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How does ICO (Initial Coin Offering) Work?

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26.01.2021
How does ICO (Initial Coin Offering) Work?

How does ICO work?

In this article, we want to know how initial coin offerings work. ICO, short for initial coin offering, is a new way to introduce and sell new cryptocurrencies.

Cryptocurrencies are gaining more attention worldwide. As people welcomed the existing cryptos, more and more new ones are entering the market these days.

This resulted in popping up numerous initial coin offerings (ICOs) lately. Since banks have rigorous processes for giving capital to startups, using this method, they can raise funds for their new cryptocurrency venture without those troubles.

In the past few years, many startup companies used initial coin offerings and raised a huge amount of money out of them.

Now, to get to know this new phenomenon in the world of technology, keep up reading this article.

Here we explain how initial coin offering works and everything you need to know about it. 

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ICO

ICO was first started in 2013 by Mastercoin that raised approximately $600,000. It was for creating a Bitcoin exchange and transaction platform.

Mastercoin is a digital currency and communications protocol layer.

After the successful capital raising of Mastercoin in 2013, numerous companies welcomed the idea and started their own ICOs. 

An initial coin offering is a technique that startups and Blockchain projects use to raise capital and sell their cryptocurrencies.

It is similar to an initial public offering (IPO). In fact, it is the cryptocurrency version of the IPO. So before defining ICO, let us explain a bit about IPO.

An IPO is when a company releases its stock on the stock exchange, and interested people can buy shares in the company for a specific price.

In this way, they will be a partial owner of the company, and in case the company does well, the value of their shares increases, and they can yield a profit over it. 

Now, how are these two concepts different?

The difference is that ICO uses cryptocurrencies, and it is not as regulated as IPOs. Also, unlike IPOs, it does not provide investors with shares of the business. Instead, it offers cryptocurrencies to investors.

Startup companies use it and give the investors cryptocurrencies, or as they call them, crypto tokens in exchange for their investments, to raise capital for their Blockchain-related projects.

ICO makes the company and investors connected directly without any intermediaries in the capital-raising process. 

This fundraising method allows anyone, from anywhere in the world, to develop a project or company.

Basic Concepts

Before going any further, it is better to know some basic concepts related to ICO. 

Token

The crypto coins that are offered in an ICO project are called tokens. These tokens are like the purchased shares in an IPO. 

Blockchain

Blockchain is a type of database, an information recording system, that stores information in blocks chained together.

It is a digital transaction ledger that is public to the entire network of computer systems. This network is a peer-to-peer network.

Each of the blocks in the chain holds several transactions along with their corresponding information.

Blockchain makes faking or alteration almost impossible because it can be updated only if the network participants verify that, so there is no way to change it after it is updated and new data is entered. 

In other words, Blockchain is a type of Distributed Ledger Technology (DLT). DLT means a decentralized database that is controlled by many participants.

Every transaction in Blockchain has an immutable cryptographic signature. This signature is called a hash. 

Cryptocurrency

A cryptocurrency is a secure form of digital or virtual money that uses cryptography for security. It does not exist in a physical form like a coin or paper money.

Although we can transfer or make payments digitally with traditional currency today, cryptocurrency works a bit differently.

Cryptocurrency uses Blockchain technology to eliminate the chance of faking or double-spending. By using Blockchain, decentralization and immutability are conceivable. 

So how is this cryptocurrency different from the traditional currency or Fiat money?

The main difference is decentralization. It means that no single authority, such as a central bank, can interfere or manipulate the balances.

Instead of central banks or other regulatory authorities, the funds are completely under the control of users. In this way, there is no chance of freezing the account or refusing access to it. 

Is it open for everyone to launch an ICO?

The answer is YES. Since there is no strict regulation on ICOs, anyone can try and get their own currency funded. But when we say anyone is allowed to do this, it does not mean that it is easy and guaranteed that you will be successful.

You have to consider all the things that may get you in trouble while doing that. Launching a project requires understanding Blockchain and cryptocurrency well.

Therefore, it is better to work with people who have related experience and can help you with it, someone who can tell if it is a good idea for you or not.

You or other people who are about to work with each other have to research and get information about this business before taking any actions.

If you considered all the aspects and came to the conclusion that you are able to do that, you can go on and create a whitepaper for your ICO project.

 Do not forget that this part is so crucial. Every detail about your currency and your innovative idea has to be mentioned in it. 

How does ICO work?

The first step is to release a whitepaper. When a company or a startup plans to hold an ICO to raise capital, it publishes a whitepaper.

This whitepaper is a document that describes some details and information about the project. The data outlined in the whitepaper can vary from company to company. But it may include the followings: 

The project main concept and goals, the amount of money that is needed for this project, what types of currencies are acceptable, how long the ICO project will run, what happens after the project completion, and some other useful information that can help the investors to decide whether they want to invest in the project or not. 

After that, the ones who want to be part of the project can buy some of the company's cryptos with fiat money like US dollars, euros, or a different digital currency. These cryptos are referred to as tokens.

If the company raises enough money to pursue the project goals, the ICO project will be considered successful.

