If investing in cryptocurrencies is the new gold rush, ICOs are the goldmines. ICOs have been the latest and hottest means of fundraising in 2017 and with the staggering amount of ICOs set to take place in 2018, this hype shows no signs of stopping.
New cryptocurrencies are generally brought into the digital space through an ICO. The first ICO popped up in 2013, but it was only in 2017 that the fundraising model really exploded. There are numerous ICOs that made their early investors almost unimaginable returns, which can be ascribed as the main reason for the recent surge of ICOs. The immense popularity of ICOs started after the success of Ethereum’s ICO. Ethereum coins were sold for $0.31 (!) during their ICO.
The success of Ethereum made investors search for similar opportunities and made entrepreneurs opportunistic, and so began the stream of ICOs. Because of the lack of regulations in the crypto space, cases of scams and companies that asked and received unjustifiable amounts of investments for non-working products have increased.
This in turn led to a global cry for rules and regulations for ICOs, and more regulatory bodies have been focusing on creating just that. From an investor point of view, this isn’t the worst thing that can happen since regulations will likely lead to higher quality, less risky ICOs and mass adoption of cryptocurrencies.
Even though it comes with high risk, it’s hard not to get excited about getting into this vibrant and often lucrative ICO space. In the following article, we will discuss all the ins and outs of ICOs that you need to know before you take start taking these risks to reach the moon.
By investing in an Initial Coin Offering, generally referred to as an ICO, you become an early investor in a new blockchain project.
You can invest in an ICO by sending, for example Bitcoin, Ethereum or NEO to the address of the ICO. Your investment will be stored in a smart contract and once the ICO is finished, you’ll automatically receive a predetermined number of the new cryptocurrency based on the total amount you invested.
Companies run an ICO to attract capital for a new blockchain or blockchain application. The difference between the two will be explained below. Before starting an ICO, the company behind it usually has found a problem in the status quo and believe that they can solve this problem with their blockchain application.
The company creates a website on which you can see the requirements and specifics of the ICO, the team, their vision, the industry they focus on, partnerships and advisers, a roadmap for the future and most importantly, their whitepaper.
In a whitepaper, a company fully describes the details of their approach and the technical specifications of their blockchain/blockchain application. Typically, potential investors make a decision on whether to invest in an ICO or not based on the information provided by the company.
Essentially, ICOs do not differ that much from crowdfunding. They are both methods for attracting both small and large investments from a large crowd through the internet.
The company behind an ICO, similar to a company behind a crowdfunding project, markets their envisioned product and tries to convince potential investors that their to-be-created product will disrupt an industry.
It is very important to realize that most ICOs do not have a working product yet. Most of the time, when investing in an ICO, you are investing in a potential product that can potentially become popular.
ICOs differ from Initial Public Offerings (IPOs), which is a commonly used method of fundraising for companies. IPOs give investors shares of a company in return for their capital. These shares represent part ownership and certain shareholder rights, such as voting rights and dividends. In contrast, the new cryptocurrency you receive for investing in an ICO does not represent ownership rights or any other rights in regard to the blockchain company.
The cryptocurrency you buy in an ICO does, however, represent a potential return. In the long run, the return depends on whether the new cryptocurrency will actually be used by consumers. This is a huge difference from shares, which are only used as proof of part ownership.
Cryptocurrencies, at least the ones to be taken seriously, will have an actual use case. For instance, with the NEO cryptocurrency, you can buy in to NEO-based ICOs and use applications on the NEO blockchain. With Civic tokens, you can make use of their identity protection services. With Edgeless tokens, you can gamble on their Ethereum-based casino platform, and with Steem coins you can use their decentralized social media platforms.
In the short run, returns are dictated by the demand for the cryptocurrency. This demand is, again, based on the expectancy that the crypto will be used in a wide scale in the next few years. Most of the newer cryptocurrencies are not being used and have yet to prove their concept.
Therefore, investing in ICOs is a very high risk/ high reward game.
Whether a cryptocurrency will actually be used at all depends on the quality of the blockchain project. Bitcoin, for example, is being used on a regular basis. Yes, the network has been coping with scalability issues, however, this indicates an increase in the usage of Bitcoin’s blockchain.
