How Does an ICO Work? | Initial Coin Offering Explained
2017 was a year of ICOs, but in the end, at least 56% of all ICOs fail within four months.
How does an ICO work and how can you avoid failure if you’re planning an ICO? The answer to both questions is to arm yourself with some knowledge of the landscape.
There are great benefits to Initial Coin Offerings, not the least of which is an opportunity to make money and be part of something big. We’re going to explain what that means now.
Keep reading to find out!
ICO: A Tale of Two Tokens
ICOs, or an initial coin offering, is similar to both crowdfunding and buying stock or investing in a company. You buy into a new token, which on the Ethereum network is usually an ERC-20 token, with a respected existing token or fiat currency.
In return, you own a certain number or share of new coins that get sent to the wallet address you’ve specified at a certain rate agreed upon in the ICO.
Before going further, we need to make a distinction between the two types of tokens offered in ICOs and how they can affect your success.
Utility Token to Sell Goods or Services
A utility token is a token that receives value from the service or product it renders. They have an inherent value the way a hammer or a car has inherent value. Some people do trade items as antiques in auctions or due to a personal interest, but the purpose of the item is to render a service of some kind.
These tend to be the most successful ICOs over time. One example of a successful utility token ICO is that of Ethereum. Ethereum is decentralized blockchain technology developed to offer applications through smart contracts.
The first token sale was in July 2013 by Mastercoin. Now Omni has helped launch other successes such as Tether. They held the ICO after stakers sent Bitcoin to an “exodus address” and received a hundred times the value of the Bitcoin in Mastercoin tokens.
Ethereum followed not long after, raising 3,700 BTC to about $2.3 million in 2014 pricing.
Both are protocols and networks that offer a service, and they’re still running strong. Ethereum is long past working in millions of dollars with more than $55 billion exchanged daily across the network. Ethereum’s market cap now exceeds $120 billion.
Security Token to Sell Investment Contracts
A security token always functions as an investment contract. They make up about 30% of all tokens (excluding fake currencies and scams). According to the SEC, the “Howey Test“ is used to determine if a token falls under security regulations. A security token is much more regulated than a utility token.
- Did you invest money?
- Do you expect a profit?
- Did you invest in a common enterprise?
- Are profits dependant on the effort of a third party?
This does not constitute ownership rights to what you invest in. They’re a guarantee of profits generated. More specifically, it’s a security, digital mutual fund, a non-equity investment against capital, or a digital ETF.
An AML and KYC must be taken to comply with regulations, making them less liquid than utility tokens which daily trade anonymously across the network. This is what has also sometimes been called a “profit right” coin.
Equity tokens are also sometimes called “governance tokens” and make up the other roughly 50% of security tokens. Equity tokens, as in IPOs, function much like stocks, futures, options contracts, tokenized ventures, and tokenized real estate.
In 2017 and into 2018 the SEC has gone after many of these tokenized securities.
ICO Concerns and Responsible Development
There is a recipe for success in most things and ICOs are no different. What are the ingredients?
- Twitter account
- Telegram chat group
- Whitepaper made available
- Open-source code
- Hardcap on token offering
- Whitelists for participants
- A clear understanding of regulatory obligations
The discovery that having a Twitter account gives four times the chance of success as having a whitepaper does is a bit unsettling. It means that catering to people’s greed and their desire for an economic opportunity can short-circuit their need for evidence-based decision-making.
The foundations the coin is built on is important. ICOs perform better when they have something to offer, such as utility on service and when the source code is made available before the launch of the ICO.
What Can I Do to Be Compliant and Successful?
If you’re planning on hosting an ICO, make sure you file with the SEC if necessary. Make sure what the requirements are and follow them in advance of the ICO. KYC and AML requirements are a big deal in these situations.
There are many projects out there such as the ERC-1400 and ERC-1404 standards on Ethereum.
Regulation from crypto-friendly nations is still unclear, while some nations outright ban it altogether. Make sure to know the laws of the country your project is based in and do what you can to follow any regulations involved.
Before the ICO: Things to Make Sure Of
Transparency of project goals and strategy, trying your best to follow regulatory guidance, security controls for invested funds, such as escrow wallets, are the best ways for an ICO to move forward.
These are also the things an investor should look for in an ICO before investing.
Some projects allow fiat currencies, others look for investment through crowdfunding platforms like CoinList, and some collect exclusively through existing cryptocurrencies. Find out what works best for you or your project.
For many retail investors and the public, they’re also at the end of the investment round offering. Before that time, there are pre-seeds, private seeds, and more which offer much higher returns at steep discounts.
It’s important to determine where in the spectrum you are to determine what kind of reward you will get. Rewards from exchanges and public ICO rounds historically net the least profitability.
Being able to tell if an ICO is a scam might just be the most important part of all. 78% of ICOs ended up being identified as a scam, with 7% failing or dying out, and only 15% successfully getting listed and traded. Of those, half meet with success, while the remaining 7% dwindles or has trouble getting off the ground.
How Does an ICO Work? With Difficulty
So, how does an ICO work? Simply follow these steps:
- Come up with a great and unique idea that is crypto-related (written down on a white paper)
- Research your competition and make sure you’re solving a real problem
- Contact a reputable lawyer to check the legal side in your country
- Create your ICO token and make it public
- Issue your white paper
- Launch a website and convince your audience that their investment is profitable, safe, and protected
- Show a clear roadmap of your project and keep your audience updated
- Launch your advertisement campaign (huge PR and marketing efforts might be needed to reach investors)
- Launch your ICO and keep it live for 40 to 50 days
- Launch your token on major exchanges, such as Binance, Bitfinex, Bittrex, or Kraken
- Keep communicating as your investors are more likely happy if your token has enough market capitalization
Depending on your outlook, they either have a one-in-three chance of success if you take out the scams or less than a one-in-fifteen chance if you include them.
iMi Blockchain is here to help you level the playing field. If you want to be trusted, trained, or prepared for the latest industrial revolution, catalyzed by blockchain, check us out!
We offer ICO consulting also for start-ups where we guide you through the whole process. Furthermore, we offer ICO training and release your token through our DLT coding services to companies and the public. Knowledge is power, so let us empower you!
Originally published at https://imiblockchain.com on February 10, 2021.
