How Does An ICO Work?
Posted on 7. August 2018 | By admin
If you’ve already read this article you roughly know what tokens are and how they work. Now we delve deeper into the matter of the ICO and why some people compare ICOs with the American gold rush.
ICOs have produced a breathtaking number of millionaires in the past few years.
Over the past 12 months, Initial Coin Offerings have raised over $600 million. By contrast, $140.3 million came from established venture capital (time-limited funds available in the form of equity). This is amazing! So what makes ICOs so interesting that they have attracted so many investors?
An ICO is now considered a rock star in the investment world. It’s a wild and untamed stroke of genius. The makers wear torn T-shirts and jogging pants and compete in an industry full of snobbish, suit-wearing business people.
Thanks to ICOs, anyone with an idea can win incredibly large financial support from a community without being tied to politics or endless bureaucracy. The idea that no matter who and when everywhere can receive unregulated financial support was more than a glorious idea. Investments will no longer be reserved only for the super rich. Everyone can get the means to make dreams and projects come true.
The Exact Sequence Of An ICO Can Be Broken Down To The Following Steps:
First of all, the developers announce the new project in order to interest people and in the best case trigger a hype. The first impression is of course the most important, so this is the main focus.
The developers then create a white paper. A white paper is a document issued by the developers. The highlights and special features of the project are presented here to attract potential investors. White papers are known as great for marketing and sales and are less exaggerated or provocative than brochures and television advertising. A white paper is prepared in an academic way to illustrate the potential to investors. Most of them are over 2500 words long and purely informative.
In the next step, the white papers will be presented to prominent members of the blockchain community to gain their support. Getting the support of the community is very important, because this is the basis of the credibility of the project and its success.
Now the developers have to create the tokens they offer for sale against Bitcoin or Ethereum. I already explained how to create the tokens above. The developers must determine the number of possible tokens (coins) and their price. It is very important to set a limited amount for the tokens, because with a limited number of tokens the demand for these is automatically increased (set by supply and demand).
At the same time as determining the number of tokens, the developers must agree on a period during which the initial coin offering is to be held. Finding a period and duration is REQUIRED, which we will discuss again later. In addition, it must be decided how much money is to be raised for the ICO.
Once all this is decided, developers must select a platform on which to promote their ICO. Some time ago this was even more difficult. Developers had to advertise massively to convince people of their cause and direct them to the website. Today, there are a number of websites that provide a platform for developers to meet these needs. Among the best ICO platforms:
Investors send Bitcoins, ETH or other cryptic currencies to the public address of the developers and receive tokens (coins) in return.
- First, the developers declare their intention to start project XY.
- The white paper will then be developed to explain and illustrate the details of the project.
- They try to gain the support and trust of a few prominent members in the crypto currency scene, who at best act as “consultants” or developers.
- Then the tokens are created. It is decided how many tokens there should be and how much money must be collected in which period.
- The ICO will then be promoted on one of the platforms mentioned above.
- Last but not least, the ICO is held.
The Two Types Of ICO:
- Currency ICO – ICO of a currency
- ICO Project
ICO Of A Currency
A currency ICO is used when the developers want to create a new currency system. The developers issue tokens, which can be traded as a new crypto currency on the stock exchanges against the already established coins – such as Bitcoin or Ethereum. The reason investors put capital into these ICOs is the tempting investment opportunity as such and the speculative gains. The best example of such an ICO is the Ethereum ICO.
In 2013, a young programmer named Vitalik Buterin worked as a Bitcoin developer. And he became more and more frustrated. He realized that the Blockchain technology has a much greater potential than just acting as a monetary system. His vision was to create an alternative form of the Internet. This vision is called Ethereum. This is a platform where people not only have access to a new form of currency (ether), but where it is possible to create a better and newer form of DAPPS directly on the platform.
The Ethereum ICO lasted only 42 days. From July to August 2014, he raised over $18 million! At that time it was the largest crowdfunding in the history of mankind. Those who were there first had an unimaginable return on investment (ROI). Who invested at the beginning only 1 BTC got 2000 Ether back. The current value of these 2000 ethers is just under 420,000 US dollars. Not bad for an investment of 200 dollars at that time! But much more important than the ROI of this ICO is the concept of the project, which represented an important change in the history of cryptography.
In an ICO project, so-called “work tokens” are created. When you buy such tokens on a crowd sale, you are given certain rights and choices within a DAPP (platform for distributed applications). One of the most famous and notorious examples is the DAO ICO on Ethereum.
