WHAT IS
A CRYPTO ICO?

Initial coin offerings (ICOs) are revolutionizing the crypto space. Instead of going to venture capitalists for early stage funding, new crypto launches are instead offering individual investors a chance to buy into the prospect of their new coin taking off.

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Initial Coin Offerings (ICOs) have revolutionized fundraising in the blockchain world, offering a new way for projects to raise capital. This guide will walk you through the essentials of what an ICO is, how it operates, the legal considerations, and what to watch out for as a potential investor.

Understanding ICOs

ICOs are a method used by cryptocurrency projects to raise funds. They are somewhat akin to Initial Public Offerings (IPOs) in the stock market, but with notable differences. Unlike IPOs, which offer shares of a company, ICOs provide investors with tokens related to the project.

The tokens issued to investors can represent a variety of things, including a stake in the project, access to a service, or a utility within the ecosystem.

How Do ICOs Work?

When a blockchain company is looking to raise money to start a new project, this company could raise money from investors.

Let’s use a game as an example. Those who decide to invest may receive a game token for investing, and these tokens are used to power the new game on the blockchain. The chess tokens could be used to play Blockchain Chess, stored, or sold on to other investors.

Here is how an ICO might look from start to finish:

1. A company creates an idea for a blockchain-based product or service.
2. Plans for the ICO are outlined in a whitepaper or similar document. This includes how much money will be raised, how many tokens will be issued, who can invest, how the tokens will be distributed, etc.
3. The ICO is marketed via the company website and appropriate social media channels to raise its visibility and public interest.
4. Investors send funds on or after the date of the ICO in exchange for tokens.
5. The new funds are used to grow the business and create or build upon an already existing product.

Are ICOs Legal?

The legality of the ICO fundraising method has raised eyebrows from regulators. Some believe that even though ICOs tout themselves as raising funds in exchange for fully functioning cryptos, they are really just skirting securities laws through this technicality.

Countries such as China and South Korea have gone so far as to build a regulatory framework that bans ICOs altogether in an attempt to not deal with this issue.

In the US, the Securities and Exchange Commission (SEC) has provided potential investors with guidelines as to when an ICO needs to be registered as a security. These guidelines generally follow the Howey Test, which is used to determine whether a transaction should be defined as an investment contract.

In the case of digital assets, the relevant questions may be:

• Is there an investment of money?
• Is there an expectation of profits from the investment?
• Is there common enterprise (defined by when the profits of an investor are tied with the success of the company)?
• Is the profit dependent on the efforts of the issuing company?

If an ICO meets the criteria of the Howey Test, it is considered a security and subject to SEC or local regulatory body regulations. This test assesses whether there is an investment of money in a common enterprise with an expectation of profits primarily from the efforts of others.

Risks and Rewards of Investing in ICOs

Investing in ICOs can be rewarding but also comes with significant risks. Understanding these aspects is crucial for making informed investment decisions.

Benefits of participating in ICOs

ICOs offer several benefits to investors. They provide early access to potentially groundbreaking technologies and the opportunity for investment returns if the project succeeds. Additionally, ICOs can democratize investment opportunities, allowing individuals to participate in projects that were once reserved for venture capitalists.

Common ICO risks and scams to avoid

Despite their potential, ICOs carry considerable risks. The lack of regulation makes them susceptible to scams and fraudulent schemes. Investors should be wary of projects with vague whitepapers, anonymous teams and unrealistic promises.

Conducting thorough research and due diligence is essential to mitigate these risks. Stay vigilant with tips on avoiding scams in trading.

ICOs vs IPOs

The primary distinction between ICOs and IPOs is the nature of what is being offered. While IPOs involve selling equity in a company, ICOs offer tokens that may not necessarily equate to ownership, but rather utility within a blockchain network.

ICO projects sell their underlying crypto tokens in exchange for other crypto such as Bitcoin or Ethereum, or fiat currency. This difference allows ICOs to operate with fewer regulatory constraints, though this is changing as governments begin to establish clearer guidelines.

Final thoughts

Investing in ICOs can be enticing due to the potential for returns, but it is crucial to conduct thorough research and understand the associated risks. Always stay updated with regulatory changes to ensure compliance and safeguard your investments.

Learn more about ICOs and cryptocurrency by joining the eToro Academy.

FAQs

What was the first ICO?

The first initial coin offering on record was completed by Mastercoin in 2013. While Mastercoin got the ball rolling, it wasn’t until Ethereum raised funds via its own ICO in 2014 that the industry started to take notice. Ethereum was able to raise 3,700 bitcoin — equivalent to $2.3m at the time — in just 12 hours. The Ethereum ICO experiment proved that this new fundraising path was here to stay and paved the way for what was to come.

Are ICOs a scam?

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. Still, this doesn’t mean that ICOs are all bad. In fact, some of the most successful cryptos 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.

What are the other ways that crypto platforms raise money?

There are now further evolutions of fundraising that provide different benefits and drawbacks. IEOs (initial exchange offerings) are similar to ICOs in the sense that a company is still selling a utility token in exchange for funds. However, an IEO is conducted directly via a digital asset exchange, which comes with its own advantages and drawbacks. Then there are STOs (security token offerings), which are a new way to sell securities via digital assets.