What is an ICO—and can you profit from it?

By issuing their own tokens and exchanging them for popular cryptocurrencies (for example, bitcoin or Ethereum) or for fiat currencies (dollars or euros), a project raises the financing needed for launch or growth. As a rule, ICOs are held at an early stage, before a full infrastructure exists. Funds are directed to the final development phase, marketing, or placed in special development funds to support the project over the long term.

At present an ICO cannot be called either a legal or an illegal way to raise investment. Its legal status, the procedure for conducting one and the requirements for companies planning to raise funds this way have not yet been defined in any country. It is also difficult to determine the legal nature of the relationships that arise during an ICO, since they are hard to classify as traditional financial relations. What can be said with confidence is that the process rests on the reputation of the people behind a crypto startup and on users’ (potential investors’) trust.

When a company wants to offer its shares to the public, it conducts an IPO (Initial Public Offering). An ICO can work on a similar principle: investors contribute funds and receive a “stake” in the company in the form of cryptographic tokens. ICOs also share traits with crowdfunding: money is typically raised to realise a particular idea, at a stage when there is no finished product.

By contrast, IPOs are regulated by national law. In the United States, for example, a company must be incorporated as a corporation and registered with the SEC (the Securities and Exchange Commission) to go public. This makes it harder to raise money at an early stage, but it offers investors certain guarantees.

With an ICO the fundraising process is much easier, but users are not protected.

By buying tokens offered in an ICO, investors primarily hope to:

• Profit by selling them later at a higher price (a classic example is Ethereum, whose tokens during its ICO in the summer of 2014 cost less than one cent, and today their price has risen to almost $400);
• Use the tokens as intended, obtaining the stated services at a lower price.

The biggest risk is simple fraud, when a project’s creators have only one goal: to collect users’ money. In addition, since there are currently no laws regulating cryptocurrency crowdsales, from an investor’s perspective the deal is always built on trust. One cannot rule out that a project may never reach the product stage or may disappoint in execution.

Moreover, in their current form ICOs are usually conducted in a single round, and the chances of obtaining additional financing are small. That, too, can be seen as a potential risk to a project’s long-term viability.

The profusion of ICOs can unsettle inexperienced investors. First, study the Token Sale Agreement carefully. Reading this document may bring to light curious details that the organisers may not have stated publicly. There are also informal indicators of a project’s bona fide intentions:

• The presence of all necessary agreements and rules, published on the website as a public offer.
• A functioning prototype.
• A well-argued white paper and other documentation.
• The use of escrow (a special conditional account on which assets, documents or funds are held until certain circumstances occur or specified obligations are fulfilled).
• Incorporation (registration) of the company.
• An unblemished reputation of the people behind the project.

You can read more about the legal aspects of ICOs here.

The “success” of an ICO is a relative notion. The commonly accepted yardstick is the amount raised. On that score, the leader at the moment (speaking in dry statistical terms and setting aside other, perhaps contentious, aspects of the campaigns) is Bancor, which in June 2017 collected 396,720 ETH in less than three hours. Another rapid crowdsale was the campaign by the Brave browser: in roughly 30 seconds the project hit its goal and raised $35m.

In May 2017 the list of successful cryptocurrency crowdsales was joined by Storj ($30m in less than a week) and Aragon—just 15 minutes after the start of its ICO the project raised the planned 275,000 ETH (about $25m).

One can also recall mobileGo ($53m), Gnosis ($12.5m in ten minutes), Blockchain Capital ($10m in two hours), Aeternity (23.4 CHF) and, finally, Status (about $100m), which caused a disruption in the Ethereum network.

Nor should one forget The DAO, a project whose collapse in the summer of 2016 led to Ethereum Classic.