ICO for Beginners — Learn How ICOs Work and What They’re About

ICOs or initial coin offerings have received a lot of press and exposure lately and now everyone wants to know what all the hype is about. If you’re in the same boat, you’ve come to the right place. In this post we’re going to break down and explain ICOs for beginners.

What is an ICO?

You’re probably familiar with IPOs, or Initial Public Offerings, where companies sell stock to raise funds. Simply put, ICO is a similar play and stands for Initial Coin Offering.

With the advent of blockchain technology, we are now able to make trustless transactions without requiring intermediary parties. The technology itself is a big step towards solving the issue of digital trust.

Given this advancement, technology startups are now turning towards blockchain technology in order to raise funds from people around the world. This is an exciting development in crowdsourcing projects and means people can now invest in upcoming startups with few limitations.

Startups that do initial coin offerings basically accept cryptocurrencies in exchange for token sales. These tokens are technically a lot like shares (not legally) and investors buy them in hopes of future profits as the prices of these tokens go up.

The last twelve months saw ICOs raising over $1.5 billion and creating many millionaires in the process — hence the hype.

Photo credit: Rick Tap

How Do ICOs Work?

All ICOs begin with an idea. A startup comes up with an idea for a blockchain related project and proposes it to the community.

If the startup finds traction, they go ahead and formally draft a white paper that provides all the details — from the team working behind the project to its technical aspects and future plans.

Other particulars are decided then, including the number of tokens that will be distributed, the price of each token and how the tokens will be used in the project’s ecosystem.

Marketing campaigns are launched after this to gain momentum and an ICO date is unveiled when the token sale is scheduled to begin. There is usually a defined time period to raise the required funds, after which the sale closes.

Investors then start receiving their tokens and plans are made for them to go live on exchanges for trading.

Obviously, this is a simplified summary and a lot of work goes behind the scenes, but the end result is a pool of early investors getting tokens from a promising startup with hopes of future profits.

Photo credit: Patrick Tomasso

Some Successful ICOs This Year

Some of the leading cryptos today saw ICOs not too long ago, with the major one being Ethereum. Initially startups used Bitcoin to raise funds, but since Ethereum was released, it has become the favorite ICO platform for most.

In its own ICO, Ethereum raised over $18 billion, and is today the second leading crypto in terms of market cap.

Other major ICOs this year include Bancor, raising $156 million, Tezos, which raised $232 million and Filecoin, which raised $250 million.

Are ICOs Legal?

Most investors are also concerned about the legal status of ICOs — something that isn’t talked about enough.

So, are ICOs legal? The answer is yes and no.

The problem here is that of following regulations, especially those from the Securities and Exchange Commission in the United States.

According to SEC rules, you cannot sell securities without proper compliance work and since ICOs are currently unregulated, there is a big question mark in each case. However, the SEC did send a warning signal in the case of the DAO, by terming it a sale of securities rather than tokens.

As an investor, it is your own responsibility to do some research and stay away from ICOs which may come under the ambit of securities.

How to differentiate ICOs and securities?

There are a lot of factors to be considered here, but one of the most obvious ones is any token’s intrinsic value, which comes from its utility.

Every ICO has a white paper and you should read it carefully. The token you are intending to buy must have a use-case. It should not be merely an instrument used for funding, it should have an actual place in the proposed project.

In the United States, they use the Howey Test to differentiate ICOs from securities, and here’s a summary of that for you:

The Howey Test for ICOs

Developed by the Supreme Court of the United States, the Howey Test defines securities according to the Securities Act of 1933 and has four limbs:

an investment of money due to
an expectation of profits arising from a
common enterprise which
depends solely on the efforts of a promoter or third party.

Generally speaking, all ICOs fit this description because there is an investment of money, investors do expect profits and ICOs are common enterprises. The only real factor that remains is the last one.

If the success of the ICO depends solely on the team behind the startup, it is likely to be termed a security. However, any real ICO needs an active community which contributes, whether by testing new developments or voting for new directions.

As long as you, as an investor, see yourself having an active role towards the success of the project, it should be safe to proceed.

Photo credit: louis amal

How to Avoid ICO Scams?

Needless to say, where there are major success stories, there are also ICOs which went bust or took off with the raised capital. Given the number of ICOs being launched these days, you get a wide selection to choose from, but here are some tips to avoid ICO scams.

Look into the team

This is usually where most ICOs fail. The team behind the project is the most important element. If the people working behind the scenes don’t have the required skills, there is no way the idea is going to come to life.

Be wary when any ICO fails to reveal information about the team behind it. Even when you do get names, be sure to research them and verify their social profiles on LinkedIn and so on.

Read the White Paper

Every ICO today releases a white paper — it is their manifesto and a comprehensive look into their idea and plans. Go through the whole white paper in order to make an informed decision on your investment. Don’t be swayed by fancy words and jargon — you need to look for exactly what the idea is, how it will be implemented, what is the future scope and how does the token fit into the system.

If these questions are not answered in the white paper, you should stay away.

Check out the community

All active projects have communities on Reddit, Slack and Telegram. Visit these communities and talk to the people. This will help you get a feel for the project and also point towards it’s actual potential.

An active community is generally a good sign because it shows that the developers are serious about their project.

That’s all for now folks. We hope our guide helped you understand ICOs and how they work. If you have any questions, please feel free to reach out and we will get in touch as soon as possible.

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