This is considered one of the most successful ICO ever, raising $257 million. Apart from this impressive ICO, Filecoin is also renowned for receiving massive investments and backings from top venture capitalists in Silicon Valley, including big names such as YCombinator, Naval Ravikant, Andreessen Horowitz, and Winklevoss Capital.
Filecoin is an open-source cryptocurrency and digital payment system that aims to build a decentralized cloud storage network using IPFS (InterPlanetary File System) to store and record data securely. Some believe that Filecoin ICO was such a big success because the project already had the backing of the investors above. In contrast, others believe that the fact that it was the first regulatory-compliant ICO in the US had a massive positive effect.
As of May 12, 2023, Filecoin traded at just $4.31.
Tezos (XTZ) – $232 million
Regarding crypto launches, few can compete with the amount of hype Tezos managed to create. Tezos is, without a doubt, a very controversial project. In short, it’s a smart contract platform that introduced the world to the first “self-evolving blockchain.” The platform stands out from the crowd by allowing token holders to approve and fund new protocol updates.
During its ICO in July 2017, the Tezos project raised over $232 million. Despite multiple roadblocks (such as the legal dispute between the Director of the Tezos Foundation and the development team), Tezos proved that projects which address real-life challenges in the crypto world (such as scalability and governance) have an excellent chance of obtaining significant financial backing.
As of May 12, 2023, Tezos traded at just $0.88.
The Most Successful ICOs of All Time by ROI
As of May 12, 2023, Ethereum is the second-largest cryptocurrency based on market cap. Distinct from Bitcoin, Ethereum serves not only as a digital currency but also as the underlying infrastructure for decentralized applications that leverage smart contracts.
During its ICO, Ether tokens were available for purchase for $0.31 per token. Remarkably, the value of Ether has since soared to over $1,768 as of May 12, 2023, delivering substantial returns on investment for fortunate ICO participants.
NXT was one of the earliest blockchain startups to garner success. It was launched in September 2013 in an initial coin offering held on the BitcoinTalk Forum, where it succeeded in raising around $16,800 worth of Bitcoin.
The cryptocurrency was designed to serve as a blockchain platform allowing small businesses, corporations, and banks to deploy their proprietary applications.
One NXT coin had a value of $0.0000168 at its ICO debut. The highest price for an NXT token peaked at $2.15, which resulted in a whopping 1,477,000% return on investment at that time.
On May 12, 2023, NXT had a market value of $0.002636.
The IOTA project is revolutionizing the world of the Internet of Things (IoT) by creating a unique transactional settlement layer that combines blockchain with IoT capabilities.
Unlike other major cryptocurrencies, IOTA distinguishes itself by employing a Tangle, a novel approach that addresses traditional blockchains’ scalability and transaction fee challenges. In the IOTA network, senders of funds must verify transactions simultaneously, decentralizing the ledger and eliminating transaction fees.
In November and December 2015, IOTA successfully conducted its ICO and raised an impressive over $400,000. Remarkably, during the crowd sale, all 1 billion IOTA tokens were sold at less than $0.001.
It wasn’t until June 13, 2017, that the IOTA (MIOTA) token commenced trading publicly on exchanges, with an initial price of $0.63. As of now, May 12, 2023, each IOTA token is valued at $0.17, showcasing the growth and potential of this innovative digital currency.
The Biggest ICO Failures of All Time
Ethereum’s DAO is probably the best-known ICO failure. DAO, the Decentralized Autonomous Organization, rallied a lot of support and enthusiasm from the crypto community.
DAO promised a new decentralized business model that commercial and non-profit enterprises could implement in their management. The ICO was a success, raising $168 million, a record figure then.
But just a few months later, hackers exploited a vulnerability in the code of the DAO smart contract, which allowed them to siphon nearly one-third of the funds. After news of the hack reached public ears, the DAO tokens were dumped immediately, which plunged the project into depths from which it could not recover.
OneCoin was one of the worst ICO failures of 2017, as it featured all the signs of a scam from its inception right until its downfall. Not many details are available, as there is no actual information to prove that any tokens were created.
Its team had no design or prototype of a product or service to show to their investors. Also, the group’s lead members had previous affiliations with other scam projects. Its founder and COO, Dr. Ruja Ignatov, is suspected of forging her qualifications on the company’s website. The website was another red flag; it did not have proper spelling and was littered with technical issues. All these signs convinced investors that OneCoin was a multi-level marketing Ponzi scheme.
