Heard of the term ICO recently?
If you did and you don’t know what it means, no worries. In today’s guide, we’re going to cover everything that you need to know about ICOs and what you can do to invest in these coin offerings. In this article, we’ll be covering the following topics.
Note: This section is a rudimentary explanation on the basics of the blockchain technology and cryptocurrencies. However, it should give you a basic understanding of how it works.
Back when Bitcoin blasted into the the mass media with its rapid rise (and eventual downfall) in 2013, the general public was exposed to the idea of the blockchain technology for the first time.
Although it sounds super technical, the term blockchain is actually just another word for a digital, public ledger.
Ledgers are accounts or statements that record financial activities. Digital ledgers work the same way but instead of using money, digital ledgers use data as a way to receive, transfer, and record transactions.
Think of it this way; when you send someone $50 on PayPal or through Stripe, the platform does not literally take $50 from their cash balance and deliver it to the recipient’s bank.
The same thing happens with buying and selling stocks on the exchange. When you buy a stock, the bank does not physically handle the stock sheets and transfer money from one account to another.
Instead, data in the form of digital numbers is transferred from one account to another within a giant, digital ledger. All of the data and information related to the transaction is stored in the ledger and stored as records.
These transaction records are then used by a central authority like banks or PayPal to verify and actually confirm the transactions.
This means that we put our trust in PayPal and banks as middlemen to verify and complete these transactions successfully.The blockchain, on the other hand, is a decentralised public digital ledger. Decentralised means that no one owns the ledger and transactions are done directly between two parties (peer-to-peer) instead of going through a middleman (3rd party) like banks or PayPal.
This situation happens because everyone who uses the blockchain stores a single copy of the entire ledger on their computer. As everyone has a copy of the blockchain, no single institution or entity can claim the blockchain as theirs which eliminates monopolies altogether.
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It is also considered a public ledger as anyone can verify their transactions (and others) on the blockchain.
You may wonder, isn’t a blockchain dangerous and unsafe if the information on the blockchain is public and everyone has a copy of it?
No, it’s not.
First off, transactions on the blockchain do not contain personal information about you, hence the term cryptocurrency. Users can see your transactions on the blockchain but they do not know sensitive information like:
- The sender of the transaction
- The recipient of the transaction
However, you should not assume cryptocurrencies and the blockchain to be completely anonymous. Instead, they are pseudonymous. We will cover this later in this post.
When a new transaction happens on the blockchain, a new record is added to the public ledger. An update is then sent throughout the blockchain network which syncs everyone’s copy of the blockchain.
For example, when someone sends you a unit of cryptocurrency that is built based on the blockchain system, you can use the blockchain’s ledger to check if the transaction is valid.
If the transaction is valid, it will be verified on the blockchain and a new record is added to your copy of the public ledger. This then sends an update to the rest of the networks in the blockchain to get everyone’s public ledger in sync with the new record.
Fortunately, you don’t have to manually verify every transaction the blockchain. Verifications are done by miners, which are basically just computers.
As an incentive for miners to verify the transactions, they are rewarded with cryptocurrencies like Bitcoins which is a store of value and can be used to exchange goods and services.
That is a simple breakdown of the blockchain technology.
Ethereum was invented by the programmer, Vitalik Buterin, as an alternative to Bitcoin.
Bitcoin is strictly used as a cryptocurrency or as a means to transfer monetary value. However, the same blockchain technology can also be used to transmit data instead of just being a payment solution.
This discovery led to Ethereum’s existence in the blockchain world.
Note: Do not confuse Ethereum and Ether, Ethereum is the technology itself while Ether (ETH) is the cryptocurrency.
Miners who verify transactions in the Ethereum blockchain are rewarded with Ether (ETH) which is the currency of Ethereum.
ETH is also used to power or execute transactions on the blockchain; think of it as a very, very small fee for miners to process your transaction.
Just like Bitcoin, you have an Ethereum address that you can use to store, send, and receive ETH and other tokens that are based on Ethereum.
The biggest advantage of Ethereum, however, is the ability to create applications on top of the technology as well as having smart contracts.
This means that you can create applications on top of Ethereum and use its blockchain as a digital ledger to store information. This technology can then be used to create smart contracts.
Smart contracts are essentially contracts or terms that are written in code. They are computerised transactions that self-executes when the terms in the contract are met or not met; they also have an Ethereum address.