The value of several ICO coins such as Ripple, Stratis and Ark is also highly dependent on their usage. If a cryptocurrency and its blockchain application can’t create a network of businesses, consumers and institutions that will use the currency for payments, they could eventually become worthless.
As mentioned above, ICOs can raise funds for both blockchains and blockchain applications.
An ICO for a blockchain means that the company has actually created their own blockchain on which applications can be built. The coin you’ll receive in return for your investment is the coin that directly relates to that blockchain. These blockchains are also called protocol blockchains, because they decide the rules, dynamics and technical specifications of the applications built on top of them. Ethereum, NEO, Bitshares and Waves are examples of protocol blockchains.
A utility token, on the other hand, is an application built on a protocol blockchain. The issued cryptocurrency, which is factually called a token, is used for the application only.
The best example is Ethereum, with its ERC-20 protocol. This set of guidelines specifies rules for applications and their tokens built on top of the Ethereum network. Popular ERC-20 tokens are Tron, ICON, OmiseGo, and Waltonchain. All these applications are built on the Ethereum blockchain and thus add an additional feature to the Ethereum ecosystem. Click here for the full list of tokens built on a protocol blockchain.
It is very important to realize the difference between the two. The blockchain movement is rapidly evolving, yet still far from maturity, and we have no idea what the industry will look like in a few years. We don’t know which protocol is going to be the foundation of the next internet, and investing in applications based on these protocols therefore comes with much higher risk.
This is because we don’t know which protocol blockchain will be widely adopted. When taking an honest look at the industry, very few blockchains and blockchain applications are actually currently being used. Time will tell which protocols we’ll be using in the near future, and which applications on top of those protocols will become popular.
Finally, you have security tokens. These are tokens that represent shares of a business, a model which will likely become illegal in most countries quite soon. These tokens do not have a use case, and grow in value as the company behind it continues to make profit.
Currently, securities already fall under heavy scrutiny, and regulatory bodies such as the American SEC have already given notice that they want to take down cryptocurrencies that are actually securities. Because these tokens will not be used for anything blockchain-related and the likelihood of a regulatory crackdown on ICOs for securities, it’s best to stay away from these ICOs with security tokens.
ICOs are extremely risky and there is absolutely no guarantee on returns. Essentially, ICOs are not much different from regular startups. When looking at the traditional startup failure rate, which is is estimated to be around 90%, it becomes easier to make a risk assessment for investing in ICOs.
Why do startups fail? Most will simply fail to deliver, like in any developing industry. The team behind a cryptocurrency startup isn’t any different. Even though the team can be experienced, well connected, funded and have all the best intentions in the world, there is always a chance that they just won’t attract customers.
Add to that we don’t know how blockchain will impact the world, on which protocol this change will be built, and how fast the technology will become mainstream. These are the ingredients for a highly speculative investment.
Besides the speculative and very risky nature of legit ICOs, there are also fraudulent ICOs in the market. Just recently, a company named Prodeum scammed their investors through a fraudulent ICO, and the scammers decided to kick their investors when they were down with a single word on their further empty website. This is only one example out of many ICOs that have been raising funds for the personal bank accounts of its founders.
The ICO market is learning and ICOs are now being heavily scrutinized. The number of websites investigating and rating ICOs are increasing on a weekly basis and these resources can help you with filtering out the rotten apples.
With the maturing of the space, proper ICO procedures and higher quality ICOs can be expected. Ethereum and NEO have been setting standards for ICO procedures with their ERC-20 and NEP-5 protocol, but the actual procedures will likely come from global regulatory bodies.
Due to the numerous malicious ICOs, cries for regulations and strict policies have been heard globally. Scams have been happening on a much too frequent basis, and these practices hurt the crypto market as a whole as they deteriorate trust and scare away new investors.
When comparing ICOs to IPOs, the biggest difference is that IPOs are heavily regulated. Numerous legal compliances, hefty amounts of paperwork, and constant check-ups on business activities are all part of the IPO world. Six guys in an attic will find it impossible to launch an IPO, but an ICO launch won’t be too much of a problem.
