What is an initial coin offering (ICO)?
- An initial coin offering (ICO) is a fundraising method used by cryptocurrency startups to gather capital for new projects.
- ICOs operate similarly to crowdfunding, allowing individuals to support a project early by purchasing its native tokens before development is finished.
- Because the ICO space is largely unregulated, investors face significant risks, including the potential for developers to abandon the project or fail to deliver on promises.
An initial coin offering (ICO) is a fundraising method where a new cryptocurrency project sells its underlying crypto tokens in exchange for upfront capital. An ICO is often the first time a new cryptocurrency is offered for sale. It serves as an alternative method of raising funds for a startup and is considered the cryptocurrency equivalent of a traditional stock's initial public offering (IPO).
How does an ICO compare to crowdfunding?
It is difficult for a startup company to make a breakthrough in any market, and the cryptocurrency market is no exception. Many innovative ideas require significant capital to develop, and founders often struggle to find a major investor who will support them.
Crowdfunding provides an alternative to the traditional financing of startups. It bypasses large venture capital funds and markets the project straight to the general public. Instead of relying on one major backer, this system gathers funds from numerous smaller-scale investors. Whoever believes in the potential of the company's offering can invest money to help the team develop their idea.
The concept of an ICO applies this crowdfunding model to the blockchain space. A team comes up with an idea for a cryptocurrency-related project and publicly announces it to allow almost anyone to invest.
How does an ICO work?
During an ICO, the project's developers present their idea in a detailed document known as a whitepaper. The whitepaper outlines the plans, including the amount of funds necessary to complete the project, the technical details of what the product strives to achieve, and the conditions under which funds can be returned if the ICO fails.
Investors who like the idea can buy the new coins or tokens in advance, typically paying with established cryptocurrencies. This provides the project with the necessary funds to enter its main development stage. The idea is that if the project is successfully completed and launched, the coins will become useful and potentially increase in value.
However, during the ICO phase, the new coins often do not exist yet or are distributed in a locked-down state, meaning backers cannot use them immediately. The coins generally only become fully usable after the development process is over. In cases where the ICO fails to gather enough funds, the new cryptocurrency is usually not created, and backers typically get their money returned.
What are the typical stages of an ICO?
ICOs generally proceed through several stages, not all of which are fully open to the general public.
| Stage | Description | Accessibility |
| Private sale | Takes place a few months before the public launch to collect initial marketing and development funds. | Closed doors; usually requires a high investment threshold. |
| Presale | The funding process becomes somewhat automated. The price of the coins typically increases with every phase of the presale. | Open to the public, but often restricted by know-your-customer (KYC) filters or random selection. |
| Crowdsale | The final stage of the offering where the broader public can participate to meet the project's funding goal. | Open to the public, often requiring whitelisting and KYC compliance to meet anti-money-laundering regulations. |
What are the risks of participating in an ICO?
Not all ICOs are stories of success, neither for the developers nor for the investors. One of the biggest advantages and, at the same time, the main drawback of an ICO is its largely unregulated status in many jurisdictions. This means that the team behind it enjoys the freedom to develop their project as they see fit, but it provides no guarantees to those funding it.
There have been numerous occasions when developers did not follow through with the vision presented in the whitepaper or entirely failed to deliver the product. In these cases, backers were left with useless coins or nothing at all. Some fraudulent operators never planned to release a product and vanished when the ICO was completed.
To help mitigate these problems, many contemporary ICOs are based on blockchains that support smart contracts. These contracts can function as a hard-coded safety mechanism, making it possible to specify the conditions under which investments will be automatically returned should the development team fail to deliver the project.
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