What is an Initial Coin Offering (ICO)?
An Initial Coin Offering (ICO) is the cryptocurrency industry's equivalent of an Initial Public Offering (IPO). Companies that want to raise funds to create new blockchain apps or services using cryptocurrencies can launch an ICO as a way to raise funds.
Interested investors can participate in an Initial Coin Offering to receive new cryptocurrency issued by a company. This token may have utility related to a product or service offered by the company or may represent an investment in the company or project.
In many cases, an ICO is a securities offering and must be registered. However, registration may not be required in certain circumstances. Regulation D, Rule 504, allows a company to offer and sell up to $10 million in securities in a 12-month period if the company files a Form D after the first sale of the securities. If a coin issuer wants to sell its coins as securities to investors, it can do so legally as long as it follows this rule. To see if a company has filed the form, check the SEC's EDGAR database.
Key Takeaways
- Initial Coin Offerings (ICOs) are a popular way to raise funds for products and services, usually related to cryptocurrencies.
- An ICO is similar to an initial public offering (IPO), but the coins issued in an ICO can also be used for software services or products.
- Some ICOs have made profits for investors, while many others have been scams or performed poorly.
- Most ICOs are security offerings that require registration.
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How an Initial Coin Offering (ICO) Works
Cryptocurrency If a project wants to raise funds through an ICO, the first step for project organizers is to decide how to structure their coin. An ICO can be structured in a few different ways, including:
- Static Supply and Static Prices: Companies can set specific fundraising goals or limits, meaning each token sold in an ICO has a preset price and the total supply of tokens is fixed.
- Static Supply and Dynamic Pricing: In an ICO, the supply of tokens is fixed but the fundraising goal can be dynamic, meaning the amount of funding received in the ICO determines the overall price per token.
- Dynamic Supply and Static Prices: In some ICOs, the token supply is dynamic but the price is static, with the amount of funding received determining the supply.
These three different types of ICOs are listed below.
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White Paper Release
In parallel with building the ICO, crypto projects usually create a pitchbook (known as a white paper in the crypto industry) and offer it to potential investors through a new website dedicated to the token. Project promoters use the white paper to explain key information related to the ICO.
- Project Contents
- The needs that will be met upon completion of the project
- How much funding is needed for the project?
- How many crypto tokens do founders hold?
- What payment methods (and currencies) are accepted?
- How long will the ICO campaign last?
The project has released a white paper as part of its ICO campaign, which aims to encourage enthusiasts and supporters to buy the project's tokens. Investors typically purchase the new tokens using fiat or digital currency, although it is becoming increasingly common to pay using other forms of cryptocurrencies such as Bitcoin and Ethereum. These newly issued tokens are similar to the shares sold to investors during an IPO.
What will happen to the funding?
If the funds raised in an ICO are less than the minimum amount required by the ICO standards, the funds may be returned to the project's investors, in which case the ICO will be considered a failure. If the fundraising requirements are met within the specified time period, the funds raised will be used to achieve the project's goals.
Who can launch an ICO?
Anyone can launch an ICO. However, regulators in the US and other developed countries keep a close eye on ICOs, ensuring they are registered where necessary.
However, this means that they may go to great lengths to trick you into believing they have a legitimate ICO, such as fake registrations, approval letters, emails, or any other form of communication that could trick someone. Of all the possible methods of fundraising, ICOs are probably one of the easiest to set up as a scam.
Just because anyone can launch and launch an ICO doesn't mean everyone should. If you're considering launching an ICO, ask yourself whether it would benefit your business significantly. You'll most likely have to go through the process of registering securities with the SEC.
Participating in an ICO
If you decide to invest in a new ICO you've heard about, make sure you do your homework. The first step is to ensure that the person launching the ICO is genuine and responsible. The second is to look into the cryptocurrency and blockchain background of the project leaders. If the project doesn't seem to involve anyone with relevant, easily verifiable experience, scam alarms should start ringing in your head.
How to distinguish an ICO from a scam
ICO activity began to decline dramatically in 2019, in part because ICOs exist in a legal grey area. If you're interested, you can research and find ICOs you can participate in, but there's no surefire way to stay on top of all the latest ICOs. Websites like TopICOlist.com compare different ICOs to each other.
You can also check out registered cryptocurrency exchanges to see which new coins are being listed and which ones are not – most of these exchanges will not list coins they have not vetted, so checking the exchanges can give you an extra layer of security.
Cryptocurrency aggregators can also help you spot potential scams and real opportunities. Aggregators do not vet new cryptocurrencies, they are purely informational. Many aggregators provide links to the project's GitHub page, website, and social media pages, discussing the problem the project is trying to solve.
