Opportunities, Risks and What to Look For
A Brief Introduction to ICOs
An initial coin offering (ICO) is a capital raising mechanism used by companies building blockchain-based platforms and businesses to secure investment. An ICO can be described as something between an IPO and Kickstarter campaign. An IPO, initial public offering, is when a private company goes public by listing on a stock exchange. This step is usually taken by a company in order to raise cash by selling part of its equity to investors. That equity, in the form of company shares, then trades publically on the stock exchange with its value rising or falling based on supply and demand.
In an ICO, a blockchain company sells part of its finite supply of cryptocurrency tokens to the general public. This is, like an IPO, done to raise cash. The investment targeted through an ICO is usually earmarked to develop, or further develop, the blockchain platform and business of the company behind the ICO. The cryptocurrency tokens ICO investors buy are also then traded on an exchange, a cryptocurrency exchange. After they start trading on the exchange, the initial ICO value of the tokens, like the shares issued via an IPO, rises or falls based on supply and demand.
Where an ICO differs significantly from an IPO, and more resembles a Kickstarter campaign, is that the cryptocurrency tokens issued do represent a share of ownership in the issuer. Rather they represent utility value – they are used to pay for use of the blockchain platform they are associated with. If that blockchain platform was for example, like Ethereum, a smart contracts and decentralised applications (DAPPs) platform, the cryptocurrency tokens would finance a user’s use of the platform’s ‘bandwidth’.
That’s a bit like investors in a Kickstarter campaign who don’t get equity in the company they back financially, but will usually receive goods and services at a preferential price in return. ICO investors receive cryptocurrency units that can be used to pay for use of the blockchain platform being backed. The ICO investor’s hope is usually there will be high demand for subsequent use of the final blockchain platform. This should mean the exchange value of their ICO tokens increases. They can then either sell them on over a cryptocurrency exchange for a profit or spend them for use of the platform at a more attractive rate than having bought them after the ICO at a, hopefully, higher price.
One important detail to note is that when investing in an ICO you don’t pay cash for the cryptocurrency tokens being acquired. They are paid for in the tokens of whichever blockchain platform is being run on. That is the Ethereum platform for the vast majority of ICOs. Which means the ICO investor must first have purchased Ether tokens on a cryptocurrency exchange.
Are ICOs A Good Investment?
If ICOs are a good investment is a very broad question and the equivalent of asking if an IPO will be a good investment. The simple answer is some will prove to be a good investment and others not. Post-ICO, if the blockchain platform proves popular, and the ICO tokens were sold at a realistic price, there should be a good chance the exchange value of the tokens rises. Should the investor then cash their tokens in by selling them over an exchange then the investment will have proven to be a good one.
However, if the blockchain platform subsequently doesn’t gain the hoped for traction post ICO, the exchange value of tokens could drop due to low demand. Obviously that will mean ICO investors lose money if they decide to cut their losses and sell. They can of course, if they believe it to be worth the risk, hold on to the tokens in the hope demand picks up. That could see the investment either turn around or sustain further losses.
Opportunities and Risks of an ICO Investment
The most successful ICO investments can be extremely profitable. There are many examples of token values multiplying several fold in the days, weeks, and months following an IPO. You could make an investment return of several hundred percent very quickly.
However, many ICO tokens also plummet in value. The majority do. Investing in ICOs is certainly high risk. Blockchain is a new technology and still developing. There are also bad actors in the space that have little intention of really making a serious effort to develop a sustainable business post-ICO. Some are outright scammers who take the investment raised through the ICO and disappear. More just aren’t particularly serious teams and either don’t have the skill-set to really build a sustainable blockchain-based business or the motivation post ICO. Or their blockchain business case just doesn’t turn out to be very good.
Selecting an ICO to invest in is like investing in any other start-up through more traditional formats. Most start-ups fail, or at least fail to live up to the expectations of founders and early investors. It’s the same with blockchain start-ups with the added risk it’s a new technology and while hugely promising is still in its early stages. Any investment in an ICO should be made with the understanding it’s high risk and the sum invested could be lost.
What To Look For In An ICO?
When conducting due diligence on an ICO that interests you as an investor what qualities should you be paying close attention to?
Product
Is there an existing product? At least a beta version of a blockchain platform? Some ICOs raise money on just a concept with the promise the blockchain platform will be build using the investment raised. That’s a big risk to take as an investor and ideally you should look for ICO where a product already exists.
Is there a clear case for blockchain? Does the use of blockchain technology make sense? Does it really improve the product or service significantly, or is required to make it work? If not, it may be better to avoid an ICO. The use of blockchain as a technology should offer obvious competitive advantages over a non-blockchain alternative or be integral to the product or service.
Business Case
Does the business case laid out in the ICO’s whitepaper make sense? Is the valuation of the company based on what is being raised via ICO realistic? Does the plan for how the money raised through the ICO will be spent make sense?
A lot of ICOs seek to raise sums far higher than what a fledgling business should really need. If tens of millions are being sought from ICO investors and there is no obvious business case. Why such a young company and product would deserve such a level of investment, at the current stage of their development, should act as a warning flag. It doesn’t necessarily mean the ICO is a scam, but raising too much investment can make companies lazy and wasteful and hinder, not help, their future development.
The Team
As is the case with any company or product, success will largely be down to the quality of the team in place behind it. Who is behind the ICO? What’s their history and track record? These questions should also be asked of key roles within the broader management team. Look into their professional history. Does it justify you putting your faith in them and backing them financially?
If you do your due diligence well and ask all of those questions of an ICO, you will give yourself the best possible chance of a successful ICO investment. Good luck!