ICO 101 — Initial Coin Offerings (ICOs)- What is an ICO & What are the Pros and Cons
Easy explanation of what ICOs are and their advantages & disadvantages.
Quick 2021 update by the author: please find the latest article on IDOs (Initial Dex Offerings) and how ICOs evolved into them right here:
0. Introduction
Dear Reader,
This article is part of a full-fledged series on Initial Coin Offerings (ICOs), Initial Exchange Offerings (IEOs), Decentralized Autonomous ICOs (DAICOS), and Security Token Offerings (STOs).
You can find the overarching PART I here:
And PART II here:
1. What is an ICO?
An Inital Coin Offering — in some cases also referred to as Initial Currency Offering — is a type of funding mechanism typically used by and for cryptocurrency projects.
The best way to look at it is actually by seeing it as some sort of a combination of:
- The fundraising aspect of a crowdfunding or crowd sale (be it fiat money or crypto, but generally mostly the latter), including the fact that some sort of soft/hard cap has to be reached in order to be valid (i.e. a minimum amount should be raised)
- The product maturity of an early stage VC investment or even business angel round (i.e. a very immature product, and in a lot of cases actually just the mere “idea” of that product)
- The fact that in return for the funds, some sort of a “token” is received, the latter becoming “tradable” just as in the case of an IPO or Initial Public Offering (i.e. when a private company goes public and everyone can start buying — “trading” — shares)
- The token sale runs on blockchain infrastructure and the tokens become available on a blockchain platform (such as e.g. the Ethereum blockchain for ERC20 tokens)
Just to make sure everyone is still following, I’m happy to include the description offered by our friends at Wikipedia:
“In an ICO, a quantity of cryptocurrency is sold in the form of “tokens” (“coins”) to speculators or investors, in exchange for legal tender or other cryptocurrencies such as Bitcoin or Ethereum. The tokens sold are promoted as future functional units of currency if or when the ICO’s funding goal is met and the project launches. In some cases like Ethereum the tokens are required to use the system for its purposes.” (source: Wikipedia)
2. Pros and Cons of doing an ICO as a Company
To get a good understanding of ICOs, it’s recommended to be aware of some of the advantages and disadvantages.
5 Advantages of Doing an ICO as a Company
- The world is your investor. The range and geographic distribution of potential investors is enormous. Literally, a huge part of the entire globe is able to invest in the company (give or take some geographic restrictions). Wire transfers from all over the world can get you millions of dollars (in crypto) in minutes, without being frozen up by the banks;
- Following from 1, the potential publicity for the company is humongous and again, worldwide;
- You can raise funds fast and have it available quickly, making it easier to build traction for the company at an early stage;
- No extensive disclosure requirements for the fundraiser (so far);
- You can raise a lot of funds at an incredibly (likely even too, but what the heck) early stage of your company.
5 Disadvantages of doing an ICO as a company
- You have a considerable risk that the regulator at some point will start chasing you! (just look at the SEC’s recent actions);
- The funds you raise are (at least for now) inherently extremely volatile;
- Communication effort and potential impact is huge. You have a worldwide investor community and you have to be able to manage the communication (especially bad communication) as well as you can;
- Most ICO investors are used to the highly speculative nature of cryptocurrencies and tend to be less patient than a traditional equity investor;
- Pressure of the community on you making progress can be strong. After all, you just raised the equivalent of a couple of million dollars from their pockets.
3. Pros and Cons of Participating in an ICO as an Investor
10 Advantages of participating in an ICO as an investor
- Early contributors can have access to and will have more liquidity in early stage companies. Being early also increases the potential for rapid capital growth;
- Depending on the ICO, there can be a big network behind it (e.g. if the token launch takes place on the Ethereum network), generating additional buzz and potential capital appreciation;
- Custody without intermediaries. The one with the private key owns the tokens;
- Limited regulatory scrutiny (so far);
- ICO coins have the same anonymity as cryptocurrencies such as BTC and ETH;
- Transparency of use of funds, an escrow can be used to verify how the funds are being spent after the ICO;
- An innovative way to deploy capital that offers a hedge against political and economic shocks;
- Contributors are usually the first users of the (utility) token — thus unlike holding a stock of a company whose products a contributor never used, ironically tokens can be more tangible than securities;
- A high risk, high reward asset which is (to some extent) disconnected from the stock market and the economy;
- Possibility to own an alternative asset not based on FIAT (state regulated) currency.
10 Disadvantages of participating in an ICO as an investor
- ICOs are not regulated and have no investor verification or protection;
- IPOs are typically supported by institutional investors, whereas ICOs are mostly supported by investors from within the community;
- As there are limited requirements to fulfil when initiating an ICO, it is very hard for an investor to elicit the correct and relevant information to make a sound investment decision (e.g. in 2017, many considered watching a couple of YouTube videos as doing sound due diligence);
- Products and projects are typically very immature, strongly increasing the inherent risk of making an investment whatsoever. In some cases one is merely investing in an idea without tangible planning for implementation;
- Aggravating the previous point, the company holding the ICO will receive the bulk of the investments at the very start and as there is little to no liability, there is essentially no pressure to actually deliver a product. Many projects either exit scam right after the ICO or slowly wither in development activity as the team enjoys their newfound riches;
- The exchanges where the tokens are eventually listed have relatively limited guidelines and policies to prevent fraudulent activities;
- Even if the token sale is fully legitimate and there is a strong project behind it, crypto exchanges and crypto wallets are hacked and stolen from on a daily basis. So the moment you log in to smile at your incredible investment returns, it might be all gone;
- If your money gets lost in some way, there is practically no way of retrieving it. Be it you losing your private keys yourself or hackers stealing your tokens, there isn’t much you can do once you lose token ownership;
- Lack in transparency. There is absolutely no enforceable obligation for a project to actually disclose the progress made, potentially leaving investors behind in a haze;
- Your investment might be prone to artificial pump-and-dump schemes, where the value of your coins can become even more volatile than in the case of an established high-market-cap crypto such as BTC.
Source: Own research + honorable mention: 1) “Inclusive FinTech: Blockchain, Cryptocurrency and ICO” — Book by Lee David Kuo Chuen, Low Linda, 2018; 2) Introduction to ICOs — Reftoken.io
Note: Quick 2021 update by the author: please find the latest article on IDOs (Initial Dex Offerings) and how ICOs evolved into them right here:
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About Ruben and NGRAVE:
Ruben Merre is a repeat tech entrepreneur, polyglot, life-long learner and founder and CEO of NGRAVE, the digital asset security company behind “ZERO”, the most secure cryptocurrency wallet in the world. Since 2018, Ruben and his team have partnered up with the top tier in nanotechnology, cryptography and hardware security, as well as thought leaders such as Jean-Jacques Quisquater, famous cryptography professor and second reference of the bitcoin paper. The result: a true end-to-end solution for managing digital assets, at maximum security (EAL7, highest security certification in the world), and an intuitive user interaction.
