Samuel Leach, CEO and founder of Yield Coin, explains how initial coin offerings work and how they are used for funding with cryptocurrencies
A new form of peer-to-peer crowdfunding, initial coin offerings (ICOs) have helped start-ups around the globe capitalise on the decentralised benefits of blockchain technology.
They have been dubbed the cryptocurrency world’s rough equivalent to an initial public offering (IPO) – when a company floats on the stock exchange to raise funds from individual investors – and are often for businesses looking to create a new crypto coin, app or service.
However, due to the infancy of this form of investment, there’s been very little regulation, leaving many investors victims of scams that have abused the unregulated environment.
That being said, it’s reported that in the UK alone, more than $7bn has been raised this year through ICOs, compared with $5bn in 2017 – showing an increase of usage regardless of the risks involved.
Yet despite these high figures, the overwhelming majority still don’t understand what ICOs are or which ones could be scams.
So, what are ICOs, how do you invest in one, and how can you differentiate between a legitimate ICO and a fraudulent one?
Samuel Leach, CEO and founder of Yield Coin, explains.
What are ICOs? Difference between ICOs and IPOs
An ICO at its most basic is a decentralised fundraising mechanism.
A cryptocurrency coin, like Bitcoin, can be independent of a platform and used as a form of currency outside its native environment – which is where they were created.
A token, on the other hand, is a digital asset that is created and given away during ICOs.
As a form of investment, an ICO is open to almost everyone and anyone who wants to get involved in the project – enabling many companies to raise much more capital than they would be able to if they went down traditional investment routes.
The structure of ICOs could be regarded as very similar to that of IPOs.
However, a key difference between ICOs and other forms of investment, such as IPOs and venture capital raises, is that investors will not get an equity stake in the project.
Further, there are two different types of token – security and utility.
A utility token is based on the promise that the token offered through the ICO can be used to gain access to a product or platform that will be created.
Investors therefore choose to invest on the basis of wanting to use the proposed product or platform, usually outlined in the company’s white paper.
In contrast, if there is an expectation that by investing in the ICO, the investor will receive a profit from the future success of the project or company, then the tokens generated in that ICO are security ones.
As these tokens are legally deemed to be a security, they are subject to federal regulations.
Given the unknowable nature of whether a project will succeed or not, much like a crowdfunding campaign from a start-up that has no proof of concept, there is a high element of risk involved in investing in an ICO.
What are ICOs? How to invest in an ICO safely
It’s essential when deciding on whether to invest in an ICO to do extensive research before committing to anything.
The important questions to ask are:
- Who is the team behind this ICO?
- Do they have credibility and experience in producing the type of product that they are proposing to create?
- What form of payment will they accept during the ICO?
The vast majority only accept Bitcoin or Ethereum but there are some who are starting to accept fiat currency now as well.
Once you’ve decided to invest in an ICO, funds must be in a personal wallet in order to make complete a transaction.
Due to the technical structure of ICOs, investment from exchange wallets is blocked.
If one were to send funds from an exchange wallet, they would lose them and be unable to recover the transaction.
Funds are transferred to the ICO via a smart contract address.
It’s essential here to have the correct address or once again, funds will be lost and unable to be recovered.
This part of investing holds the most security risks and as a rule of thumb, never send funds to a supposed contract address sent through email or social media – even if it appears to be from the ICO organiser.
More often than not, tokens purchased during an ICO will be directly sent to the address from which the investor contributed.
However, when storing large sums, it’s always wise to move balances to a cold hardware storage wallet, such as Trezor, Ledger Nano S or KeepKey.
This is the most safe and secure way to hold both coins and tokens, while guaranteeing access to them if required to make a transfer.
What are ICOs? How to avoid an ICO scam
With the high risks involved in ICOs, it’s important to enter into them with your eyes wide open.
Start by reading the white paper as this will enable you to evaluate the feasibility of the project the ICO team is trying to create.
Also, be sure to monitor the ICO’s social media presence – by being part of their social channels, such as Slack or Telegram, any questions about the legitimacy of the project should be answered.
If the project spokespeople block your questions or refuse to respond, it’s a clear red flag that something dodgy is going on.
Further, always be sure to investigate the project team.
Check each team members’ social media channels to confirm their existence and then verify them through Google searches – this may even prove to give unpublicised information, which could be favourable or not.
By doing this, an understanding of the quality of the team can be formed, influencing the likelihood of the project being legitimate and worthy of investment.
Lastly, understand the ICO’s token economics.
Having a large pre-mined project is questionable and deserves further analysis – especially if the supply of tokens is large, with no market-model around it to help the value thrive.
In addition to this, if the token supply continuously inflates at a large rate, it is better to be safe and not invest.
With more eyes than ever on the crypto market, the number of ICO scams are sadly swelling and constantly evolving to avoid detection.
Regulation will gradually be introduced but until then the best advice is to only invest if you’re absolutely sure and never invest more than you’re ready to lose.
Like any new technology, there are risks involved, so don’t invest in to the hype. Do the research, and you’ll protect yourself from falling victim to scams.