The DAO, or Decentralized Autonomous Organization, was a decentralized risk capital fund designed to finance future projects at the Ethereum Ecosystem. This is how it was supposed to work…
People invested in DAO by depositing Ether and getting “DAO Token” back. These DAO tokens have then made their owners part of the DAO community.
Suppose Jonas wanted to finance a project with the DAO, then he would present the project to the DAO community. The owners of the tokens would then vote for one and if Jonas gets the majority of votes, his project would be financed with the required number of DAO tokens.
This was a revolutionary idea that was also well received by the mainstream press. This ICO went down in history as one of the greatest. This ICO raised over 150 million US dollars in ether, which was 14% of the total amount of ether at that time. Unfortunately, the infamous DAO attack occurred and the equivalent of $50 million was stolen in Ether. This attack had a big impact because it resulted in the Ethereum Hardfork, which led to two different Ethereum tokens: Ethereum and Ethereum Classic.
Another good example of an “ICO project” is Augur, a decentralized market analysis system.
Today, ICOs collect an incredible amount of money. The Brace ICO, an Ethereum-based browser, managed to collect $35 million in 30 seconds. That’s about $1.2 million per second! The Tezos ICO has become one of the largest ICOs of all time, with more than $200 million. The question you’re certainly asking yourself is:
“How can I make sure that the money I invest is used correctly by the developers?” What happens if they just leave? Let’s answer that question briefly.
What Steps Should Be Taken To Avoid Being Cheated At ICOs?
Since ICOs are not regulated, they attract a lot of fraudsters. So if you want to invest in an ICO, you should be sure in the end that the capital you are investing is being used correctly. Here are the points to watch out for, so as not to fall into the trap of fraudsters.
The project developers should be able to clearly define the purpose of the project and explain this in simple short sentences. If they take too much time and talk “around the bush”, this can mean that they have no clear agenda or are hiding something from you.
Make sure that the developers are not anonymous. There should be 100% transparency when it comes to names, business plans, locations and much more. You should be able to get all the information you need to make a good decision.
There should be a legal framework between the developers, the contributors and the general terms and conditions of the ICO.
Another aspect: You must ensure that the capital provided for the ICO is loaded onto an escrow wallet. An escrow wallet is simply a multi-signature wallet that requires several keys to open. One of these keys must have a third party!
Keeping these four points in mind, you can quickly and easily filter out the scammers and devote yourself to projects that actually have potential.
Are We In A Bursting ICO Bubble?
Since a huge amount of capital has recently flowed into ICOs and many people are getting involved, it is legitimate to be a little afraid that ICOs are in a similar bubble as the DotCom or the American real estate bubble back then.
To understand how a bubble works, let’s take a look at the most famous bubble, the dot com bubble from 1997-2002.
Only around 1997 did the Internet become really big and tech companies sprouted like weeds from the ground. Investors began to provide capital in large sums. Many were afraid to miss something (FOMO – fear of missing out). Many invested in companies without really knowing if the business model could work.
Common sense had said goodbye and every company on the Internet tried to go public. Waren Buffet said to these IPOs:
The fact that a bubble market has enabled the creation of bubble companies has led the company to look beautiful only from the outside to get money from investors instead of earning it for them. Often an IPO, i.e. a pure IPO, was the goal of the company and not the potential profit for companies and investors. – Goods Buffet
Waren Buffet had hit the nail on the head with this statement. Most of the companies that had received millions from their investors have failed and turned out to be pure fraud. Finally, the DotCom bubble burst in 2002.
companies failed and had lost several million within a year. The most famous example is Pets.com, which lost over 300 million US dollars in 268 days! But while 1 of 2 companies collapsed, the companies that have survived have fundamentally changed our lives to this day! The best example of this is probably Amazon. Before the bubble burst, one Amazon share was worth $100. After the bubble burst, one Amazon share was worth 7 US dollars, it even managed to climb back up to 600 US dollars per share!
The parallel between the ICO bubble and the dot com bubble is somewhat frightening, but “those who do not learn anything from history are forced to repeat it”. Like dot-coms, ICOs have attracted a large number of investors who are afraid of missing out. Like the dot coms, ALL investments in ICOs are based on pure speculation. You have to realize that most ICOs do not have a working concept. Many don’t have an alpha version of their end product. Most ICOs are therefore pure speculation that a project will work.
Most projects will fail before they reach their final stage. The reason why the Ethereum ICO worked so well was the dedicated team led by the talented developer Vitalik Buterin. Another problem that plagues many an initial coin offering is the greed of the developers. Some developers only create projects that promise something nice, but never have the goal to lead the project to the last phase.
