What is an Initial Coin Offering (ICO)? Everything you need to know

What is an Initial Coin Offering (ICO)?

An initial coin offering (ICO) mirrors the traditional concept of an initial public offering (IPO) in the cryptocurrency industry. It serves as a means for companies aiming to generate funds for developing a new coin, application, or service.

Potential investors have the opportunity to participate in an ICO by purchasing tokens offered by the company. These tokens may hold utility linked to the company's product or service or signify ownership in the company or project.

How an Initial Coin Offering (ICO) works?

When a cryptocurrency project intends to raise funds through an ICO, the project organizers initially decide on the coin's structure. ICOs can adopt various structures, including:

• Static supply and static price: The company establishes a specific funding goal or limit, where each token sold in the ICO holds a predetermined price, and the total token supply remains constant.
• Static supply and dynamic price: An ICO features a fixed token supply alongside a flexible funding goal. This setup implies that the funds collected during the ICO dictate the overall token price.
• Dynamic supply and static price: Certain ICOs incorporate a dynamic token supply but maintain a fixed price. Here, the funding received determines the token supply.

In addition to structuring the ICO, the cryptocurrency project typically develops a presentation document, commonly referred to as a white paper within the crypto industry. This white paper is made accessible to potential investors through a dedicated website established for the token. The project promoters utilize the white paper to convey crucial details pertinent to the ICO:

• The project's objectives
• The problem the project aims to address upon completion
• The funding requirements of the project
• The portion of virtual tokens retained by the founders
• Accepted forms of payment (e.g., currencies)
• The duration of the ICO campaign

The project unveils the white paper as part of its ICO campaign, designed to attract enthusiasts and supporters to invest in the project's tokens. Investors typically have the option to purchase the new tokens using fiat or digital currency, with the growing trend of utilizing alternative cryptocurrencies like Bitcoin or Ethereum for payment. These newly issued tokens function akin to shares of stock offered to investors during an IPO.

What occurs with the funds?

If the funds collected in an ICO fall short of the minimum threshold set by the ICO's criteria, they might be refunded to the project's investors, rendering the ICO unsuccessful. Conversely, should the funding criteria be met within the designated timeframe, the raised funds are utilized to advance the project's objectives.

Who has the ability to initiate an ICO?

Anyone has the capacity to initiate an ICO. With minimal regulation of ICOs in the U.S. at present, individuals with access to the requisite technology are able to launch a new cryptocurrency freely.

However, this absence of regulation also implies that individuals may resort to deceptive tactics to convince others of the legitimacy of their ICO and then vanish with the funds. Among the various funding avenues available, setting up an ICO is perhaps one of the simplest methods to perpetrate a scam.

Investing in an ICO

If you're considering investing in a new ICO, it's crucial to conduct thorough research. Begin by verifying the authenticity and accountability of the individuals behind the ICO. Subsequently, delve into the track record of the project leaders in the crypto and blockchain realms. Any absence of relevant and easily verifiable experience among the project leads should raise concerns.

Even though anyone can establish and launch an ICO, not everyone should do so. Hence, if you're contemplating organizing an initial coin offering, evaluate whether your business stands to gain significantly from it.

Special considerations

ICO activity experienced a sharp decline in 2019, partly due to the legal ambiguity surrounding ICOs. Investors can explore and identify ICOs for potential participation, although there's no foolproof method to keep track of all the latest initial coin offerings. 

There's always a risk of falling victim to a scam when investing in an ICO. To mitigate the risk of ICO scams, consider the following:

• Ensure that project developers have clearly defined goals, typically outlined in straightforward white papers with concise objectives.
• Seek transparency from companies launching ICOs. Investors should expect full transparency regarding the ICO's operations.
• Review the legal terms and conditions of the ICO carefully. As traditional regulators often do not oversee this space, investors must verify the legitimacy of an ICO themselves.
• Verify that ICO funds are stored in an escrow wallet, offering protection against scams through multiple access keys.
  Some ICOs may require using another cryptocurrency to invest in the project, necessitating the purchase of other coins.

