What Is an ICO, How Does It Work, and Should You Invest In One?

ByJulija A.
February 25, 2022

An ICO, or Initial Coin Offering, is a way for startups and businesses to raise investments by issuing their cryptocurrency. Instead of selling equity in their company with an IPO or relying on alternative financing methods, companies can create their own blockchain and sell tokens. Their investors can then use these tokens on the company’s platform to purchase its product or services or exchange them for other cryptocurrencies.

Sounds a bit complicated? Don't fret - in this article, we will cover everything you need to know. Let's define ICOs, how they work, and whether you should invest in one.

What Is an ICO?

An ICO refers to companies raising funds by issuing a new cryptocurrency. Businesses can issue their digital coins or tokens and sell them to people looking to invest in a particular company or into an up-and-coming cryptocurrency.

Typically, the advantage of having an ICO is that the investors can purchase these for a pittance. From there, they can either use them on the platform when it launches or hold them and trade on crypto exchanges later. Likely, the price will rise due to cryptocurrencies' volatile nature. 

The premise of buying cryptocurrency under a penny and then selling it for a profit makes these tokens or coins a lucrative opportunity for various investors. It also gives the company more chances of raising the needed funds than relying on traditional investing opportunities. Businesses will need to create their own blockchain in order to create a new coin or token,  

Blockchain is the underlying technology that cryptocurrencies like Bitcoin and Ethereum are built on top of. Blockchain has been reshaping money as we know it in the last decade, and current blockchain statistics prove that it is well on its way to reshaping other aspects of our lives as well. 

The blockchain is essentially a digital ledger that keeps track of all transactions made on it. It's incredibly secure and difficult to tamper with. Once the company creates its blockchain and cryptocurrency or tokens on it, it can launch an ICO and sell those to its investors. 

The tokens created on the network can have different values. Some of them could be virtual equity in the company or can be used as a currency to purchase the company's product or services.

How Does an ICO Work?

Now that we know what an ICO is, let's look at it in a bit more detail.

When a company decides to launch an ICO, it will embed its new currency with a value. Then, they need to find people interested in purchasing that value. 

For that, teams need to create a white paper. This document contains all the pertinent information about the project. It explains the currency or token, how the users can use it, the technical details of the blockchain and token economics, and when the token will be listed on a coin exchange.

The white paper is then created along with a website that describes everything about the project. This initial information is meant to entice investors into buying tokens during the ICO phase.

Once this has been completed, the team behind it will start promoting their product.  The goal is to get the product in front of potential buyers as much as possible. Typically, they will post on various social media channels, crypto forums, and other online platforms, such as online lists of initial coin offerings. The more people know about it, the better chances are of raising the needed funds.

Some ICOs will be an initial sale; others will have a whitelisting period or even a pre-sale. Depending on when the investors get on board, the price per token might be higher or lower.

Companies can structure their ICOs in a couple of different ways. They can adjust either the supply or the price so that the ICO will match their end goals. For example, they can set up a fixed price and fixed coin stock to make the math easier for both the team and investors.

Alternatively, there will have a finite supply amount, and the price may differ depending on the amount raised in the ICO. Yet other ICOs will have a fixed price per coin, but the supply might change depending on the amount of funding received.  

Apart from actually having their investors purchase tokens or currency, some ICOs will also reward people for their participation in raising awareness about the upcoming ICOs. These can take various forms, such as bounties or airdrops. To earn tokens as rewards, you could post about the ICO on relevant platforms or perform other tasks that will help the company promote its initial coin offering.

In this scenario, you are investing your time into the ICO, and these tokens can also be traded on a crypto exchange later for the same price as if you’d bought them at a sale.

A Brief History of ICOs

If we look at the history of ICOs, they can be traced back to 2013, when Mastercoin raised around 5,000 BTC in its coin offering. At that time, it was one of the most successful crowdfunding campaigns ever.

Probably the most famous one is Ethereum's ICO, which took place in 2014. The new blockchain, which can be programmed beyond what Bitcoin had offered at the time, gained much support. It raised $18.4 million, which helped it skyrocket in popularity to become the second-largest cryptocurrency that reshaped blockchain technology. 

However, it wasn't until 2017 that ICOs started becoming a really popular fundraising opportunity and saw a slew of successful initial coin offerings. In 2017, the crypto world saw 342 new tokens, whose initial coin offerings raised nearly $5.4 billion throughout the year.

What Are Some Examples of Successful ICOs?

There were a lot of successful ICOs in their time, and if the current statistics about cryptocurrencies are any indicator of crypto growth and adoption, there are yet more to come. However, the three most popular ones were  EOS, Telegram Open Network, and Bitfinex. These raised $4.1 billion, $1.7 billion, and $1 billion, respectively.

On the other hand, an excellent example of how an ICO can fail is AriseBank. They wanted to raise money through their ICO but were accused of fraud and eventually shut down.

