An initial coin offering or ICO is an event where a company sells a new cryptocurrency to raise money. Investors receive cryptocurrency in exchange for their financial contributions.
In many ways, an ICO is the cryptocurrency version of an initial public offering (IPO) in the stock market. While it’s possible to make sizable profits through ICOs, a lack of regulation makes them extremely risky. In this guide, you’ll learn all about ICOs, including how they work and their pros and cons.
Defining Initial Coin Offering
An initial coin offering (ICO) is the cryptocurrency industry’s version of an initial public offering (IPO). Unlike IPOs, initial coin offerings operate on the blockchain instead of the stock market. Cryptocurrency ICOs can also be referred to as token sales or token funding.
Its purpose is to raise money for a business venture by selling digital tokens to those who are willing to invest. Often, the token gives investors access to features of the project. It could also increase in value over time, allowing early investors to make a profit.
The premise of buying cryptocurrency under a penny and then selling it for a profit makes these tokens or coins a lucrative opportunity for various investors. It also gives the company more chances of raising the needed funds than relying on traditional investing opportunities.
During the Ethereum ICO, investors received Ether (ETH) in exchange for Bitcoin. The company sold more than 7 million ETH in the first 12 hours, worth more than $2.2 million at the time.
How Does an ICO Work?
When a company decides to have an ICO, it announces the date, rules, and buying process in advance. On the date of the ICO, investors can buy the new cryptocurrency.
Most ICOs require investors to pay using another cryptocurrency, with Bitcoin (BTC) and Ethereum (ETH) being two common choices. There are also ICOs that accept fiat money.
The purchase process typically involves sending money to a specified crypto wallet address. Investors provide their own recipient address to receive the crypto they buy. The number of tokens sold during an ICO and the token price can be either fixed or variable. Here are examples of the ways this can work:
- Fixed number of tokens and price: The company sets both of these ahead of time, such as offering one million tokens at a price of $1 per token.
- Fixed number of tokens and a variable price: The company sells a fixed number of tokens and prices them based on the amount of funds it receives. More funding results in a higher token price. If it’s selling one million tokens and raises $2 million, each token would have a price of $2.
- Variable number of tokens and a fixed price: The company sets a fixed price but doesn’t limit the number of tokens it will sell. An example would be if a company sells tokens at $0.50 apiece until the ICO ends.
Anyone can launch an ICO. Because of the low barrier to entry, many new types of cryptocurrency are launched through this process.
If the money raised in an ICO is less than the minimum amount required by the ICO’s criteria, the funds may be returned to the project’s investors. The ICO would then be deemed unsuccessful. If the funding requirements are met within the specified period, the money raised is spent in pursuit of the project’s goals.
Advantages of an ICO
Here are the advantages that a project launching an ICO can offer:
- They offer high potential profits if you can determine which cryptocurrency is a good investment. Since you’re buying early, prices are often lower, and some ICOs offer tokens at discounted rates.
- ICOs are accessible to anyone. Unlike some IPOs, there aren’t any restrictions on who can invest.
- It’s a fast, efficient way for start-ups to raise funds.
Disadvantages of an ICO
Like any investment, ICOs also have their fair share of disadvantages. These are:
- Because cryptocurrency projects are volatile, there’s a significant risk that the token loses value or ends up failing entirely.
- The lack of regulation results in more scams and mediocre projects. Just sorting through upcoming ICOs for a quality project can feel like searching for a needle in a haystack.
- It usually takes some knowledge of crypto wallets to invest in ICOs. For those who are new to crypto, it’s often easier to stick to cryptocurrency stocks or publicly traded coins.
Releasing of a White Paper
When a cryptocurrency startup firm wants to raise money through an ICO, it usually puts its plans on a “white paper” to provide investors with important information. This pitchbook is available to potential investors via a new website dedicated to the token.The promoters of the project use their white paper to explain important information related to the ICO:
- What the project is about
- The need that the project would fulfill upon completion
- How much money the project needs
- How many of the virtual tokens the founders will keep
- What type of payment (which currencies) will be accepted
- How long the ICO campaign will run
The project releases the white paper as part of its ICO campaign, which it designs to encourage enthusiasts and supporters to buy some of the project’s tokens.
The Image of ICO
Any good idea can be used in a negative way — this is the story of ICOs. As a good fundraising concept they have often been co-opted for nefarious purposes, especially scams. Still, this doesn’t mean ICOs are all bad. In fact, some of the most successful cryptocurrencies started out using this very method, and can lead to huge returns for investors in the process. Just be careful to fully understand how an ICO works before you invest your hard-earned money.
ICOs are a new concept and some raise concerns with the actual value of the tokens and how easy it is for the issuer to get rich. It is also not a secret how this method is widely used by scammers in the crypto space. Ultimately, time will tell whether this becomes the future of funding businesses or merely a “get rich” scheme by issuers.
