A beginner’s guide to ‘ICO’ crowdsales
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Both the popularity and the success of ‘Initial Coin Offerings’, more commonly known by the abbreviation ‘ICO’ seem to be going from strength to strength in 2017.
The number and variety of projects seeking to raise funds through an ICO bas exploded over the last couple of years and this growth shows no sign of slowing down. At the same time, the amount raised by successful sales is also growing, an example of which being Aragon which raised a record $25 million this week – and had to close down the sale early as they had already raised their pre-defined maximum funding cap. What’s more, the price growth of ICO tokens post-sale has seen investors pocket some astronomical profits recently.
Of course past success is no guarantee of future returns, and one must be very careful about risking significant sums of money on the assumption that these trends will continue. But nevertheless, these successes have generated a lot of interest, including from investors outside the usual cohort of cryptocurrency enthusiasts.
So if you are one of those people who have heard about this ‘ICO’ thing but don’t really have a clue what its all about, then this article is for you. I will guide you through the basics of what an ICO is, what to look out for and how to evaluate them, and where to go to get the best information, news and analysis.
What is an ICO?
As stated in the intro, the term ‘ICO’ stands for ‘Initial Coin Offering’. This is modeled after the familiar stock market term ‘IPO’, which stands for ‘Initial Public Offering’ and is used to denote the launch of a company’s shares on the stock market when they first become available to the public.
The use of the word ‘coin’ can be traced back to the origin of this practice as a method of distribution for alternative digital currencies. Today, however, most ICOs are not selling a coin designed to be used as a general purpose currency, but rather a token associated with a specific app, project or business. As a result, you may also come across the alternative (and in my opinion more accurate) term ‘Initial Token Offering’ or ‘ITO’.
Are ICOs Legal?
Perhaps the best answer I can give to this question is to say that a properly formatted ICO is not illegal.
As long as the company behind the ICO does not misrepresent their coin or token as a financial security, and as long as investors follow any and all local laws of their own country regarding reporting of income, it is perfectly legal for everyone involved.
But because this is currently very much an unregulated, or lightly regulated market, there are few legal requirements for the company and few legal protections for the buyer. This can have advantages in cost and complexity of fundraising for the company, and can open up the possibility for ordinary retail investors to back early stag start-up companies which would otherwise have only been able to accept investments from private individual and funds like VCs and angel investors
In many cases these legal guarantees, for example the legal ownership of a certain percentage of a company attributed to people who own its shares, are replaced by cryptographic guarantees, for example smart contracts which automatically distribute a certain revenue share to token holders whenever a payment is made and before the money even gets into the hands of the company themselves. But at the same time, it is important not to be blind to the fact that this also means that legal recourse may not be available when things go wrong in the same way that it would for an investor in the regulated stock markets.
Understanding What You Are Buying in an ICO
There is a great deal of variety in the different types of coins and tokens sold in ICO crowdsales. Exactly what they represent, what rights or benefits accrue to them, and the economic principles which determine their value can be very different from one token to the next.
This is very different from a traditional stock market IPO, in which investors are always buying basically the same thing: a share in the ownership of a company. It is therefore crucially important to understand exactly what you are buying before you take part in an ICO.
To help you out, I have created a list below with a few examples of different economic models used by tokens that have previously been sold in initial coin offerings. This is not meant to be a comprehensive list, as this is an ever-changing market with novel approaches created on a regular basis, and some projects may span multiple categories, but hopefully it will give you some idea what to look for and how to approach valuing a token.
As the name suggests, an app token is designed to be used within a specific app, on a specific website, or in a specific game.
Generally speaking, some kind of mechanism should be put in place to ensure that the value of the token is tied to the value of the app. There are, however, different ways to do this and the model chosen will influence the value of the token.
There are two common methods.
The first is to require payment for services within the app (anything from advertising fees to premium services and in-app purchases) to be made with the app token. Demand for services therefore increases demand for the token, which should theoretically increase their value. For example, KoCurrency is a cryptocurrency price prediction platform where users are required to pledge intelligence on intelligence contracts using the platform’s internal tokens. By doing this they add value by making the platform’s predictions algorithm smarter. Therefore, new users who want access to theoretically more accurate predictions data, will need to pay more for the tokens if the value of the data continues to go up.
In some other cases a percentage of tokens used to pay for products or services are ‘burned’, thereby decreasing the supply and again increasing the value of remaining tokens. In some other cases a percentage of tokens used to pay for products or services are ‘burned’, thereby decreasing the supply and again increasing the value of remaining tokens.
The second method is to distribute a percentage of either revenue or profits to people who own the token, proportionally to how many they own. Some decentralized apps built using blockchain technology may use smart contracts to distribute revenue; it is possible for this to be done in a way that makes it impossible for the company behind the app to withhold payment, as these ‘dividends’ can be sent prior to the company themselves receiving funds.
