What Is an Initial Coin Offering (ICO)?
An initial coin offering (ICO) is the cryptocurrency industry’s equivalent of an initial public offering (IPO). A company seeking to raise money to create a new coin, app, or service can launch an ICO to raise funds.
Interested investors can buy into an initial coin offering to receive a new cryptocurrency token issued by the company. This token may have some utility related to the product or service the company is offering or represent a stake in the company or project.
- Initial coin offerings (ICOs) are a popular way to raise funds for products and services usually related to cryptocurrency.
- ICOs are similar to initial public offerings (IPOs), but coins issued in an ICO also can have utility for a software service or product.
- A few ICOs have yielded returns for investors. Numerous others have turned out to be fraudulent or have performed poorly.
- To participate in an ICO, you usually need first to purchase a more established digital currency, plus have a basic understanding of cryptocurrency wallets and exchanges.
- ICOs are, for the most part, completely unregulated, so investors must exercise a high degree of caution and diligence when researching and investing in them.
How an Initial Coin Offering (ICO) Works
When a cryptocurrency project wants to raise money through an ICO, the project organizers’ first step is determining how they will structure the coin. ICOs can be structured in a few different ways, including:
- Static supply and fixed price: A company can set a specific funding goal or limit, which means that each token sold in the ICO has a preset price, and the total token supply is fixed.
- Static supply and dynamic price: An ICO can have a fixed supply of tokens and a dynamic funding goal—this means that the amount of funds received in the ICO determines the overall price per token.
- Dynamic supply and fixed price: Some ICOs have a dynamic token supply but a fixed price, meaning that the amount of funding received determines the supply.
White Paper Release
Alongside structuring the ICO, the crypto project usually creates a pitchbook—called a white paper in the crypto industry—that it makes available to potential investors via a new website dedicated to the token. The promoters of the project use their white paper to explain important information related to the ICO:
- What the project is about
- The need that the project would fulfill upon completion
- How much money does the project needs
- How many of the virtual tokens will the founders keep
- What type of payment (which currencies) will be accepted
- How long the ICO campaign will run
The project releases the white paper as part of its ICO campaign, which it designs to encourage enthusiasts and supporters to buy some of the project’s tokens. Investors can generally use fiat or digital currency to buy the new tokens, and it’s increasingly common for investors to pay using other forms of crypto, such as Bitcoin or Ethereum. These newly issued tokens are similar to shares of stock sold to investors during an IPO.
What Happens to the Funds?
If the money raised in an ICO exceeds the minimum amount required by the ICO’s criteria, the funds may be returned to the project’s investors. The ICO would then be deemed unsuccessful. If the funding requirements are met within the specified period, the money raised is spent in pursuit of the project’s goals.
Who Can Launch an ICO?
Anyone can launch an ICO. With very little regulation of ICOs in the U.S. currently, anyone who can access the proper technology is free to launch a new cryptocurrency.
But this lack of regulation also means that someone might do whatever it takes to make you believe they have a legitimate ICO and abscond with the money. Of all the possible funding avenues, an ICO is probably one of the easiest to set up as a scam.
Buying Into an ICO
Do your homework if you’re set on buying into a new ICO you’ve heard about. The first step is ensuring that the people putting up the ICO are honest and accountable. Next, investigate the project leads’ history with crypto and blockchain. If it seems that the project doesn’t involve anyone with relevant, easily verified experience, that’s a red flag.
Even if anyone can establish and launch an ICO, that doesn’t mean everyone should. So if you’re thinking about organizing an initial coin offering, ask yourself if your business would substantially benefit from one.
Special Considerations
ICO activity began to decrease dramatically in 2019, partly because of the legal gray area that ICOs inhabit. Investors can research and find ICOs in which to participate, but there is no surefire way to stay abreast of all the latest initial coin offerings. You can use websites like TopICOlist.com and websites that compare different ICOs against one another.
The U.S. Securities and Exchange Commission (SEC) can intervene in an ICO if necessary. For example, after the creator of Telegram raised $1.7 billion in an ICO in 2018 and 2019, the SEC filed an emergency action and obtained a temporary restraining order, alleging illegal activity on the part of the development team.2 In March 2020, the U.S. District Court for the Southern District of New York issued a preliminary injunction. Telegram was ordered to return $1.2 billion to investors and pay a civil penalty of $18.5 million.
There is no guarantee that an investor won’t be on the losing end of a scam when investing in an ICO. To help avoid ICO scams, you can:
- Make sure that project developers can clearly define what their goals are. Successful ICOs typically have straightforward, understandable white papers with clear, concise goals.
- Look for transparency. Investors should expect 100% transparency from a company launching an ICO.
- Review the ICO’s legal terms and conditions. Because traditional regulators generally do not oversee this space, an investor is responsible for ensuring that an ICO is legitimate.
- Ensure that ICO funds are stored in an escrow wallet. This type of wallet requires multiple access keys, which provides useful protection against scams.
