The world of finance has been going through big changes recently. One of the biggest changes in the past couple of years has been the introduction of Initial Coin Offerings (ICOs). It's no surprise that one of the most popular questions in the crypto space this past year has been 'what is an ICO?'.
Before we get into details about ICOs though, I need to make sure you have a fair understanding of the technology behind ICOs — blockchains and smart contracts. If you’re already confident in your understanding of these two technologies, feel free to skip to “The Concept of an ICO”.
If you've come here to read about ICOs because you're planning on investing in a cryptocurrency, please keep in mind that it should be done only on a trustworthy exchange!
So, let’s get started!
Table of Contents
What is an ICO: Blockchains
A blockchain is not Bitcoin or any other cryptocurrency. Cryptocurrencies use the blockchain. Put simply, a block is a group of transactions. The chain is a group of blocks that are connected to each other. Put those two words together, and there you have it — blockchain.
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All these blocks linked together on the chain form a public database. This database is public because it is shared with hundreds or even thousands of computers. We can think of these computers as the servers for the blockchain/database.
(These computers are called nodes).
Any changes made to the database need to be verified by more than 51% of the nodes. If they are not verified, the change cannot be made. This makes it very hard to hack the database because you would need to hack more than 51% of the nodes, and the nodes are normally owned by lots of different people and companies.
This effect is called decentralization — meaning, the database is not stored in one single place, but instead in lots of different places.
When we talk about “changes” to the database, these are transactions of data. In the case of Bitcoin, for example, these are transactions of Bitcoins — people transferring Bitcoin to other people.
(For more on blockchain technology, read our "Blockchain Explained" guide.)
Now, on to the next piece of technology that ICOs use.
Tokens & Smart Contracts
The transactions that happen on the database are not just limited to financial transactions like the ones on the Bitcoin blockchain. Instead, they can be anything that has value.
For example, the value of the transaction could be a house or a share of a company. Of course, you can’t physically place a house or share of a company onto the blockchain. Instead, you need something that represents the value of the house or share of the company.
I welcome you to the world of tokens. A token is created to represent the value of something. For example - a house, electricity, store credit, or a share of a company.
These tokens cannot be applied directly to the blockchain, as blockchains can normally only process transactions of their own cryptocurrency — like Ether on the Ethereum blockchain and Bitcoin on the Bitcoin blockchain.
Instead, the tokens must use an application.
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You can think of dApps as the interface you see when you use Instagram or Twitter, but behind Instagram and Twitter is a series of coded applications. These coded applications are the smart contracts.
These smart contracts are unique for many reasons. These reasons include the following:
- They can automatically process transactions;
- The transactions are triggered by certain conditions that are written into the smart contract;
- Imagine it like this: “WHEN Peter pays 100 Ether into the smart contract, THEN John’s house token is sent to Peter”.
- They use blockchain technology, so the conditions of the smart contract cannot be changed.
So, you now know about the two pieces of technology that have made ICOs the success that they are today. Now, let’s talk about what an ICO is!
The Concept of an ICO
ICOs can be compared to IPOs. An IPO is an Initial Public Offering — this is a term used when a company first releases their stock onto the stock market. Before that, the company’s stock was private and its shares were not available to the public. Hence, Initial Public Offering. It's important to understand the differences between IPO and what is an ICO.
When companies list themselves on the stock exchange, people and other companies that are interested in the companies can purchase shares in the company for a certain price.
The shares can be used to vote on specific actions that the company is taking as you have actually become a partial owner of the company! If the company does well, the value of their shares similarly increases, and you can sell them at a later stage for a profit.
ICOs are not as neat and clean as IPOs. ICOs can be considered as a means of crowdfunding.
With an ICO, you get a token. These tokens do not give you any long-term authority or ownership of the project; they are merely a means for the project to raise funds.
However, once again, if the project succeeds, the value of your token could increase. So, you could sell the token for more than you bought it for (if you wanted to, that is).
How Do ICOs Work?
To simplify the core concept of an ICO or explain what is an ICO better:
How ICO Works | Source: cleveroad
If you want to start your own cryptocurrency or dApp, you will need a lot of money. To get this money, you can run an ICO. If people are interested in your ICO and think the project is good, they can buy your token for a certain price.
These prices are normally set in Ether (ETH), however, some projects accept more than one cryptocurrency — normally Bitcoin (BTC) and Litecoin (LTC).
