What are ICOs? Initial Coin Offerings Explained
If you are already familiar with the stock market, you should know about initial public offerings (IPOs). Unsurprisingly, anything related to finance such as IPOs have their counterpart in the crypto space, namely initial coin offerings (ICOs).
Initial coin offerings are initiated by blockchain companies primarily to raise funds. These companies would already have pre-mined or pre-minted a large stock of crypto coins or tokens to be sold to the first buyers (known as the primary market).
When an Initial Coin Offering is successful, ICO investors are (in theory) compensated in the form of increased coin future values.
Why are ICOs initiated in the first place?
Starting a business isn’t easy. New companies need to raise capital to pay rent, wages, procurement costs, and several other expenses. Many startups, therefore, apply for business loans which (often) come with less than favorable repayment terms.
Another way for founders to raise capital is to attempt to pitch ideas to private investors who provide capital in return for a significant stake in ownership of the new company. Alternatively, a company can ‘go public’ by selling shares of stock to public investors, through the IPO process.
Initial Coin Offerings (ICOs) work the same way like IPOs, in that startups sell their valuable assets (their own operational cryptocurrencies) to the public. However, there is one very important caveat.
In ICOs, the startups don’t actually sell their shares, because their crypto tokens don’t represent the shares of future profit. Rather, in ICOs, the startups sell some of their operating rights or privileges on the network.
For example, many aren’t aware of this, but some of the current Ethereum in circulation was actually pre-mined before the network was launched in June 2015. When the first ETH are sold through an ICO, early investors could theoretically use the Ethereum network as much as they wanted depending on how much ETH they had bought.
In a proof-of-stake blockchain network such as Cardano, pre-mined ADA tokens that are sold through an ICO can be used for staking and earn staking rewards.
How an Initial Coin Offering Works
Initial coin offerings disrupt traditional business financing. Specifically, by allowing startups to create and sell cryptocurrency coins as securities.
Blockchain platforms like Ethereum and Stellar, allow startups to create their own cryptocurrencies with relative ease. One New Zealand based startup which did just this in 2018, was Coingrid Ltd. They released an Ethereum based token which cryptocurrency investors can buy using Ethereum. Once Coingrid has raised enough Ethereum, they plan to use funds to build a new Christchurch-based cryptocurrency exchange. (The Coingrid ICO is ongoing.)
Some ICO coins are still profitable to this day. See our list of coins
Is Investing in an Initial Coin Offering Profitable?
One of the easiest ways to profit from ICO investments is to buy the coins early and to sell them as they peak in value. Tron’s ICO in 2018, early investors who bought TRX tokens at $0.002 per coin were later able to sell coins for a substantial profit when the coins reached $0.25 in value.
The biggest challenge here is that investors need to accurately time the market entry and exit points. It is important to note that not all ICOs are successful. For this reason, investors need to be careful when choosing a new project to invest in.
Investing in Utility ICO Coins
An alternative way to invest in ICOs (and considerably lower the level of risk involved), is to invest in ICO coins which have long-term utility value. Most ICO coins only exist to be used for fundraising purposes. The value of such coins can, therefore, diminish quickly once fundraising targets are met.
However, utility coins are different.
At their most basic level, utility coins are designed to serve an ongoing function after ICOs are complete. Ether is one example of a utility token/cryptocurrency. While initially tokens were used to raise startup capital, coins are today used on the Ethereum blockchain to pay for network bandwidth and storage.
People like decentralized app developers who use Ethereum, therefore, have to use ether to pay to make use of the platform.
In the case of Ethereum, continued demand for ether has seen coins retain value after the ether initial coin offering. Ether also have the potential to increase further in value, as the Ethereum network itself increases in popularity.
How to Choose ICO Coins to Invest In
At a minimum, you should assess the viability of new startup business ideas. Background checks should then be performed on companies and individuals bringing the coins to market.
In most cases, the whitepaper, the official document that highlights the rationale behind the existence of the cryptocurrency and the network technology, is what you should be examining with scrutiny.
If the whitepaper sounds too technical for you, there are plenty of beginner-friendly expert content on social media and trusted coin reviewers that can help you to understand how why the ICO may look promising.
Lastly, if you want to invest in non-utility coins, you should always plan in advance how long to hold ICO coins for. This is considerably more risky compared to investing in utility tokens, but the reward yield may be far greater than that of utility tokens — yet again, there is no guarantee for this.
Invest in ICOs at your own risk. If you simply want to invest in cryptocurrencies for the long-term, it’s totally fine to buy them at exchanges like Easy Crypto.