Some ICOs require that another cryptocurrency be used to invest in an ICO, so you may need to purchase other coins to invest in the project.
ICO Hyping
ICOs can generate a substantial amount of hype, and there are numerous sites online where investors gather to discuss new opportunities. Famous actors, entertainers, or individuals with an established presence, like Steven Seagal, have encouraged their followers or fans to invest in a hot new ICO. However, the SEC warned investors that it is illegal for celebrities to use social media to endorse ICOs without disclosing what compensation they received.
Boxing superstar Floyd Mayweather Jr. and music mogul DJ Khaled once promoted Centra Tech, an ICO that raised $30 million at the end of 2017.6 Centra Tech was ultimately deemed a scam in court, resulting in the two celebrities settling charges with U.S. regulators, plus three Centra Tech founders pleading guilty to ICO fraud.
Investors seeking to participate in ICOs should familiarize themselves with cryptocurrency and understand everything about an ICO before participating. Because ICOs are barely regulated, prospective investors should exercise extreme caution when investing.
Initial Coin Offering (ICO) vs. Initial Public Offering (IPO)
IPOs raise money for companies seeking funds from investors and result in the distribution of shares of the company’s stock to investors. For ICOs, crypto companies raise funds through the sales of coins or tokens. In both cases, investors are bullish about the company or the cryptocurrency and invest based on the belief that the asset’s value will increase over time.
The primary difference between an ICO and an IPO is that investing in an ICO doesn’t secure an ownership stake in the crypto project or company. ICO participants are gambling that a currently worthless currency will later increase in value above its original purchase price.
KEY TAKEAWAYS
- IPOs are highly regulated and scrutinized by government organizations such as the SEC, while ICOs are largely unregulated.
Although IPOs are generally funded by more conservative investors anticipating a financial return, ICOs may receive funding from risk-tolerant supporters keen to invest in a new, exciting project. An ICO differs from a crowdfunding event because it offers the possibility of financial gain over time, whereas crowdfunding initiatives receive donations. ICOs are also referred to as “crowdsales.”
Advantages and Disadvantages of Initial Coin Offerings
Online services can facilitate the generation of cryptocurrency tokens, making it exceptionally easy for a company to consider launching an ICO. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute the tokens by transferring the coins to individual investors. But because financial authorities do not regulate ICOs, funds lost due to fraud or incompetence may never be recovered.
Early investors in an ICO are usually motivated by the expectation that the tokens will gain value after the cryptocurrency launches. An ICO’s primary benefit is the potential for very high returns.
But the legality of cryptocurrency or digital assets is not guaranteed to persist. In 2017, the People’s Bank of China officially banned ICOs, slamming them as counterproductive to economic and financial stability.9 In 2021, the Chinese government went on to ban cryptocurrency mining and declared all cryptocurrency transactions illegal.
Examples of Initial Coin Offerings
Ethereum’s ICO in 2014 is an early, prominent example of an initial coin offering. The Ethereum ICO raised $18 million over 42 days. In 2015, a two-phase ICO began for Antshares, later rebranded as Neo. The first phase of this ICO ended in October 2015, and the second continued until September 2016. During this time, Neo generated about $4.5 million.
In another example, during a one-month ICO ending in March 2018, Dragon Coin raised about $320 million. Also, in 2018, the company behind the EOS platform shattered Dragon Coin’s record by raising a whopping $4 billion during a yearlong ICO.
The first instance of the SEC cracking down on an ICO occurred on Dec. 11, 2017, when the agency halted an ICO by Munchee, a California company with a food review app. Munchee was attempting to raise money to create a cryptocurrency that would work within the app to order food. The SEC issued a cease-and-desist letter, treating the ICO as an unregistered securities offering.
How do you know when new coins are launched?
Many exchanges, websites, and aggregators list new coins. Some examples are Coinbase, Gemini, Kraken, CoinGecko, and CoinMarketCap. You can also find new coins announced on social media platforms such as Twitter.
Is an initial coin offering (ICO) legal?
Initial coin offerings (ICOs) are legal. However, the ICO is illegal if the project and coin don’t pass the Howey Test used by the U.S. Securities and Exchange Commission (SEC) to determine if an offering is an investment instrument.
What is an ICO used for?
Creating a blockchain and cryptocurrency is a costly endeavor. Developers must pay for legal counsel, programmers, facilities, and other expenses. An ICO is intended to raise funds to pay for the costs incurred during a blockchain’s or coin’s development.
Investing in cryptocurrencies and other initial coin offerings (ICOs) is highly risky and speculative. This article is not a recommendation by ZP Enterprises or the writer to invest in cryptocurrencies or other ICOs. Because each individual’s situation is unique, a qualified professional should always be consulted before making financial decisions. Investopedia makes no representations or warranties regarding the accuracy or timeliness of the information contained herein.