The most widely-used form of smart contracts are in ICOs or Initial Coin Offerings. ICOs are crowdfunding campaigns that are usually used by startups to raise funding for their ventures.
For example, to invest in an ICO, you need to send the amount in ETH that you wish to invest to the ICO’s smart contract address. This smart contract will automatically hold your ETH until the crowdfunding target is hit.
When the crowdfunding target is achieved, you ETH tokens will be changed to the ICO’s token (we will explain this later).
Everything is also automatically done by code so you don’t have to worry about losing your money in the process unless the code in the smart contract is already malicious, to begin with.
However, malicious smart contracts will never be released to the public due to two reasons: smart contract audits and the technical nature of the cryptocurrency community.
Smart contract audits are done by companies that specialize in reviewing smart contracts. This means that these companies (that are run by experts in smart contracts) do a full audit and review of the code inside the contract to make sure that nothing is malicious or broken.
If a contract is deemed to be safe and working perfectly, the smart contract address will be released to the public. If not, the contract will have to be rewritten and edited to fix the issues.
The community also helps a lot in determining if smart contracts are safe. Usually, smart contracts are uploaded on the Github or the official website of ICOs. This allows developers to go through the contract to see if anything is out of the ordinary.
Allowing full transparency on smart contracts builds trust in an ICO. If an ICO does not have a smart contract anywhere on their website or Github as well as having zero mentions of audits, be wary.
That is a simple breakdown of what Ethereum is. We suggest learning more about the technology by reading resources from pages like:
To put it simply, ICOs are crowdfunding campaigns by startups to raise money for their ventures. The reward of investing in these crowdfunding campaigns is the startup’s own token.
Remember when we said that Ethereum allows applications to be built on top of its platform?
When a startup decides to move on with an ICO, they can create their own token or coin instead of using ETH as the default storage of value. This means that you can even create your own Bitcoin-clone or token with Ethereum’s technology.
While tokens act as an incentive for investing in the startup, they are plenty of use cases for it.
For example, some startups may decide to use their token as a way of distributing dividends among investors. However, startups usually offer their tokens with either one of these expectations for their investors:
- An expectation that the tokens would rise in value (like how ETH and BTC rose in value)
- A percentage return or dividends of the company’s profits to the investors
In the first case, startups offer their tokens in hopes that the token would rise massively in value over the years. The second case can be seen in applications like Etheroll, where the profits are distributed among token holders based on the amount of tokens that they have.
Tokens are very similar to stocks in the stock exchange; for example, you invest in Apple and you get AAPL stocks. Invest in Microsoft and you get MSFT stocks.
Tokens are the same; if you invested in Ethereum, you get ETH tokens. Invest in Basic Attention Token and you receive BAT tokens.
ICOs are powered on smart contracts. As we’ve mentioned earlier, these contracts execute the terms inside of them when a target is met. Usually, ICOs would set a minimum amount of money to raise for their campaign. Let’s run with an example to demonstrate this point clearly.
Let’s assume that we are running Startup A.
Startup A wants to raise $10 million for their application. Startup A then creates an Ethereum-based token of their own with the initials STA as the token name.
Startup A then decides that an investment of $1 is equal to 10 STA tokens. This means that Startup A is offering 100 million STA tokens for its funding target.
A day after the campaign was run, Startup A managed to raise exactly $10 million for their ICO. The 100 million STA tokens are then released to the investors.
For example, people who invested $10 in the ICO will get 100 STA tokens while someone who invested $100,000 will receive 1 million STA tokens.
The investors are now proud holders of the STA token which they can then decide to hold or trade on exchanges.
Now, what if the ICO did not meet its minimum funding requirement?
Somewhere in the smart contract’s code, there is a code that executes if the minimum funding target is not reached. This code is written in such a way so that the investors get back the money that they’ve put in the ICO.
If the investments exceed the minimum requirement, startups usually have a list of milestones in place to cover that. However, most smart contracts are smart enough to stop deploying or return investors’ money if the funding target is reached.
Token holders are treated the same way as stockholders in a traditional IPO. If a company goes bankrupt and is liquidated in the process, the tokens will still exist (as they are in smart contracts) but the value of the token will fall massively and will be rendered worthless.However, the ICO scene is not mature enough yet for strict regulations to take place. Stockholders in the stock exchange may still have a chance to recover their money if a company is liquidated but the same cannot be said for ICOs.