In this case, the value of the investors' shares will increase, and they will benefit from this investment. Contrarily, if the company does not do well, they have to pay the funds back.

So, now that you know how initial coin offering works, let us find out more about it.

Types of ICOs

There are two types of initial coin offerings. Here we explain each of them. 

Public ICOs

There is a public initial coin offering that anyone can participate in it. Almost anyone can join in this type and invest in it. It is actually a form of crowdfunding. 

Private ICOs

As the name indicates, this kind of initial coin offering is only for specific participants, not the general public.

In private initial coin offerings, a limited number of investors are able to join in the project and buy tokens. The company will specify those who are qualified for the project.

As the initial coin offering is not as highly regulated as IPOs, this type of ICO is becoming more popular because it can be more secure and safe. 

What to consider while investing in ICOs?

In order to find out which ICO projects you can participate in, the tips below may help you. Hence, before deciding to invest in any project, it is better to consider the following tips:

  • Not providing a roadmap

A legit startup or company always makes plans for its future. So there should be detailed information about their roadmap.

If they are not sharing any details about their roadmap, they may not have a plan at all. Always make sure to read their whitepaper carefully.

  • Code

Check out to see if they share their code with the public. Reviewing a project's code is a proper way to make sure it is legit.

Valid projects will share their code on Github so that everyone be able to review the code. So if there is no code, then there is no project. 

  • Using money

You are investing your money in the project, so of course, you have the right to know how they are using the money raised from their ICO.

If the project is not sharing any details about how they are going to use the money, they may not be reliable. They may share this information in their whitepaper. 

  • Not publicizing their team

Not knowing who is working on the project or whether they have a relevant background or not is something that needs to pay attention to, because scams do this to make it difficult for you to verify related people to the project.

  • Too good to be true

As you may know, when something is too good, there may be something fishy about it.

If they offer you a project with insanely high profits or impossible products, you better think twice about that project because there is a chance that it is a scam. 

  • PR

Media activity can help you authenticate the project. Projects usually create an active community, and they do so by hiring professional marketing experts.

You can also check quality publications for mentions since positive mentions mean that the project is more valid.

  • Competitors

In any business, there are always competitors. So, find out if there are any competitors and how different or better they are doing compared to their competitors. 

 

ICO benefits

Initial coin offerings have extensive benefits for founders as well as investors. Here we can find out some of its advantages.

1. More liquidity

Lack of liquidity is the biggest problem in investments. ICOs enable higher liquidity and more fluidity of funds than company shares by using tokens.

These tokens have value even at the moment they are purchased. In this way, investors have the opportunity to make considerable gains quickly.

2. Anyone can join

Anyone can buy the tokens and even sell them to anyone internationally and take advantage. Participating in ICO projects is not limited to just some accredited investors.

Besides, you can invest any time you want. You can be one of the early contributors by being watchful enough to purchase tokens as soon as the launch.

3. No geographical barriers

Since ICOs use cryptocurrencies, they are available for anyone everywhere in the world. It is all about global accessibility.

Startups can raise funds from wherever they are and from whoever they want. There are no geographic boundaries. 

4. Low competition

Initial coin offering is a new concept in the business and technology world, so many people are not familiar with this method yet. They still use traditional fundraising methods for their projects. This means there is still no high competition in this area. 

5. No middleman

As you purchase cryptos in ICOs, there are no intermediaries between you and the person you want to sell the tokens to.

You can buy the cryptos you purchased as soon as they are created and sell them immediately. The price of tokens can vary; this means there is a great chance of making a considerable profit.  

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Safe or not?

As we mentioned before, ICOs carries a lack of regulations. This must be its biggest downside.

Maybe it seems an incredible opportunity, but there are significant risks involved that you have to be careful about, and also, it is not easy to identify scams.

Hence, investing in ICOs must be done thoughtfully. In this way, you won't end up losing all your money.

So what are these risks we are talking about? 

The project progress is not fully transparent, and you do not know how exactly it is going. You have to make sure that the company and its team are experienced enough to fulfill their promises because there is no guarantee to return your funds if it does not go as expected.

As you know, ICO projects are all about cryptocurrencies. Due to the price volatility of cryptocurrencies, the investment in them is also unstable.

The most important thing is that there is always a potential risk that the project being a total scam. Therefore, before any investment, it is necessary to research the startup company you are about to deal with and find out if it a legitimate one or not.

But the question is how to do the research? 

You can ask the people you find reliable or contact the company itself. It is better not to trust the company chatrooms or forums because they can pay people to write positive reviews. Also, do not trust the company's ads.

As mentioned above, there are no proper regulations in ICO projects, so anyone who intends to invest in it should be very cautious to make the right choice.

However, this absence of regulation may not be permanent. Since cryptocurrency is getting more attention day after day, the ICOs, as well, will be an essential way of fundraising. In this way, governments will attempt to implement some legal arrangements to make initial coin offerings as reliable and transparent as possible.  

Final words

Now that you know everything about ICO and how ICO works, you can better decide whether you want to give it a try or not. Although there have been some successful ICOs, they still do not have reliable regulatory approval. Therefore, before taking any actions, be careful, and make sure to do enough research. 

 

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