Cryptocurrency

Initial Coin Offering (ICO): How Do They Work?

By Fotis Dixon

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Reviewed by: Fotis Dixon

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Initial Coin Offering (ICO)

If a company or entity is planning to launch a new crypto app or blockchain service, how do they find the funds required? It is through a method called Initial Coin Offering (ICO).

ICOs and IPOs are comparable business practices whereby corporations sell their shares to raise equity capital.

Investors can buy a new cryptocurrency during an ICO event. ICOs are mainly raised by startup companies that have ventured into the crypto market.

ICO is highly beneficial for investors as they can directly interact with the ICO issuers without having to deal with any intermediaries.

Different Types of ICOs

ICOs are of two main types: Private ICOs and Public ICOs.

  • Private ICOs: As the name suggests, private ICOs are private events where only selected investors such as financial institutions and high-net-worth individuals are invited to invest.
  • Public ICOs: Anyone can invest in a public ICO. Its aims are similar to raising a crowdfunding campaign to support a particular cryptocurrency. One downside of public ICOs is that it is difficult to regulate the investors as well as the terms of investment.

The Method of Working of Initial Coin Offering (ICO)

ICO is a complex process that requires the utmost care to avoid untoward incidents, frauds, or duplications.

Initial Coin Offering (ICO)

The methods of working on an ICO from the initial stage of conception to the final stage when it is made public on the coins’s official website are detailed in the following paragraphs.

Creation of the Coin

The major prerequisite of an ICO is a well-defined coin. So the first step in creating an ICO is the creation of an ICO coin. The token’s possible use cases, i.e., whether the coin is an asset or utility coin, are determined at this stage.

Structure of ICO

The ICOs are structured in the following ways.

  • Static Pool with Static Price and Static Supply: The coins sold in this structure have a fixed price, and the coin supply will also be limited. The companies offering these ICOs will have a definite goal regarding the amount of funds to be raised.
  • Dynamic Pool with Static Supply but Dynamic Price: In this structure, there will only be a limited supply of tokens, but the price will be dynamic and change according to the market trends. The amount of funds that the platform needs to meet the funding needs determines the price of the coin from time to time. If the target is far from being achieved, then the price of the tokens will rise and vice versa.
  • Dynamic Pool with Dynamic Supply and Static Price: Here the price of each coin will be predetermined but there will be an unlimited supply of the coins. The supply of ICO coins will end when the funding requirements are met.

Release of the White Paper

A whitepaper is an official document that gives prospective investors details about a particular ICO. The main way to assess the credibility of an initial coin offering (ICO) is to look for a well-written white paper.

The contents of the white paper include but are not limited to:

  • The intent of the project
  • The objective or value expected to be achieved with the completion of the project
  • The estimated cost of the ICO project
  • The estimated number of coins that will be set aside as the founder’s contribution
  • The accepted payment methods and currencies for buying the coins during the ICO
  • The start date and the duration of the ICO

White papers help investors decide whether to buy or stake particular coins on the ICO list during the event and help the coin platform spread the word about their aims and expectations.

Promotion of the Coins

At this stage, the news about the ICO event will be spread through various social media platforms such as Facebook and X. The coin is promoted to any available channel so that the information reaches the right bunch of investors.

Launch of the Initial Coin Offering (ICO)

The final stage of this process is the official release of the ICO. The ICO will be limited by supply, price, or both. So, the investors must make swift decisions and invest at the earliest available option.

Market Regulations for ICO

You all know that cryptocurrencies are decentralized without any regulatory oversight. But, given the various cases of fraud and hacks rampant due to the above reason, some governments and central authorities have put forth regulations in the field of ICOs.

The Chinese and South Korean governments have implemented a complete ban on ICOs. Some countries such as Australia, New Zealand, Hong Kong, and the United Arab Emirates (UAE) have specific regulatory guidelines for ICOs

There are still other countries that are in the process of finalizing the regulatory processes regarding ICO such as the United States and Canada.

Benefits of an Initial Coin Offering (ICO)

An investor needs to learn about the benefits of investing in an ICO to make the right decision. The benefits of an ICO as well as the platforms offering the is given below.

  1. ICO is a viable method for companies at the startup stage to raise capital for their activities and it is a great opportunity for investors to invest in an emerging project.
  2. ICO is an opportunity for its proprietors to market their projects.
  3. ICO is a fast mechanism that prevents investors from most of the challenges inherent to the decentralized ecosystem.
  4. ICO is offered by platforms built and run based on blockchain technology, which offers the latest benefits to its users.
  5. ICO increases the liquidity of the tokens in the market.
  6. There are no intermediaries in the ICO market, which is beneficial for all the parties concerned.
  7. ICOs provide a high return on investments (ROI). As the duration of an ICO is short, it is easier for investors to gain returns.

Risks Associated with ICOs and Ways to Protect Yourself

Like any other dealing in the cryptocurrency industry, ICOs are also subject to many risk factors, which, if not careful, can cause a huge loss of money to investors. The major risks related to ICOs are explained here.

  • Most companies that offer ICOs are startup companies. They don’t need to have a well-developed ecosystem or stable objectives behind their operation.
  • There are no proper regulatory mechanisms governing an ICO. The lack of disclosure measures results in less or incomplete information about the ICO, which results in wrong evaluation on the part of the investors.
  • In most cases, ICOs do not have a clear-cut statement of their purposes or terms and conditions, which can be challenging for the investors.
  • The value of the coins offered through the ICO is not stable and can fluctuate with market conditions. This can sometimes result in huge losses to the investors.
  • Lack of an adequate amount of liquidity can sometimes lead to the failure of the ICO.
  • If the location of the company is outside the territory in which you reside then it can be difficult to recover any losses if it occurs.

Here are the ways to protect yourself from the risks associated with ICOs.

  • You should get proper information about the ICO by evaluating its documents and white papers. Make sure that the demand for the ICO is reasonable and is not hype or based on any speculations.
  • Educate yourself about the purpose of the company in raising funds through the Initial Coin Offering (ICO). You should invest only after being convinced about the profitability of investing in the token.
  • Study the market conditions of the time and make sure that the general price volatility of the cryptocurrencies does not affect your particular investment.
  • Make sure that you invest in coins that have adequate liquidity and the required supply in the market.

You should check out these warning signs and refrain from investing in these ICOs.

  • ICOs cannot offer guaranteed returns. The returns are based on the market conditions and performance of the coin at the given time. Do not invest in such ICOS that specify any percentage of returns.
  • Do not invest in a coin that promises high returns. The returns can be low concerning the market conditions.
  • You should not invest in the ICO if the company is forcing you to decide on an investment quickly without giving you enough time to learn about the offering.
  • Unsolicited ICO offers you receive through SMS, e-mails, or social media handles need not be solid all the time and therefore, should not be trusted without proper knowledge.

The Bottom Line

ICOs are events that hold double benefits for both the companies as well as the investor. It is a means for startup companies to gather money to fund their projects.

ICOs are beneficial for investors because they can invest in new cryptocurrencies at the initial stages of their development and become part of the platform’s development processes.

If you make the right choices after carefully considering the pros and cons of a particular investment, then you can have long-standing benefits from an iCO.

Fotis Dixon

Fotis Dixon is a business expert from the UK. He's written lots of articles about the newest market research and trends, especially on cryptocurrencies. Fotis is good at breaking down different topics to give useful information, helping readers stay updated on emerging trends.

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