Until there is a proper authority or institution for ICOs, startups can lose their investments without any legal repercussions other than a tainted reputation among the cryptocurrency scene.
With that being said, you can try to go for legal actions if a startup uses or loses their investments recklessly.
The most popular and common way of participating in an ICO is to use ETH as an investment.
This means that you’ll send ETH to an ICO’s smart contract to invest in it. That sounds simple but there a few things that you must ensure of before you participate in any ICO.
1. Make sure that your ETH is in a personal wallet, NOT an exchange
When you buy ETH from exchanges like Coinbase or Kraken, your ETH token is stored in the exchange’s wallet.
An exchange wallet and a personal wallet is completely different. When you store your tokens on an exchange, you are putting your trust in the integrity and security of the platform to keep your tokens safe.
Major exchanges like Gemini and Coinbase are strictly regulated which means that the security and safety of their wallets are top-notch. However, platforms are also vulnerable to hacks or bankruptcy which may lead to closures.
Personal wallets, on the other hand, are wallets that are only available to you. They are not owned by a 3rd-party and cannot be accessed by anyone unless you give (or leak) your private keys to someone.
You don’t want to store your ETH in exchanges if you want to participate in ICOs as there are a lot of issues between sending and receiving the tokens. Instead, you want to move your ETH to your own personal wallet.
There are a lot of differences between a personal and an exchange wallet.
First off, personal wallets are only accessible by you and are not owned by anyone else. This means that tokens in personal wallets can only be sent and moved by you.
Remember to never leak any information about your ETH wallet EXCEPT for your address. Everything else such as your private wallet key should be kept private and be unknown to everyone else.
Think of your ETH address as your bank account number and your ETH wallet private key as your credit card PIN number. It’s OK to give people your bank account number for transactions but it’s not OK for you to give people your PIN number.
Some personal wallets that are highly recommended include:
- MyEtherWallet (Browser-based wallet)
- MetaMask (Firefox and Chrome browser addon)
- Mist (Desktop wallet)
- Parity (Desktop wallet)
- imToken (iPhone wallet)
- imToken (Android wallet)
As a general rule, you should only move your ETH and tokens to an exchange when you want to buy or sell. Otherwise, keep your ETH tokens in your personal wallet at all times.
Do note that exchanges charge fees (sometimes too much) to move your tokens from the exchange and vice versa.
2. Correctly identify the details and smart contract address of the ICO
Due to the technical and often vague nature of ICOs, incorrectly moving your money or giving out the wrong information can lead to loss of your ETH tokens.
Therefore, it is extremely important for you to know the details of the ICO such as:
- The date of the ICO
- The time of the ICO (make sure that you convert into your timezone for convenience)
- The terms of the ICO
- The conversion rates of the tokens
The most important thing, however, is to know the correct smart contract address of the ICO.
Make sure that you drill this into your mind; if you send your ETH to a contract other than the ICO’s smart contract address, there is no way for you to claim a refund or get your token back.
This means that the only way to get your misplaced tokens back is if the recipient himself sends it back to you. However, due to the pseudonymous nature of the blockchain, the chances of that happening is virtually zero.
To make sure that you stay safe during the ICO process, follow these guidelines:
- Bookmark the official website of the ICO. The official website usually contains step-by-step instructions on how to participate in its ICO. Never, ever trust any website other than the official one.
- Subscribe to the ICO’s newsletter or mailing list. Usually, ICOs will use e-mails as a way to remind investors about the date of the ICO and the correct smart contract address to send ETH to.
- Join the ICO’s Slack or Telegram group. The official Slack and Telegram channels of ICO’s usually contain plenty of discussions and information on participating in it.
- However, be careful about sending money to addresses that you see on Slack or Telegram. Nowadays, most reputable ICOs only release their smart contract address through their official website, NOT through a Slack or Telegram channel.
- Whenever you see a smart address on the channel, double check it with the official website’s address. If it’s not the same, report it to the channel’s admin & moderators.
- Also be careful of phishing links and fake URLs.
To prevent situations like these from happening, ICOs nowadays only release the smart contract address on the day of the ICO, usually an hour or two before the estimated time.
3. Sending ETH to the smart contract address
This is the exciting part of ICOs – actually investing in it with your ETH tokens.
Usually, an ICO will state its expected time to begin on its official website. While startups can give you an estimated time to participate in the ICO, the most accurate way to get into one is to figure out its starting block number.