When you invest in an ICO, you send your ETH, BTC, LTC, or whichever currency you want to pay in, to the ICO smart contract. This smart contract then sends you the amount of tokens that you have paid for.
There are usually two main reasons for buying tokens from ICOs - to sell the token in the future for a higher price, and to use the token for its purpose.
Tokens normally provide the holders of the token with benefits, like discounted fees, a share of profits or premium features.
Some tokens can be used to purchase things on the project’s app when it is created — these types of tokens are known as utility tokens.
How Do Investors Know Which ICOs to Invest In?
Just because the idea is good, it doesn’t mean the project will be good!
An idea can seem really good, but then completely fail once it raises the funds. It’s true, unfortunately. There have even been cases in which ICOs have turned out to be complete scams! So, now that you understand what is an ICO make sure that when researching an ICO, you are careful.
Investors will usually pay close attention to the following things:
1. The competition: does the project have any competitors? If so, what are they doing differently to their competitors?
2. The team: who are the team working on the project? Do they have good, relevant backgrounds? Have they worked on similar projects before?
3. The use of the funds: how are they going to use the money that they raise from their ICO?
4. The roadmap: what do they plan to do and how long is it going to take them?
5. The tokens: how many tokens will there be? What is the price of each token? How many tokens will be sold in the ICO and how many will be kept for other things?
Another alternative could be using an ICO watch app. There are separate businesses forming that dedicate their time to research, review, categorize and follow market news around different ICOs. One such application is Coinview - it allows users to keep track of how different ICOs are performing and monitor their cryptocurrency performance.
That’s a lot of questions, I know. The good news is, you can normally find most of the answers in their White Paper! Opinions about the project and reviews are important. That said, you should always make sure to do your own research to form your opinion. A lot of information on the Internet can be inaccurate or based on emotion!
What is a 'White Paper'?
Knowing what is an ICO is almost as important as understanding what is a white paper. A white paper is a document that presents the idea that the ICO is raising money for. It contains a lot more detail than the descriptions you will find on the ICO’s website.
You’ll find things like system architecture, the need for their idea (the problem it is solving etc.), the uses of the token, market data, and growth projections.
You will also often see a list of team members, investors, and advisors. Although, this is normally displayed on the website itself, too.
For an ICO to be successful, it needs a good, solid white paper. If you ever find an ICO is live but doesn’t have a white paper, I wouldn't recommend buying any tokens from it.
Very few people will want to invest in a project that doesn’t have a well-thought-out white paper.
A good white paper will also provide information on what the funds are going to be used for. The focus needs to be on the funds being used to grow the business and not for personal gain. This is important!
A Further Note
As you can see, you find most of the answers you need from an ICO’s white paper. However, you should continue your research outside of the white paper and the ICO’s website.
You should check how well they are keeping their community updated. A good way to do this is to join their Telegram group (if they have one) or view their forums. From there, you can see how they are handling questions, comments, and everything else in between.
An Example of a Successful ICO
BitDegree is the world's first blockchain-powered online education platform with tech talent acquisition. The project collected approx 32,500 ETH during the crowd sale and successfully reached the Hard cap.
For the team members, each had a full history provided, and an MVP was presented.
The roadmap is also detailed, and the community was kept up to date with blog posts and forum answers. As you can see, it is important to gain the trust of the community. This was a crucial part of success — nobody gives money to people that they don’t trust.
Now that you know what is an ICO, keep in mind that ICOs are new, which means there are very few regulations. So, as mentioned earlier, you should always be careful when choosing an ICO to invest in. It is extremely important to do your own research!
You should understand the creators behind the ICO and the market that the ICO is entering. Always study and consider their ability to deliver on the project on time and on budget. Learn about what they are planning on doing with the funds that they receive, and use their roadmap to see when they say their project will be launched.
How to launch an ICO?
If you are creating an ICO and not investing in one, you need to understand how investors research ICOs. You need to understand that they need to see all the things we have mentioned — otherwise, they will not trust your ICO.
You need to keep your community updated, treat them with respect, and ensure that your project can do what it says it will do. Always make sure you can deliver your project on time, and never lie.
If, however, you're looking in an alternative way of investing in the crypto market (and the technology that it's built upon), and are planning on purchasing some crypto coins, do make sure that you're doing so from a trusted exchange! Binance and Coinbase are two great options.