Pseudo-Shares and DAO tokens
A token may also represent a share in the success of a broader project, business or fund with multiple products, services or interests not tied to a specific app.
This usually involves the company or other organization committing to share a certain percentage of revenue or profit to token holders.
In this way, the token may represent a kind of pseudo-share in the organization, but without the legal ownership which goes with a real company stock.
Some organizations may once again use smart contracts to automatically manage finances, and this may provide security for token owners by automatically distributing funds according to pre-defined rules enforced by the blockchain. These smart contracts may also confer additional rights on token holders, such as the ability to vote on the future of the organisation and changes to the smart contracts which control it. By doing this, the organization is transitioning from a conventional business to a ‘decentralized autonomous organization’ controlled by its token holders. This is sort of similar to the way a company’s shareholders technically own and control a company, but may incorporate more direct and more comprehensive participation from token holders. Once again, these rights are enforced by cryptography and the blockchain network, rather than laws and courts, which has many advantages but also some disadvantages.
Coins and platform tokens
Most of the app tokens, DAOs and revenue share tokens as described above do not need their own blockchain network. But sometimes new blockchains are launched with different features which also need their own coins.
These coins derive their value in the same way as something like Bitcoin: they have a limited or fixed growth supply, and the more people need to own some for using that network the more value they gain.
In valuing these coins one must pay close attention to the inflation / deflation dynamics. Often coins will require inflation, at least to begin with, to pay the miners or minters who secure the network (something which token holders may well be able to participate in to earn rewards, by the way). But they may also destroy tokens taken as fees or lock up tokens for specific use-cases. The pattern through which coins enter and exit the available supply has a big impact on the value of each individual token.
Asset backed tokens
Some tokens are designed to represent the value of an underlying asset. Because of the difficulty in creating a hard connection between a physical and a digital asset, you will generally need to either trust the company behind this a great deal and / or ensure proper traditional legal regulation and protection is in place to ensure that the token really is backed by the full value it claims to be backed by.
Where do you store ICO tokens?
You will store your tokens in a digital wallet just the same as you would store a cryptocurrency like Bitcoin.
Which wallets you can use is dependent on which blockchain the tokens are issued on. Most commonly tokens launch on Ethereum, meaning that you can use any Ethereum wallet, or using protocols which piggy-back on the Bitcoin network like Omni or Counterparty which each have their own easy to use web wallet as well as more comprehensive ‘node’ software.
If you are concerned about hacking, it is often possible to store tokens offline in ‘paper wallets’. It is best to follow instructions provided by the ICO organizer and ask them questions via social media to find the best wallet to use for buying and storing tokens.
Where to learn about the latest ICOs
In recent months the explosion of interest in these token sales has led to a simultaneous explosion in the number of services providing information and analysis about them to prospective investors. This means that there is now a wealth of good quality information that is readily available to anybody who is interested. Here is a list of some of my favourite sources to get the low down on upcoming sales as well as informed analysis about their potential:
Token Market: This is quite a new service, but has very rapidly carved out a name for itself as the most comprehensive and reliable source of information about upcoming, ongoing and completed sales.
For each token they create a summary page with a description of the project and a n outline of all the key facts and specs, as well as links to more detailed information, They also include feeds of the latest news and social media posts, and allow you to follow projects that interest you or sign up for alerts.
One of the things I’ve personally found most useful about this site is the ‘ICO calender’ which lists the starting and end dates of all the main crowdsales in an easy to read calender format. For anybody who participates in these things regularly, this makes planning and allocating funds much easier.
Smith + Crown publishes research and analysis of blockchain investments. They also maintain a list of upcoming and ongoing crowdsales with summaries and links. Although I’ve found this list less comprehensive than the calender created by Token Market, Smith + Crown’s expert analysis and independent research are great quality and well worth taking a look through.
ICO Alert is another company offering independent research reports, which you can purchase using Ether. They also offer alerts notifying you when a new sale is going to start. I’ve never purchased one of their reports myself, but the free sample report they have made available on their site was accurate and informative.
ICO Countdown: This was one of, if not the first ICO information site and has been around for a while. They have a simple one page list of crowdsales with relevant dates, but don’t include in-depth analysis. It is entirely free to use their site, and they excel at screening projects to exclude anything they deem high risk for investors. When they do exclude a project, they generally publish a blog posts detailing the reasons behind it.
Bitcointalk: You either love it or hate it, but the altcoin boards of this popular Bitcoin forum are an invaluable source of information. Actually, most people seem to hate it but still just can’t seem to get away from it because you will find all sorts of insight and information posted here that you just won’t find anywhere else. Unfortunately you will also get endless amounts of unfounded hype and FUD from people with a vested interest in convincing you of a particular viewpoint, and you will have to wade through page after page of posts from other newbies who don’t have a clue, many of whom still seem to think they are world class experts. If you can read between the lines and critically analyze what you are reading, and if you have plenty of time to spare doing it, this is a great resource. But don’t believe everything you read.