The starting block number is based on the current block number that is being mined on Ethereum’s network.
Recall what we’ve mentioned earlier about verifying transactions on the blockchain by miners; the blockchain gets its name from a series of data blocks that are verified one by one, thus forming a chain.
Each block in a blockchain has to be verified individually and incrementally. This means that miners must verify blocks starting from block #1 to block #2, block #3, and so on.They cannot mine block #1 and then move to block #4 and then go back to block #2.
Therefore, ICOs are usually started based off a block number rather than a specific time. To check the current block number that is being mined on the Ethereum network, head over to EthStats to find out.
For example, the current block number at the time of writing is block #3,987,514.
Startup A wants to launch its ICO at block #4,000,000.
Therefore, the time to send your ETH to Startup A’s smart contract address is when the block that is currently mined goes to block #4,000,000. You can also send your ETH on block #4,000,005, for example.
Do it too quickly and you will get an error on your transaction. Do it too slow and you might miss out on the ICO.
4. Understanding Ethereum gas prices
When sending ETH to a smart contract, an important concept that you must grasp is the transaction’s gas.
We’ve mentioned earlier that ETH is used as an incentive for miners to verify your transaction. It is also used as gas to power your transactions in the network; think of it as “fuel” for your ETH transaction.
The more gas that you input for your transaction, the quicker your transaction will go through as miners receive more rewards for their efforts. If you have too little gas, the transaction will fail (you won’t lose your money, though) as miners are not interested in verifying your transaction due to the lower incentives.
During ICOs, there are many people that are looking forward to participating in it. Therefore, the Ethereum network can get congested due to the massive amount of transactions compared to the number of miners.
Therefore, you’ll need to significantly increase the gas price for your transactions to go through during congested ICO periods. By using a website like ETH Gas Station, you are able to determine the average gas prices for transactions.
Calculating gas prices, however, is extremely complicated (for no reason, actually).
To keep it simple, gas is measured in amounts like 21,000 and 42,000. However, this is not equivalent to 21,000 or 42,000 ETH, so don’t panic!
You should see gas prices in your ETH wallets depending on which one you use. A rule of thumb to apply when changing your gas prices is to x10 the initial amount for your transaction to go through in peak periods.
If you want to have a chance at participating in an ICO, if your default gas price is at 21,000, change that to 210,000 instead.
5. Receiving your tokens
If you’ve successfully sent your tokens to the ICO smart address, when the funding target is reached, the ICO’s tokens will be sent to your personal wallet immediately.
Going with the earlier Startup A example, you will receive STA tokens in your personal wallet when the ICO is over and when the target funding is reached. The smart contract is smart enough to know which address to send the tokens to so you don’t have to worry about that.
Once you’ve received your tokens, you are free to do whatever you want with it.
Note: Some ICOs may lock up your tokens for a period of time for a week or two. After the lockup period, your tokens will be released to your wallet automatically. ICOs do this as a way to prevent flipping which is a massive sale of tokens on exchanges after the ICO.
6. Alternative ways of investing in ICOs
While most ICOs are funded with cryptocurrencies, investors can also use cash to invest in ICOs.
Cash in the cryptocurrency world is referred to as fiat. So, if you see the word fiat, it means real money e.g your USD, EUR, etc.
Sites like Bitcoin Suisse offer investors the chance to use fiat to invest instead of using cryptocurrencies.
However, you should know that fiat investments usually have requirements such as:
- KYC requirements. This means that to invest with cash, you need to provide your ID and proof of identification such as your personal address and bank accounts as part of the Know Your Client procedure in investing. However, most exchanges have KYC procedures in place so it is not something that is limited to fiat investment.
- An investment of at least $5,000. Fiat investments are also not for small-time investors. You are expected to invest at least 4-figures to participate in it. Some ICOs may require 5-figure investments for fiat investors.
- Only certain countries are allowed. For example, Bitcoin Suisse does not allow US investors to invest in their platform due to laws and regulations. Some countries such as North Korea are also banned from investing due to policy issues.
There was a point in time where investing $10 in Bitcoin or Ethereum would have made you a multi-millionaire today. Hence, ICOs are banking on that fact to raise funding for their tokens.
However, it is important for you to understand why tokens rise in value.
The first and most common reason for a token’s rise in value is hype. Ethereum is a perfect example of this statement.