So the parallels to DotCom are very big and it can be a bit worrying to think about it. But there are no real market experts. All we can do is speculate. We do not know if we are in an “ICO bubble” or not. What we can do is to be wise with our money. Don’t let a good sounding project confuse you which promises too much. Please read the above points again before investing.
The advantages and disadvantages of an initial coin offering
Advantages Of An ICO
They give promising projects a chance: Let’s take another look at what Ethereum has achieved in recent years. Ethereum became the second largest and second most powerful crypto currency in the world, with a DAPP platform for developers and new projects. Ethereum is indeed “the platform on which the future is built”. And all this started with an ICO.
Does not require unnecessary paperwork: Many projects are never completed because they fail because of bureaucracy. To get capital through an IPO or crowdfunding, the developers have to do a lot of paperwork. Often they do not get the necessary papers to be allowed to collect funds. For an ICO, on the other hand, you only need one white paper (all the details of the project). Afterwards, each interested party can read the white paper and decide whether they want to invest in the project or not.
Building a Community: ICOs give developers the opportunity to build a community around the project. A healthy community gives the project immense credibility. Another advantage is that the members of the community can influence the project and hold the developers to account.
Exposure of the project: A hype about an ICO can work wonders in the detection of fraudsters. But this can also be done the other way round, if the developers “expose” themselves and their project, the more people learn about the project. This in turn can increase the number of investors.
Early access to potentially valuable tokens: Some tokens have the potential to become a truly valuable crypto currency. ICOs give investors a chance to invest in damn cheap tokens. During the Ethereum “Vorverkaufs” an Ether costs about 0,35-0,40 US-Dollar! Today an ether costs over 350 US dollars!
Incentive for innovation: The resounding success of some ICOs over the past 12 months has given developers an extra incentive to innovate and develop more exciting projects.
Disadvantages Of An ICO
Looking for a lot of scammers: Since an ICO requires little paperwork, many fraudsters are attracted, who create dizzy papers or fake white papers to simply collect money. Some developers also deliberately leave important details out of the white paper to make the projects seem even more tempting. The consequence of this fraud is that fewer and fewer people believe in the Blockchain technology, which can become a real disaster.
It is based on pure speculation: As soon as you invest in a Tokensale, or ICO, you invest in the project and the idea behind it. Read the white paper and if you think the team is credible and the project is promising, then you should invest. But you have no idea if the project will succeed or not.
Over 90% of start-up companies fail and blockchain projects cannot deny themselves this “rule”. The developers could become lazy and sluggish, not bothering to finish the project. What we should not forget is that there is always the possibility that the project will fail due to hackers and their attacks. The DAO is a perfect example of this.
Election catching: Let’s take a look at the BAT ICO known today. The ICO was over after 24 seconds and had collected over 35 million US dollars. But what shocked people was that not very many people could become part of this ICO. The largest amount of the tokens was distributed among a few individuals. The fact is that over a quarter of BAT tokens are owned by a single person…
These people are called whales. It is people who have a lot of money and means to manipulate ICOs according to their wishes. Among other things, they do this by paying extremely high mining fees, denying the others access and taking a privileged position at the ICO. At the BAT ICO, the “Wahle” paid $2220 in transaction fees to make sure they got the biggest piece of the cake. Afterwards the tokens are immediately sold again to take the profit, to the suffering of all those who really believe in the project, as the price then rushes back into the cellar (supply and demand).
Network congestion: The high activity of an ICO leads to a large load on the blockchain, which can lead to a bottleneck. During the ICO status – which raised $100 million – there was a backlog of orders on the network, so many people who wanted to invest in status could only watch their transactions fail.
Storage of tokens: You may not be able to store some tokens in any of your crypto-wallets. You can store all tokens created on Ethereum in your Ether-Wallet. Tokens created outside of Ethereum, however, are usually very difficult to store.
Government interventions: This place is getting scary. Due to the high number of fraud and the large amount of unregulated capital, various governments may decide to regulate ICOs. If ICOs are banned by governments, this can mean death for many crypto currencies. The mainstay and core element of crypto currencies is the idea of a decentralized and government independent payment system.
ICOs will always remain a part of the blockchain and cryptocurrency world. We can’t estimate the good they’ve achieved yet. They have made an incredible contribution to the birth of innovative technologies such as the Ethereum and Golem. They gave DAPP developers all over the world an incentive to create further innovations and they came around again with newer and more exciting technologies.
However, there is no doubt that ICOs can be a “necessary evil”. Man tends to exploit all loopholes to his own advantage. Unfortunately, ICOs seem to have become a tool for these people. What we can do as individuals is to take more responsibility and research correctly and accurately. Study the white paper, consult the development team of the ICO project and only then should you invest your money.