With the impressive amount of money raised through these coin IPOs, many scammers soon saw it as an easy opportunity to gain quick funds. As the number of scams grew, ICOs started raising negative attention along with the much-needed funds for the actual companies. And while the attention from investors is more than welcome, that of regulators definitely didn’t help matters for some companies and individuals.

In 2017, with the massive growth of ICO-related scams, the SEC turned its attention to this unregulated investment option. The first ICO to be halted by the SEC was Munchee, a California company that offered cryptocurrency that users can use to order food within its app. The SEC treated this ICO as an unregistered securities offering and issued the team a cease-and-desist letter.

Who Can Launch an ICO Offering?

Anyone can launch an ICO. While it used to be predominantly a method for blockchain startups to raise funds, it's now becoming increasingly popular with large companies as well. For example, Kodak launched their own token named KODAKCoin back in 2018, and it saw some success but ultimately got shut down.

If you are a company leader and wondering whether you should launch an ICO or not, it is essential to consider whether crypto blockchain can work with your company’s processes. It is important to determine upfront what kind of value your company can sell through cryptocurrency. Sometimes, running an IPO (Initial Public Offering) could be a better solution.

What Are the Benefits of Launching an ICO for a Startup?

There are many reasons why a startup would want to launch an ICO. The most obvious one is that it's a way for them to raise money, but there are other benefits as well:

- raising awareness about the project;

- spreading the word through social media channels & marketing campaigns;

- creating brand loyalty and building a community of investors through a token offering;

- encouraging the development and growth of their token;

In What Ways Can Investors Benefit From Participating in an ICO?

As mentioned earlier, there are many reasons why you might want to participate in an ICO as an investor. The main premise of a company having an ICO is that you can purchase their products and services with the cryptocurrency you bought for next to nothing. Similar to how crowdfunding sites and other alternative investment routes work, ICOs are the way for young companies to raise funds and create amazing products with the help of early investors.

You can profit from it by investing early on (pre-ICO or crowdsale), which will allow you to make a profit when and if the tokens go live for a higher price. 

Should You Invest in an ICO?

There are always risks involved when it comes to investing. This is true regardless of whether you're putting your money into stocks, bonds, or cryptocurrencies. However, you can minimize those risks and earn a decent profit from participating in an ICO with due diligence and research.

As we mentioned earlier, ICOs are an excellent way of getting in on the ground floor of a new cryptocurrency project. However, since there are also a lot of risks involved, it's important to do your homework before buying into an ICO.

After all, what is an ICO, if not an investment? And all investments are risky by their very nature. With that in mind, here are a few things to pay attention to so you can minimize the risk:

  • The team behind the project 

What experience do they have in this particular field? Do they have any previous successes or failures that you can research?

  • The product itself

What does it do, and is there a market for it? What is the actual value of this product, and how much demand is there in the current marketplace?

  • What are they using your money for?

How will they spend your funds to ensure that their project becomes a success? What skills are needed from other team members, developers, etc.? How much will those cost?

  • What rewards are you getting in return for your ICO tokens? 

What kind of profit can you expect to see when selling back tokens once their value increases? How many tokens will you be able to purchase with the same amount of money in the future?

  • What are the risks involved?

What could go wrong that would prevent this project from being a success? Are there any major red flags that you should be aware of?

How To Invest in an ICO?

Now that you know what to look for, it's time to start investing in some ICOs. The first thing you'll need is a good cryptocurrency wallet to store your newest crypto coins in.

From there, it's as simple as finding the right project and sending them your funds. Depending on accepted currencies, you may be able to make your deposits in fiat or crypto. You can usually find this information on the project’s website or whitepaper. 

Once you've deposited your funds, sit back and wait for your tokens to be distributed after the ICO has ended. ICO is an excellent way to diversify your crypto portfolio without investing too much upfront.

FAQ

Did Bitcoin have an ICO?

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Bitcoin didn't have an ICO, but the first cryptocurrency to use an ICO used it as part of their campaign. Mastercoin raised around 5,000 BTC in its initial coin offering, which was worth around $500,000 then.

How do you make money from ICO tokens?

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Essentially, when the project is completed, and the tokens are listed on an exchange, you can sell them for a profit. Typically, the purpose of an ICO is to provide early investors with a discount on the token’s price. What makes ICOs so appealing to investors is that they have the potential to generate massive returns - oftentimes within a relatively short period after investing.

What is the purpose of an ICO?

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If you are wondering, “What is an ICO?”, it could be easily defined as a way for startups to raise funds by issuing their own cryptocurrency. It’s also a great method for creating brand loyalty and building a community of investors.

About author

Albert Einstein is said to have identified compound interest as mankind’s greatest invention. That story’s probably apocryphal, but it conveys a deep truth about the power of fiscal policy to change the world along with our daily lives. Civilization became possible only when Sumerians of the Bronze Age invented money. Today, economic issues influence every aspect of daily life. My job at Fortunly is an opportunity to analyze government policies and banking practices, sharing the results of my research in articles that can help you make better, smarter decisions for yourself and your family.

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