What is an Initial Coin Offering? Well, getting public money in order to start or expand business has, historically, been pretty hard. You need to find investors, go public and sell shares or loan money through business financial instruments.

There can be quite a lot of red tape around raising money as well. From regulations and centralized verification to the sheer administrative cost, which eats into how much money you get out.

Now we have crowdfunding platforms, such as Kickstarter or GoFundMe, but they still need a third-party to collect money on our behalf. Which is where the ICO or Initial Coin Offering comes into play.

ICOs are Not Quite Like Bitcoin

It’s a pity that the name ended up including the word “coin” because it creates the impression that what’s being offered is pure cryptocurrency. The “coins” in ICOs are actually something called “tokens”. These may be built on another cryptocurrency platform. such as Ethereum. Which is popular because of its ability to create “smart contracts”. Tokens are usually sold for other cryptocurrencies such as Bitcoin or even for traditional fiat currency in some cases. The token is a representation of something. It can be a vote, a right, a product or anything really. The idea is that those who have bought tokens will get a specific promised thing in exchange for that token one day. Alternatively, the token itself can be sold at a profit it the company takes off.

A token could be a concurrency on its own blockchain or it could exist on another cryptocurrency blockchain, such as Ethereum. The problem is that the word “token” can mean different things. Bitcoin is a “value” token, but in the context of ICOs, the word might also refer to other things. Let’s look at two common types of tokens.

Utility Tokens

Utility tokens are proof that you are entitled to some sort of future product or service. You pay for the token now and you’ll get the product or service when it’s ready. Well, if, it’s ever ready.

It’s best to think of utility tokens as a sort of decentralized Kickstarter. Whoever holds the token has proof they are entitled to whatever the token stands for. They aren’t any sort of investment.

Security Tokens

Security tokens, on the other hand, are meant to act as an investment. Their value is tied to an asset of some sort. Like shares, they can also come with voting rights. Legally security tokens can fall under the same laws and regulations as securities.

The Typical ICO Process

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ICOs are not standardized by any means, but by now there’s a similar general process for most of them. So if you are looking for an ICO to put money into, look out for the parts that should be in place to make it all work. It usually starts with the heart of an ICO, the whitepaper.

The Whitepaper

Every ICO needs a so-called “whitepaper”. This is the core document that explains the technology behind the blockchain variant for this particular project. It also includes all the other information that a prospective investor would need to make an informed decision about handing their money over.

There is no standard format for a whitepaper, but in general, you can expect to find a few things in each one.

First of all, the whitepaper has to explain what specific problem the project is trying to solve. Then it should clearly explain how that problem is going to be solved. There should be clear records of who the people on the team are, their credentials and everything should be properly sourced.

Tokens Go on Sale

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Once all the preamble is done, the actual tokens are put up for sale. While fiat currency is accepted in some cases, most of the time tokens are sold in exchange for other cryptocurrencies. Such as Bitcoin or Ethereum.

They Get Down to Business

Now that you have your tokens, the company uses the money raised to execute their plan. If it goes well, you either get rich because your tokens are now worth much more than you paid for them, or you lose your money. For utility tokens, they could also appreciate in value, but if you simply get the product or service promised in exchange for that token, then it’s still a good outcome!

It’s a New Way to Raise Funding

It’s important to understand that ICOs are very new. Which means no one really knows exactly how they should be handled. On the one hand, this means that there are amazing opportunities now before governments get their regulatory claws into the model. On the other hand, it also means ICOs are risky in general.

It’s like being one of the first people to buy shares at a stock exchange. Today the model of public shares in a company is well understood and monitored by independent bodies. At the outset, no one knew what sorts of problems would crop up, so they made it up as they went along.

ICOs are very exciting and will probably allow for companies to exist that might have been impossible before. It’s crowdfunding decentralized and democratized. But freedom and risk go hand-in-hand.

There’s Major Scope for Fraud

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ICOs are attractive to startup projects because they are fast, can raise millions in minutes and don’t have to go through any sort of centralized oversight.

The problem with that should be obvious. Just about anyone can create a legitimate-sounding project, create an ICO and then get a mountain of money. They can then also take all of that money and abscond with it. Something that is popularly known as an “exit scam“.