A month back, ETH experienced a dramatic rise from being valued at $50 to nearly touching $400 in a month.
The hype started mainly from the technology’s adoption by mainstream companies and conglomerates. Organizations like the EEA (Enterprise Ethereum Alliance) as well as several big-name events like Coindesk and Consensus 2017 added even more fuel to the fire.
The hype reached a peak when names such as Toyota and Microsoft were involved with Ethereum. This led to massive coverage by the media which prompted a demand for ETH which leads us to the 2nd factor.
Demand and supply are also a major contributor to token values. Again, Ethereum is a great example of how a token can rise massively in value thanks to increased demand.
After the widespread coverage of Ethereum on the Internet and publications, hordes of new investors rushed to exchanges to get their hands on ETH. This led to increased amounts of ETH buy orders on exchanges which led to higher prices.
ETH holders, on the other hand, were not selling their tokens in an effort to drive the price as high up as possible. This lack of supply paired with an increased demand proves the basic economic statement; an item with high demand but low supply will rise in price – just like ETH.
The value of a token is also largely determined by the number of tokens in circulation. In general, the lower the circulation of tokens in a market, the higher its price. For example, Bitcoin only has 16 million tokens in circulation compared to Ethereum’s 93 million (as of today).
Hence, the value of Bitcoins is going to be higher than ETH as it more scarce due to the lower supply.
For tokens like Siacoin and Dogecoin where the circulating supply is well over 10 billion tokens, prices are less likely to be more than $1 due to the large supply.
The final factor for a rise in a token’s value is its future use case. A token or technology that has a chance to become something revolutionary in the future will appreciate in value due to its potential.
Ethereum is touted as the successor to Web 2.0 as well as being the future of data transmission. Tokens like BAT and Golem also have value thanks to their ambitions which will definitely disrupt the tech scene if the projects are a success.
However, the same 3 reasons above can also be the reasons for a token’s downfall.
Hype can raise a token’s value but it can also bring it down extremely quick. A few weeks ago, the Ethereum community was preparing for a massive rise in price after an announcement was made by Andrew Keys about a large startup with ‘millions of users’ that is ready to launch its ICO.
Rumors spread like wildfire and there was massive hype on the identity of the startup. On the day of the announcement, it was revealed that the company is Kik, a social media platform.
While it is true that Kik has millions of users, it was a letdown to the Ethereum community as they expected a company that was truly a giant in its scene. The Kik announcement immediately led to a staggering dip in the value of ETH (a 30% drop in one day).
Therefore, it is extremely important for you to do research on an ICO’s team, their project, and the viability of their idea. Lofty ambitions are not always great as you never have a guarantee of success.
The second incentive for investing in ICOs is to receive a portion of the startup’s profits for the fiscal year.
DigixDao tokens (DGD), for instance, are stored based on the value of real-world gold. Therefore, profits that are obtained from the trading of gold is directly shared with holders of the token.
Etheroll, an Ethereum-based gambling platform also offers profit sharing with its token holders.
ICOs are still in its early stages which means that regulations are lax for the moment.
However, you should be prepared to abide by regulations and enforcements by the government as the ICO space matures. Basically, you should expect for ICOs to receive regulations similar to investing in stock markets and IPOs. As of today, there is one notable regulation for potential ICO investors:
To put this into perspective, the United States is very strict when it comes to anything that involves investing. Right now, only accredited investors are able to participate in private placements of securities.
You might think that ICO tokens are just tokens and not securities but regulation officers have a strong and contrasting opinion to that. ICOs are generally labeled as a sale of equity in the investment world.
The trouble with regulators comes from the fact that ICOs cannot directly control the type of investors for their ICO – they cannot ensure that only accredited investors can participate.
Some ICOs will ask if you are a US citizen, but there is no verification of that statement. Platforms like Bitcoin Suisse got one step further by asking for ID verification to invest.
However, if you are using cryptocurrencies like ETH to invest in ICOs, there’s no way for the team to know that you are from the US or Singapore. Even if they were to apply geoblocking, you can easily use a proxy or VPN to bypass the block.
Bigger ICOs are taking preventive steps by hiring lawyers to solve this issue. It is a necessary step as tokens sales are very vulnerable to criminal charges in the US should the SEC decide to intervene which is inevitable as the industry matures.
However, that should not deter you from participating in ICOs for now. As long as you believe in the project, investing in ICOs is an excellent alternative to traditional stock market and assets investments.