ICO hype

ICOs often generate significant hype, and various online platforms host discussions among investors about new opportunities. Notably, celebrities like Steven Seagal have endorsed ICOs to their followers, prompting caution from the SEC, which stated that such endorsements must disclose compensation.

For instance, boxing superstar Floyd Mayweather Jr. and music mogul DJ Khaled promoted Centra Tech, an ICO that raised $30 million in 2017. However, Centra Tech was later exposed as a scam, leading to legal action against the celebrities and guilty pleas from three Centra Tech founders for ICO fraud.

Prospective ICO investors should possess a thorough understanding of cryptocurrency and carefully evaluate all aspects of an ICO before participating. Due to the limited regulation of ICOs, exercising caution is essential when investing.

Initial Coin Offering (ICO) vs. Initial Public Offering (IPO)

Initial Coin Offerings (ICOs) and Initial Public Offerings (IPOs) serve as mechanisms for companies to raise capital from investors. IPOs involve the sale of shares of the company's stock to investors, while ICOs involve the sale of coins or tokens issued by crypto companies.

Investors in both IPOs and ICOs typically have positive expectations about the company or cryptocurrency and invest with the anticipation of future value appreciation.

The key distinction between an ICO and an IPO lies in the nature of the investment. In an IPO, investors acquire ownership stakes in the company, represented by shares of stock. Conversely, participating in an ICO does not confer ownership rights in the crypto project or company. Instead, ICO participants speculate that the value of the purchased coins or tokens will increase over time, potentially yielding profits.

While IPOs typically attract conservative investors seeking financial returns, ICOs may garner funding from risk-tolerant supporters interested in backing innovative projects. Unlike crowdfunding events, which rely on donations, ICOs offer the potential for financial gains over time and are sometimes known as "crowdsales."

Pros and cons of Initial Coin Offerings

Online platforms simplify the creation of cryptocurrency tokens, streamlining the process for companies considering launching an ICO. ICO managers oversee token generation based on the ICO's terms, receiving and distributing tokens to investors. However, since ICOs lack regulatory oversight, losses from fraud or mismanagement may be irrecoverable.

Initial investors in an ICO typically anticipate potential token value growth post-launch, highlighting the ICO's main advantage: the prospect of substantial returns. Yet, the legal status of cryptocurrencies isn't guaranteed. For instance, in 2017, the People’s Bank of China banned ICOs, citing concerns about economic and financial stability. Subsequently, in 2021, the Chinese government extended the ban to cryptocurrency mining and outlawed all cryptocurrency transactions.

How can one determine the launch of new coins?

Numerous exchanges, platforms, and aggregators serve to list newly launched coins. Among them are Coinbase, Gemini, Kraken, CoinGecko, and CoinMarketCap. Additionally, announcements about new coins often surface on social media platforms like Twitter.

Is it legally permissible to conduct an Initial Coin Offering (ICO)?

Initial coin offerings (ICOs) are considered legal. However, an ICO could be deemed illegal if the project and its associated coin fail to satisfy the criteria outlined in the Howey Test, which the U.S. Securities and Exchange Commission (SEC) employs to assess whether an offering qualifies as an investment instrument. In some cases, developers might opt for issuing a Simple Agreement for Future Tokens (SAFT) to mitigate legal risks.

What purpose does an ICO serve?

Developing a blockchain and cryptocurrency involves significant expenses, including legal fees, programming costs, infrastructure, and other expenditures. An ICO serves as a means to raise funds to cover these development costs.

Investing in cryptocurrencies and ICOs carries substantial risks and speculative elements. This article does not constitute investment advice from Investopedia or the author to invest in cryptocurrencies or ICOs. Due to the individual nature of financial situations, consulting a qualified professional is advisable before making any investment decisions. Investopedia does not guarantee the accuracy or timeliness of the information provided herein.