But some investors were fooled, OneCoin scamming them out of $350 million. This prompted Indian authorities to raid a OneCoin meeting, where 18 members were arrested. Another clear sign was that they accepted fiat currency from investors, not Bitcoin or Ethereum, like most ICOs.
Other ICO failures are not due to them being scams but due to human error. In this category falls Enigma. It is a coin focusing on cryptography and security, promising new encryption methods. But in an ironic twist of fate, Enigma’s mailing list, website, and Slack accounts were all hacked before the company launched its official ICO. Enigma CEO Guy Zizkind’s account did not have two-factor authentication set up.
Hackers used Slack to promote a fake early ICO round. Many investors caught that the email was a scam, but others were duped, and they gave $500,000 worth of Ethereum to the hackers. This discouraged many from reinvesting.
The Best ICO Alternatives
Suppose an ICO is not necessarily to your liking, and you have a negative opinion about this crowdfunding strategy. In that case, you should know that there are several alternatives to ICOs that you can consider:
A Security Token Offering (STO) is like an ICO but fully SEC-compliant. The startups that launch an STO declare their tokens as securities upfront. STOs can be divided into Reg D (available to institutional investors only) and Reg S, which is for STOs outside US borders.
Reg A+ is the most sought-after category, as retail investors can contribute.
The Interactive Initial Coin Offering (IICO) is a unique model proposed by Vitalik Buterin to serve as a fairer version of an ICO. It was created to deter scenarios where FOMOs and gas wars can lead to whales overwhelming smaller investors.
The Kleros project was the first to test out an Interactive Initial Coin Offering. Investors can set a maximum cap for the sale, and if this amount is exceeded, the extra tokens will be refunded. This gives all participants an equal chance at purchasing tokens.
Initial Supply Auction
This ICO alternative is a crowd sale that starts at a relatively high price and then successively lowers until the auction closes. Investors purchase at the level they think the price is fair for the token. Metronome is a smart contract project which started its crowd sale as an Initial Supply Auction.
A Simple Agreement for Future Tokens is a method that can be used to overcome the risk that usually comes with ICOs. To avoid such issues, the investors that send their funds will get their tokens only when the network is operational, and the tokens actually have a use. This ensures the project receives the funds it needs for its development, and investors will have a functional token for the platform.
Nowadays, most ICOs projects reserve some of their tokens to an airdrop. An airdrop involves giving away free tokens to community members in the hope that these individuals will be convinced to become new users.
The usual amount distributed is under 5% of tokens via an airdrop. Some can go out and spread almost all of the token supply, keeping just a portion for the team, and then wait for the token to increase in value once it hits the market.
Venture Capital (VC) Funding is also an ICO alternative that should be considered. Raising money through VC can give you several advantages.
VCs are led by experienced entrepreneurs that have dealt with many businesses. They have an eye for project proposals with potential, which means that if your business gets approved by a VC investor, you most likely have a good product.
VC raises highly covered by business media outlets.
Since VCs are businesspeople with an established reputation, you can reach a more outstanding market and connect with various entrepreneurs.
Vitalik Buterin, the founder of Ethereum, was the first to merge the characteristics of the DAO model with ICOs, resulting in the DAICO system.
A DAICO has a system that involves the smart contract being divided into two separate parts:
- The first part of the contract enables investors to send funds to the startup, stopping them from contributing after a specific limit. The funds cannot be accessed by the project team at this point.
- The second part commenced automatically after the first phase, setting a ‘tap’ to limit the funds the team could withdraw. Token holders can vote as they are now in a ‘Decentralized Autonomous Organization’ (DAO), and the project team must submit a project development proposal. Stakeholders vote and decide whether the tap limit will be raised so the project team can withdraw more considerable funds. If the team or the stakeholders are unsatisfied with the progress made, they can self-destruct the smart contract, which will return the rest of the funds.
ICOs were one of the most widely used forms of crowdfunding in the digital assets space in the early years of the industry’s evolution. However, over time, many scams were detected operating through ICOs, which is why a growing reluctance towards this strategy began.
While ICOs offer tremendous opportunities, you need to exercise extreme caution and conduct thorough due diligence is crucial if investing in a digital asset or ICOs. The absence of regulatory oversight and the presence of scammers highlight the need for careful evaluation and research before participating in any ICO.