If there isn’t a section dedicated to coin descriptions and the website has no readily available information beyond nonsensical phrases like “The Internet’s Greatest Home for Perfect Human Specimens,” it’s probably best to pass on the site.
The U.S. Securities and Exchange Commission (SEC) can intervene in ICOs if necessary. For example, after the developers of Telegram raised $1.7 billion in an ICO in 2018 and 2019, the SEC filed emergency actions and obtained a temporary restraining order, citing illegal conduct by the development team. In March 2020, the United States District Court for the Southern District of New York issued a preliminary injunction ordering Telegram to return $1.2 billion to investors and pay a civil penalty of $18.5 million.
There is no guarantee that you won't get scammed when investing in an ICO, but there are other steps you can take to avoid ICO scams.
- Make sure the project developers can clearly define their goals: successful ICOs usually have a clear, concise white paper with clear and concise goals.
- Demand transparency: Investors should expect 100% transparency from companies launching ICOs.
- Check the ICO's terms and conditions: Regulators and issuers are still working out how this process will work, so it's your responsibility to ensure your ICO is legal.
- Ensure that your ICO funds are stored in an escrow wallet. This type of wallet requires multiple access keys and provides effective protection against fraud.
Some ICOs require you to use another cryptocurrency to invest in the ICO, so you may need to buy other coins to invest in the project.
ICO Promotion
ICOs can generate a lot of buzz, and there are many online sites where investors can gather to discuss new opportunities. Like Steven Seagal, well-known actors, entertainers, or other individuals with an established presence also encourage their followers and fans to invest in trending new ICOs. However, the SEC warned investors that it is illegal for celebrities to use social media to endorse ICOs without disclosing the compensation they received.
Boxing superstar Floyd Mayweather Jr. and music mogul DJ Khaled previously promoted Centra Tech, an ICO that raised $30 million in late 2017. Centra Tech was eventually found to be a fraud in court, the two big names settled their lawsuits with US regulators, and the three founders of Centra Tech pleaded guilty to ICO fraud.
Be sure to familiarize yourself with cryptocurrencies and understand all about ICOs before participating. Fake ICOs are not stopped, they are only discovered, so potential investors should be extremely careful when investing.
Initial Coin Offerings (ICOs) and Initial Public Offerings (IPOs)
An Initial Public Offering (IPO) must follow a very structured process that involves marketing, roadshows, brochures, capital investment by the company itself, and other steps to inform and entice investors to buy the shares after they are listed and start trading on the stock exchange.
In many jurisdictions, creating cryptocurrencies is not illegal. However, if it meets the test criteria used by the local regulator, it may be considered a security in that country and become an ICO. In the United States, the Howey test is used. If a coin offering meets this test criteria, the SEC will consider it an unregistered securities sale and enforce compliance.
The Howey test is not just for the SEC to use. Research the ICO yourself. If a project requires you to invest money in a common undertaking in hopes of benefiting from the work of others, it is an investment contract, no matter what it's called. If the project's managers don't treat it as an investment contract, it's probably not worth your money. There are cases, however, where it may not be a scam, but unless you have money to spare, it's best to let someone else find out.
Initial Coin Offering Example
An early and notable example of an initial coin offering is Ethereum's ICO in 2014. Ethereum's ICO raised $18 million in 42 days.
As another example, Dragon Coin raised around $320 million during its month-long ICO that ended in March 2018. Also in 2018, the company behind the EOS platform raised a massive $4 billion in a year-long ICO, breaking Dragon Coin's record.
The first case of the SEC cracking down on an ICO occurred on December 11, 2017, when the SEC blocked an ICO by Munchee, a California company that runs a food review app. Munchee was trying to raise funds to develop a cryptocurrency that would allow users to order food within the app. The SEC treated the ICO as an unregistered securities offering and issued a cease and desist order.
How does an Initial Coin Offering work?
ICOs typically publish a whitepaper that describes how the company will issue the coin and how it plans to use the funds raised. A whitepaper is similar to a pitchbook. More credible ICOs have a long development track record, notable contributors, a community to follow, and are active on social media with posts that don't promote the coin.
What does ICO mean?
An initial coin offering is a group or company’s first attempt to raise funds for a blockchain and cryptocurrency project.
What is the difference between an IPO and an ICO?
An initial public offering is when a company lists its shares on a public exchange, and an ICO is an attempt by a small private company or group to issue cryptocurrency to raise funds for a project.
Conclusion
An Initial Coin Offering (ICO) is an opportunity for investors to invest in new cryptocurrency and blockchain projects. Be careful when investing in an ICO. Although there have been big profits made in the past, many unscrupulous people are trying to scam unwary investors with fake offerings.
Before buying into an ICO, do your homework and find out everything you can about the developer, the project, how the coin will be used on the blockchain, what the blockchain is for, etc.
