Today investing in cryptocurrencies and blockchain-related projects, including those based on the Ethereum network, is becoming more and more popular. In 2017, a project known as Bancor, raised about $200 million in one day via an initial coin offering.
An initial coin offering is a crowdfunding strategy that allows new ventures to bypass rigorous compliance requirements that they would have to meet if they were to create an initial public offering (IPO). Because the process of an ICO is much easier from a regulatory standpoint compared to an IPO, it is accessible and attainable to a lot of companies. The downside of this fact is that when something is easy to do, you will see a lot of people doing it, including those who don’t really know what they are doing.
Typically, before an ICO happens, a company presents information about itself in a whitepaper that describes what the project is about, what needs in the marketplace the project will meet after the ICO occurs, how many of the tokens collected during the ICO creators of the project will keep for themselves and how long the ICO is going to last. ICOs are especially popular on the Ethereum network because the network has a lot of functionality and allows new ventures to create new tokens very easily.
Bancor ICO was about building a new liquidity network that allows its users to convert any token used on the Ethereum network into any other token used on the network with no third parties involved.
Early investors in an ICO-backed venture are fundamentally betting that the project they are supporting will become successful and the value of the token goes up significantly. When the number of people who begin using a product by a blockchain-based startup starts increasing, the value of the token starts going up significantly.
Most blockchain-based networks, including Bitcoin and Ethereum, are decentralized and transparent, which is why pricing of the tokens of these networks is all about market supply and demand. There is no authority that can issue more tokens quickly in the way a government can print money during the process that is typically called quantitative easing. There is also no authority that can decide to withdraw the currency from circulation, which means that if a company has a good idea, delivers on its promises and reaches a wide adaptation of its product, the price of its token will raise enough to make investing in it a very good deal for early investors.
Risks associated with investing in ICOs
Because there is no strict regulatory process for a company to start an ICO, investing in projects via ICOs is extremely risky. A IPO is a country with a strong legal system, such as the United States or the United Kingdom, give you a lot of rights and protections. During an IPO, you are buying into ownership rights of the company. None of this happens with an ICO. During an ICO, you are buying currency and you are betting that it will go up in value.
Additional risks have to do with the fact that many of the securities and exchange governing bodies in various countries are considering regulating ICOs in the same way they regulate IPOs. There is also a fear that the current conditions of the ICO marketplace have created a bubble that will burst soon. If you are considering investing in an ICO, you need to remember that such investments are even riskier than investing in established cryptocurrencies themselves.
During an ICO, you will rarely see even a demo of how the future product is going to work, which means that you are taking a pitch on faith. This is much riskier compared to most forms of traditional investments.
Even collecting a lot of funds during an ICO doesn’t mean that the company will be able to successfully build what it promised because collecting money and building a business are very different things. Being successful in the former doesn’t automatically lead to success in the latter. In fact, many business experts and venture capitalists are strongly convinced that having too much money during an early stage of a venture can lead to a variety of problems that can plague the business, including management issues and wrong priorities.
However, despite of all these concerns and issues, some of the ICOs have become very profitable to their early investors.
The best way to approach investing in an ICO is to think about it as any other investment and use analytical mindset and thinking. Start with looking into documentation that the company is making available and determine if the suggestions outlined in the whitepaper make sense from practical standpoint. If they do, the project will be likely to succeed both in short-term and long-term. The token that the project is offering should be a key part of the project, not just something to give to early investors.