ICOs were all the rage back in 2017 — what do you need to know about this method of fundraising, and how can you protect yourself against bad actors?
An initial coin offering (or ICO for short) is a crowdfunding technique that blockchain projects use to raise capital and create a new cryptocurrency. The ICO market was thriving in 2017 and 2018 — but these days, due to a variety of factors, other methods for token offerings are more popular.
How Does an ICO Work?
At first glance, ICOs are not too different from an initial public offering, where companies start selling shares to the public on the stock exchange. But although IPOs are regulated by the U.S. Securities and Exchange Commission, as a rule, ICOs are unregulated, and thus many ICO tokens have ended up in hot water because they didn't comply with federal securities laws. Another big difference is that buying crypto tokens doesn't mean you'll have an ownership stake in the company.
For legitimate ICOs, the first step is devising a business model and exploring how blockchain technology will be used. Startups may seek early feedback from ICO investors or venture capitalists. From here, the new project will develop a white paper that explains what their digital currency is for — and the document may include forward-looking information about the return on investment a contributor can expect.
Many crowdsales struggle to gain momentum at this stage because they lack legitimacy — in 2020, we are a long way from the ICO craze of 2017. The new token could be regarded as a solution looking for a problem. A lack of hype on social media could also make raising money impossible. According to Blockchain Simplified, up to 53.3% of ICO projects failed to close their token sales in 2018.
ICO projects that are successful will need to get their digital assets listed on cryptocurrency exchanges. Ethereum has commonly been used for token sales because of the blockchain's smart contract functionality.
The Danger of Scams
As the hype surrounding utility tokens surged in 2017, scammers saw an opportunity to hold fraudulent ICOs — and sadly, a lack of regulation meant many managed to get away with it.
Some criminals promised returns from virtual currencies that were simply too good to be true. Even ICO projects backed by celebrities, such as the boxer Floyd Mayweather, were later found to be fraudulent.
Just like any other investment in fintech, due diligence is essential. Before backing an ICO, ask yourself these questions: Does the white paper give you everything you need? Is the team behind this blockchain project credible? Is transparent information provided about the progress of the token sale?
The SEC Flexes Its Muscles
The United States has taken a dim view toward initial coin offerings — irrespective as to whether they were for legitimate projects or not.
Telegram, a popular encrypted messaging app, raised $1.7 billion in an ICO in 2018 for a new blockchain project known as the Telegram Open Network. But last year, the SEC accused the company of breaking federal securities laws by failing to register the token sale. Telegram has now been forced to cough up an $18.5 million fine, and return $1.2 billion to investors.
Despite all the doom and gloom, there have been some big successes in the world of ICOs. Ethereum and NEO are just some of the big names that successfully managed to raise capital through an initial coin offering. Now, ETH is the world's second-largest cryptocurrency by market cap.