While some embrace the free-spirited cryptocurrency market, governments simply cannot accept this model of fundraising. This is because a government has an obligation to protect its citizens, and protecting them from getting scammed isn’t an exemption. Even though there are far more legit ICOs than there are scams, there is a need for a legal framework for the execution of ICOs.
A problem with this is that regulatory bodies haven’t been able to classify ICOs due to their novelty. Are cryptocurrencies currencies, commodities, assets or something else altogether? Governments around the globe have been working on giving cryptocurrencies and ICOs some sort of legal status; once this happens, we can expect a lot of new laws and regulations for the crypto space.
Given the current state of blockchain technology, ICOs have been the best thing that could’ve happened. This is because the large amounts of capital that have been pulled into the crypto space by ICOs have given an enormous boost to the development of blockchain technology and the required infrastructure.
Additionally, each ICO does their own marketing and targets different audiences, and collectively they reach a globally-dispersed and diverse demographic pool. All ICOs are marketing blockchain technology and cryptocurrencies, which is great for the industry as a whole.
Projects with amazing potential have been launched and will be launched in the future, and those few diamonds will eventually lead to the mass adoption of blockchain technology. We are still waiting for the blockchain killer app, the application that will be used by non-blockchain enthusiasts, and this killer app will likely be launched through an ICO.
Finding that killer app will be difficult, and likely lead to several investments in slow growers. However, once an ICO does take off, they can be extremely profitable. Even though the total value of the crypto market has gone up anywhere from 5 to 20 times, depending on the date you start measuring, the capital investments ICOs have been asking for hasn’t increased by much.
The ICO space is incredibly competitive, and therefore ICOs can’t ask for too much capital. However, due to the enormous increase in investors and money in the market, ICOs that do blow up blow up big.
This sounds promising, and it is. There is just one thing you need to do, and do thoroughly: your own research! This doesn’t mean just watching a video on the ICO website. This means thoroughly researching the ICO whitepaper and assessing aspects of the project such as its goals, how does the business generate revenue, what problem does the application solve, etc.
Look at every member of the project team. Do they have experience with blockchains and blockchain applications? Are they experienced entrepreneurs? Is the team sizable?
And then, there is one very important question you need to ask yourself as well: is blockchain and a cryptocurrency needed for the problem this company wants to solve?
A lot of ICOs raise money for an idea that can also be solved, or already is solved, through the use of the good old internet.
To answer all these questions, use as many sources as you can. The website of an ICO is a good starting point but for obvious reasons, the worst source for a balanced assessment of the project. Don’t blindly ignore the naysayers of a project either; instead, listen to them and try to tackle their critique to better assess the quality of a project and its ICO.
We’ve been emphasizing the risk involved when participating in ICOs, and it should be emphasized for good reason. However, there are also amazing opportunities and truly great projects being launched through ICOs. When you make a habit of conducting thorough research and ensure you’re not being lulled by the dream of a Lambo but by the amazing vision of a project, you just might find that killer app.
With the rising popularity of ICOs, tools for scrutinizing such projects have been on the rise too. Most tools are semi-professional, so always take the assessments with a grain of salt.
Many people are calling themselves ICO experts after making one good call. Because of this, always use multiple tools and resources in your own assessments. Also note that there’s no way to know if a website has been paid for a good review or has other reasons for subjectivity.
Here’s a list of helpful ICO resources:
Hopefully, this article has made it clear that investing in ICOs comes with a lot of risk. Be very wary of scams, ICOs that don’t need a blockchain or a cryptocurrency, and ICOs that have slim chances of actually being used in the near future.
Differentiate between protocol and utility cryptocurrencies, and investigate on which blockchain a utility application is built. And always ask yourself the question: does this cryptocurrency I’ll receive from the ICO actually serve a purpose?
Legal frameworks for ICOs are in development and will filter out a lot of the rotten ICO apples. Securities will likely become subject to a vast array of regulations, and regulatory frameworks for ICOs will probably arrive within the next year. Keep a keen eye out for any changes in regulations, and how this will affect the ICOs you’re invested in or have an eye on.
That being said, investing in ICOs can also have an enormous potential upside. Invest in Blockchain has compiled a list of the top ICOs of 2018 to help you with your search. Just remember: always do your own research before investing in an ICO.
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