How to Spot Dodgy ICOs

ICOs have been made illegal in several countries, including China and South Korea. Even in countries where they are not explicitly against the law, governments and trade bodies have given stern warnings to potential investors about the risk of putting money into an ICO.

Even when an ICO is 100% legit, the risk is still no better than any other sort of investment. Add to this that, unlike shares, you are not getting company equity, and you have to be really sure that your money is going to the right place.

While there is no foolproof system for spotting an exit scam or generally dodgy ICO, there are a few general pointers that should help you identify red flags before any of your hard-earned cash goes bye-bye.

Always DYOR for an Initial Coin Offering!

“DYOR” or Do Your Own Research has become another crypto-related term that is thrown around on forums and websites. This little bit of jargon represents some sage advice, however.

You can’t simply trust the information given to you directly by the people selling the ICO. You need to find third-party information they have no control over that confirms whatever claims they are making. If the window of opportunity to get in on an ICO is very small, it’s better to just pass on it. After all, limiting time is one way to prevent people from thinking too hard about something and pressuring them into getting on board. The plan with an exit scam is to get as much money in as little time as possible and then disappear. ICOs that are high on pressure and short on time should be a big red flag.

Also, be wary of getting your information from forumites, bloggers or influencers. Remember that it’s easy to pay people for promotional purposes. While we are now seeing laws and regulations on platforms like YouTube that force disclosures of interest, it’s not yet standard practice.

Do Background Checks on the People

An ICO has people behind it. Who are these people? Are they real? Are they actually involved?

The first thing you want to see is a list of specific people with contact details and histories, listed on the ICO site. Then you want to go visit the social media accounts or other third-party domains of each person and make sure they really are involved.

It’s easy to steal a name, a photo and other information about someone and set up a fake list of people on your site. It’s also relatively easy to confirm who those people are and if they are involved. So there’s no excuse for handing over your money before making sure the crew is legitimate.

Are the Promises Realistic?

Everyone who puts money into an ICO should understand that there are never any guarantees. If that’s what you are looking for you’re better off putting your money into a low-risk, regulated investment instrument. Preferable after consulting with a licensed financial adviser. So whatever the people behind an ICO promise, there are always significant odds that you’ll lose some or all of your input.

That being said, some promises are inflated, unrealistic and a big red flag. Think carefully about the promised return on investment that’s on the table. Can it be done? Has it been done before?

Is the Initial Coin Offering Whitepaper Good?

Every ICO has a whitepaper. A document explaining the technical details of how the ICO works. What makes it special and how it will achieve what it sets out to do. Doing a good whitepaper is hard. It requires original thinking, problem-solving and hard work. If scammers went to the trouble of crafting a legitimate whitepaper, they might as well run a legitimate ICO. This is why a suspicious whitepaper is a key sign that you should head for the hills.

Of course, most of us don’t have the technical expertise to really understand the nuts and bolts of cryptographic technology and the other technical details of the ICO project. However, a legitimate ICO will want prospective buyers of their tokens to have a clear idea of what they plan to do. If the whitepaper is vague, short on details and completely incomprehensible to you, then you either have an incompetent team or a scam. Neither is a sign that you should hand over your money!

There’s also the possibility that a given whitepaper has simply been plagiarized, so once again DYOR and see if anyone else has spent time analyzing the whitepaper in question.

Does the Initial Coin Offering Business Model Make Sense?

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No matter what sort of business venture you give money to, the process by which it will sustain itself and grow needs to be crystal clear. You need to know how the service or product will work, how it will bring in money and judge if it’s likely to be a success.

If you can’t understand the business model, legit or not, it makes zero sense to put your money into it. So rather look for another opportunity.

Think for Yourself

In the end, no one can stop you from spending your money as you wish, but it is important that anyone contemplating putting money into an ICO should know that there’s a non-zero chance that money will be gone forever. Not just with the Initial Coin Offering scams, but also the usual way. Where a risky business venture just doesn’t take off.

ICOs are already having an impact on the speed with which new ideas and new companies can raise capital, but the Wild West phase will end sooner or later. As with any ground-floor phase, the potential profits are astronomical. However, the proportional risk is just as great. As always, caveat emptor.

What do you think about the risk of Initial Coin Offering? Let us know down below in the comments. Lastly, we’d like to ask you to share this article online. And don’t forget that you can follow TechNadu on Facebook and Twitter. Thanks!