What is an ICO (Initial Coin Offering)?

A look at what ICOs are, how they work, and what to look out for.

ICO stands for “Initial Coin Offering”. Put simply, this is a way for a new currency venture to raise start-up capital quickly, without the need for regulated entities such as banks. ICOs allow early investors to grab a piece of the pie, and this usually involves paying the start-up in Bitcoin (or sometimes Ethereum) in exchange for tokens. This is often called a “token sale”. ICOs take place over a stated period of time, and when they close, these tokens can be exchanged for the new currency, or securities – or whatever the terms state –  when it goes live.

How Do I Know if I can Trust it?

To be frank, you don’t. Well, not 100% anyway. There are a couple of indicators to look out for though:

  • Notability – Often, ICOs have received the backing of a large, notable company. This is usually done to gain the trust of potential investors. Alternatively, a “big name” might be on board.
  • A White Paper – This is a statement of intent. There are several things to look out for on a white paper (WP): a clear picture of what the project is about, goals, amounts required, number of tokens on sale and the percentages that are on sale to the general public or investors, and what the money will be used for. You’ll also want to see time frames for the return on your investment, and a clear indication that your money will be returned if the ICO fails to raise the required money, or the start-up fails.
  • Proof of Work – A company offering an ICO should have an online presence and be transparent about the people behind the start-up, but there should also be some proof that there is a real underlying cryptocurrency. Either a proof-of-work algorithm should be in place (a code to show that the work required to mine a new cryptocurrency has been done), or there should have been some successful pre-mining.

Give me Some Examples of ICOs

Ok, so the biggest example was with Ethereum. Ether tokens went on sale at $0.40 and raised $18 million in Bitcoin (BTC). Today, Ethereum is the second-largest cryptocurrency by market capitalisation, trading at over $500. Meanwhile, Filecoin raised over $200 million in an hour to smash the all-time record earlier this year.

There are huge amounts of ICOs running at the moment though – 2017 really is the year of the ICO. This isn’t necessarily a good thing though, as it is difficult for less knowledgeable investors to discern between the real and the fraudulent. In November, a start-up called Confido raised $375,000 from its ICO and then vanished. The signs were there though; no real online presence and no proof-of-work algorithm. Another, Tezos, raised over $200 million but has since been stuck in an expensive legal battle after investors lost confidence due to internal fighting.

What About the Legality?

This is still a bit of a grey area. South Korea, the world’s third largest centre for crypto-trading, has banned ICOs because of the risks associated with unregulated fundraising. Other countries are considering following suit, most notably the US and Japan, the other two of the “big three”. Certainly, ICOs are risky. But investors will argue that Bitcoin is risky, and that, in fact, so are all cryptocurrencies. They have a point, and there is a precedent that sound investment in ICOs can lead to big money; just ask investors in the Ethereum ICO. It pays to do your reading though, and to look for those big-name backers and the warning signs of whether the ICO you’re considering is legitimate, or whether there is any chance of it succeeding in what is becoming a very crowded, competitive market.

In the coming weeks, I’ll be putting start-ups under the spotlight, and reviewing companies and their ICOs. Stay tuned!