The main idea of ICO and description of its working process, the reasons to buy tokens issued by ICOs, explanation of soft and hard caps, information on the issues related to regulation and investor protection.
Blockchain-related topics are extremely hot nowadays and ICO is one of those. Our readers have already received an information on tokens issued by ICOs and their classification system, so now is the time to be introduced with one of the biggest trends in the crypto industry which is called either the future or just another scam.
An ICO (or a token sale) is a digital crowdfunding campaign in blockchain industry. It is a means of raising money for a startup by creating digital tokens and selling them to investors. The first ICO was held by Mastercoin in July 2013. EOS, a smart-contract platform, raised around $4 billion, making it the biggest token sale of all time.
How do ICOs work?
To raise capital through an ICO, a blockchain startup writes a whitepaper — a public document, which describes what the project is about. The company says how much money they need to undertake the venture and what portion of that money goes to the team. The company issues digital tokens and makes them available for public purchase. Usually, ICOs are hosted on smart-contract platforms, such as Ethereum. Then, enthusiasts and supporters can fund the project by buying these tokens for fiat or cryptocurrency, such as bitcoins or ethers. If the startup does not raise enough capital, money is returned to the investors.
Why buy tokens?
Tokens provide incentives for investors. Firstly, tokens can give their holders an access to the company’s goods and services. Secondly, if the startup is successful, their tokens are in demand and, thus, appreciate. This means that investors can sell them at a much higher price than that at which they were bought. For example, during its ICO in 2014 Ethereum raised $18 million with only $0.4 per ether. At the time of writing, one ether costs around $410. Thirdly, tokens can entitle their holders to a share of the company’s profits, much like regular securities.
In order to be easily traded, tokens need to be compatible with exchanges. The easiest way to do it is to hold your ICO on the Ethereum network. Ethereum has come up with a special format for tokens, ERC20, which means that exchanges do not need to write special code for each token to add it to their list.
What are soft are hard caps?
ICOs can be capped or uncapped. An uncapped ICO takes as much money as they can get. For example, Tezos raised $232 million, which puts it into the top 10 biggest ICOs. A capped ICO has fundraising goals: a soft cap and a hard cap. If an ICO reaches its soft cap, then it is considered a success. A hard cap is the maximum amount of money an ICO requires to cover all needs. If an ICO surpasses its hard cap, money raised over the hard cap is returned to the investors.
What should I know?
While a great crowdfunding tool, ICOs lack in regulation and investor protection. ICOs allow entrepreneurs to bypass regular capital-raising intermediaries, such as venture capitalists and stock exchanges, which naturally attracts fraudsters and scammers. 2017 has been the year of ICOs with dozens of new projects appearing every month. According to various sources, nearly have of them went out of business in just four months. Many of those were what we call ‘Pump-and-Dump’ schemes. Scammers increase public interest to their projects by talking up the value of their ICOs and, thus, driving up the prices of their tokens. Having raised enough money, scammers abandon their projects to never deliver on their promises. Be wary of scams and fraud and do your research, if you decide to invest in an ICO. Read the whitepaper and the roadmap, look up the team on LinkedIn and Twitter, read feedback on forums.
What about regulation?
ICOs are considered a grey area when it comes to regulation. Many countries are still only developing appropriate legal frameworks, others simply ban them. Gibraltar has done a lot of progress in this area, as their framework for regulating distributed-ledger technologies, which also covers ICOs, has been in effect since January 1, 2018. China, one of the biggest players in crypto space, has banned all ICOs within the country in September 2017, demanding all money previously raised in ICOs to be returned to investors. The U.S. Securities and Exchange Commission states that ICOs can be subject to law regulation depending on the nature of a particular token.