Unveiling Initial Coin Offerings: A New Era of Fundraising in the Crypto World
The cryptocurrency realm has its own method of raising capital known as an initial coin offering (ICO), akin to the traditional IPOs in the corporate sector. When a firm plans to generate funds for a novel blockchain application or service, launching an ICO serves as an effective strategy for fundraising.
To gain new cryptocurrency tokens introduced by the company, investors can participate in an ICO. These tokens may symbolize a part of the organization or project, or offer some utility concerning the service or product provided.
Key Insights
Products and services leaning towards cryptocurrency often utilize ICOs as a widespread method for gathering capital.
While similar to IPOs, ICO-issued coins may possess additional functionality within a software product or service.
Although a handful of ICOs have proven fruitful for backers, many ventures either underperform or are fraudulent.
Generally, ICOs fall under security offerings and require proper registration.
The foremost task for a cryptocurrency initiative seeking capital through an ICO is to decide on its coin’s framework. Multiple configurations are possible, such as:
Fixed token supply and price: With a predetermined funding objective or cap, each token’s price is pre-established, and their total supply remains constant. Fixed supply, adjustable pricing: Tokens have a fixed supply, while a dynamic funding target governs the token price based on received funds. Adjustable supply, fixed price: Here, the funding amount determines the token supply, which remains uncapped while the price stays constant.
Below are examples illustrating the aforementioned ICO types:
Unveiling the White Paper
In parallel with framing the ICO, a crypto venture typically prepares a pitchbook—in cryptocurrency terms, a white paper—made accessible to prospective investors through a dedicated website. This document clarifies critical aspects related to the ICO, such as:
- The project’s essence
- The necessity it aims to satisfy upon conclusion
- The capital required for the endeavor
- The proportion of tokens retained by founders
- The accepted payment (currencies)
- The ICO campaign’s time span
Coins comparable to shares sold during IPOs are presented to supporters and enthusiasts to purchase through the ICO’s campaign, propelled by the project’s white paper. Payment methods range from digital currency to other crypto options like Bitcoin or Ethereum.
Tracking the Money Flow
Should fundraising satisfy the stipulated criteria within the designated timeline, the collected capital is allocated towards realizing the project’s objectives. Conversely, if the raised sum falls short of the minimum threshold, it may be refunded to investors, rendering the ICO a failure.
Eligibility for Initiating an ICO
Although anyone can commence an ICO, regulatory bodies in developed nations like the U.S. tighten oversight over ICOs, ensuring they undergo registration if applicable.
Yet, the ease of establishing an ICO can lead to deceitful tactics, including counterfeit registrations, approval documents, or misleading communications. As a potential funding route, ICOs are often manipulated as fraudulent ventures.
While technically feasible for anyone to create and launch an ICO, not everyone should pursue it. Reflect on whether your enterprise would gain substantial benefits from such an endeavor, and remember the likely need for registering a security with the SEC.
Participating in an ICO
Conduct thorough research before investing in a new ICO. If team members exhibit unverified or irrelevant expertise, be wary. Comprehensive scrutiny of the project’s team, their public presence, and their history is imperative.
Examine registered crypto exchanges for newly listed coins, as they often exclude unvetted entries. This step can enhance safety while exploring potential investments.
Cryptocurrency aggregators serve as information hubs, offering insights into new coins and associated risks or opportunities without vetting visibility. They guide users to the project’s GitHub, websites, and social media for a deeper understanding.
Bypass projects if nonsensical phrases and vague information dominate their descriptions, as these are red flags for scams.
The U.S. can step in during ICOs when needed. A notable case occurred in 2018-2019 when the Telegram team raised $1.7 billion. The SEC intervened, leading to a U.S. District Court directive for Telegram to return $1.2 billion to investors and settle an $18.5 million civil penalty by March 2020.
While there’s no foolproof way to avoid scams when investing in ICOs, several precautions can minimize risks:
- Developers must clearly articulate their goals.
- Utilize a secured wallet. Such wallets require multiple access keys, offering improved scam protection.
Certain ICOs may necessitate other cryptocurrencies for investment, prompting the purchase of alternative coins to engage in the project.
The Buzz Around ICOs
ICOs can generate remarkable excitement, with numerous online platforms hosting investor discussions on the latest opportunities. Celebrities like Steven Seagal have promoted hot ICOs, yet the SEC warns that such endorsements without disclosed compensation are unlawful.
Similarly, boxing legend Floyd Mayweather Jr. and music icon DJ Khaled once endorsed Centra Tech’s ICO, amassing $30 million by late 2017. Ultimately, the court deemed Centra Tech a scam, resulting in settlements with regulators and guilty pleas from its founders for ICO fraud.
Thorough comprehension of cryptocurrency and the intricacies of an ICO is essential before engaging. Since fraudulent ICOs are caught rather than forestalled, potential investors must exercise utmost caution.
Unlike ICOs, IPOs adhere to a well-defined process involving marketing campaigns, roadshows, brochures, and company capital input, all to inform and entice investors to purchase shares post-listing on public exchanges.
While cryptocurrency creation is largely legal, if it aligns with the criteria for securities in a given jurisdiction, it becomes subject to ICO regulations. The U.S. utilizes the Howey Test to dictate whether a coin must be treated as an unregistered security sale.
Guidance
The Howey Test isn’t exclusive to the SEC. Assess ICOs independently—if investing in a common enterprise with profit expectations from others’ efforts is present, it constitutes an investment contract, irrespective of its label. If managers don’t recognize it as such, it’s likely unworthy of your funds. While some projects may not be outright scams, exercise discretion before diving into speculative investments unless you can afford potential losses.
2014 marked Ethereum’s ICO, a landmark in initial coin offerings, securing $18 million over 42 days.
Dragon Coin exemplifies a March 2018 ICO, amassing $320 million in a month. In 2018, the EOS platform surpassed this, accruing $4 billion over a year-long ICO.
The SEC’s first major ICO intervention occurred on Dec. 11, 2017, halting Munchee’s ICO, a California-based firm with a food review app, as their project intended to create app-integrated cryptocurrency. The SEC classified the ICO as an unregistered security offering, issuing a cease-and-desist letter.
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