The cryptocurrency sector remains mostly unregulated to date. It has both advantages and drawbacks. While lack of regulation ensures user privacy and lack of intermediary charges, there exist certain loopholes and uncertainties too. The crypto coin makers face funding woes as well. A lot of crypto projects managed to become functional owing to ICOs.
The basics of Initial Coin Offering (ICO)
An initial coin offering is used for raising capital for executing a cryptocurrency project, powered by Blockchain technology. It is much like an initial public offering. ICOs remove intermediaries involved in the capital-raising process. So, there is a direct link between the investors and the company. Notably, both parties’ interests are aligned.
There are 2 kinds of Initial Coin Offerings- Private and Public.
- In a private ICO, a few investors can participate. Only the accredited investors such as high net-worth individuals and financial institutions can participate in such ICOs.
- Public initial coin offerings can be compared to crowdfunding for the crypto sector. Almost every person can become an investor in a public ICO.
The rise of Blockchain technology and cryptocurrencies has made ICOs quite popular in recent years. An ICO utilizes Blockchain technology and its decentralized systems for capital-raising activities.
The steps involved in an ICO
- Identification of investment targets is the first step. It also involves creation of the project whitepaper.
- Token creation- the token may be linked to assets. However, these are not cryptocurrencies but altered form of existing cryptocurrencies.
- Promotion campaign- These campaigns are run mostly online to attract potential investors.
- Initial offering- Post token creation, these are given to the investors. Typically, the companies may use the proceeds for launching a new product.
There are 2 types of tokens used in ICOs. These are Equity and Utility tokens.
Equity tokens are there for offering investors a share in the project. They are somewhat like stocks. However, their legality is still dubious. Utility tokens offer you access to the service/ product of the entity running the ICO. Most ICOs come with utility tokens. The supply is usually fixed.
The legal stance on ICOs
As a matter of fact, the cryptocurrency sector remains outside the periphery of the govt backed financial institutions in most countries. Only a handful of nations have accepted cryptocurrencies officially so far. So, when the concept of ICO was created, it took the govt in many countries by surprise. Depending on where you live, taking part in an ICO may be illegal. In South Korea and China, for example, it remains illegal. Even in many Western countries, the governments are now preparing new regulations to categorize and legalize ICOs. Some countries like Hong Kong, the UAE, and New Zealand are ahead of others and they have already come up with guidelines for ICO.
In the USA, the SEC has the power to intervene if it deems activities pertaining to ICO creation to be bordering on the illegal side. One noteworthy instance is the Telegram ICO that took place in 2018 and 2019. It led to the SEC filing an emergency action lawsuit.
Things to keep in mind when you deal with ICOs
To take part in an ICO, you should have a good knowledge of cryptocurrency and exchanges. It is not only about the legality of an ICO. You have to possess some cryptocurrencies as the tokens can only be purchased using pre-existing cryptocurrencies. So, you have to be a crypto wallet user. To learn about an upcoming ICO, you should check out the online crypto forums and groups on social media platforms.
How an ICO is different from an IPO?
An ICO may look like an IPO but there are some key differences. The IPOs deal with investors but in the case of an ICO, the supporters of a cause or concept may also be involved with a project. Unlike the IPOs, ICOs are unregulated in nature. Owing to the decentralization, ICOs are typically freer structurally than IPOs. While in an IPO, the investor gets a stock share in the company in lieu of investment. In an ICO, there is no stock but investors get a share of a cryptocurrency token.
How to ensure an ICO you are considering is genuine and worth the investment?
While making investments in an unregulated sector is always risky, you can reduce your risk level by checking a few things carefully before investing in any ICO. These are:
- First of all, you must check the project whitepaper and find relevant information on core team members. Successful ICOs have clear, concise goals.
- You should look for the applicable legal terms and conditions.
- You should pick an ICO where funds are stored in a secured escrow wallet.
- The whereabouts of the token have to be analysed prior to picking an ICO. The investors must know about things like its intrinsic benefit, distribution method used, and any associated equity.
- You have to analyze the timeline mentioned in the project whitepaper to figure out feasibility of the concept. Look for the deadlines and schedules.
- You should check the language used in the project whitepaper. It should be clear and precise, and not replete with gimmicky terms targeted at amateur people. The USP of the concept or products must be clearly defined.
The pros and Cons of ICOs
- Since it is unregulated, starting an ICO takes less time and steps.
- It has potential for lofty returns.
- As there is almost no limitation on picking ICO investors, investors from anywhere can put their money in an ICO.
- There are prospects of gain through a rise in token value in the future.
- Owing to lack of regulation, risks of scam and frauds are higher in the sector.
- As there is no governing authority, funds lost in frauds are gone for good.
- Popular web-based platforms and services like Twitter, and Google have stopped showing ICO advertisements.
- Sometimes, ICOs are launched before the actual product is ready. So, you may be investing funds in a concept.