How do ICOs work?

How do ICOs work?
on May 21, 2018

ICO’s are the cryptocurrency world’s equivalent of stock market IPO’s. The crowdfunding concept, made popular in the late 1990’s by rock bands seeking support for independent album releases and touring, is taken a step further by ICO’s which leverage the decentralization and worldwide reach of cryptocufrencies.

You’ve got a great idea, you’ve filed a patent and you control the tech behind something truly great that has lots of market potential. How do you realize such a project? How can you go from idea to reality? You need funding and proper project management. ICO’s guarantee the former.

First thing is to publish your vision through an academic-inspired format that is now ubiquitous in the world of cryptocurrencies: a whitepaper. That’s how Satoshi Nakamoto made Bitcoin known to the world and that’s how all ICO’s work ever since. In fact, Bitcoin can be considered the world’s first successful ICO! It has a whitepaper, it has a vision and purpose and the crowds made Bitcoin what it is today!

After publishing a whitepaper, the community gets to know your idea. It is then time to promote the ICO so that more people find out about it. The more people become interested in your idea, the greater the funding potential. After proper promotion work is done, the community should know about your project and, if the idea is really attractive, there should be demand for a share of your project by now.

The project owners then reserve a share of the future prospects for themselves and a share of it for the crowds. If the project requires U$ 1 million in funding to get started, the ICO should be planned for, say, 5 million U$. 20% of these funds should be allocated to the project, with 80% being distributed to stakeholders. It is crucial to balance the interests of the project with those of the investors. Withholding too large a share for the project may look greedy, whereas allocating too little could leave a project partially funded and incomplete. Transparency and honesty are key to a successful ICO. Informing the people who believe in your project is crucial to keep the community excited and trusting in your vision.

Then comes the great day! A coin or token generation event is held where shares are distributed transparently. All token and coin transfers should be committed on the blockchain. This is where the cash investment by all stakeholders become shares in the project. The shares are represented by the tokens. If the total token allocation is expected to be worth U$ 1 million and 20% is reserved for the project, the blockchain should reflect this fact. The project’s blockchain address should be known to all so that the funds can be audited by the community. Every stake should also be committed on the blockchain, so investors have a complete vision of the ICO process.

When successful, an ICO is able to leverage the power of worldwide crowds to fund cool and exciting projects. You may have invented a neat solar power system, an electric car, or you may have composed an awesome music album. All crowdfunding can be done via the ICO method! Creating a currency using Ethereum or NEO is not a difficult task. In fact you can find free source code to create your own token freely online!

Once the shares in the project go public, they usually become tradeable on exchanges. That’s how, for example, Power Ledger, which is an amazing project from Australia, gets traded like a regular cryptocurrency on exchanges like Bittrex or Binance. What’s behind POWR is an amazing project with immense potential, but the tokens generated during its ICO get traded like any other cryptocurrency. It’s an interesting world of interwined projects and complex relations between cryptocurrencies themselves. At any time of the day, you can measure the value of tokens generated in ICO’s against Bitcoin or Ethereum, which makes the crypto ecosystem both exciting and mysterious at the same time.

So, in essence, ICO’s are simply crowdfunding projects that leverage the decentralized power of cryptocurrencies. Anyone anywhere in the planet can become a stakeholder in the most interesting projects without ever having set foot on the project’s country of origin! Whether you’re investing in Cardano ADA, which is also known as the “Japanese Ethereum”, or in Power Ledger in Australia, ICO’s made it possible for these projects to raise millions of U$ in funding to get started with their vision.

All this freedom comes with a price. A lot of ICO projects are run by scammers who abuse people’s trust and good will to make a quick dollar and then disappear. ICO scams are easily found via web search and we won’t go into excessive detail here. Suffice to say that you must perform due diligence before investing your money into ICO’s. As with everything else in cryptocurrencies, the crowds determine the success or failure of a crypto project. Bitcoin depends on its vibrant and active community in order to stay alive. The same applies to every ICO out there. When a fraud is suspected, make it public, discuss on Reddit or Twitter, raise awareness. Many times it’ll be miscommunication and the project many be legit. Other times there’ll be real cause for concern and the project leaders should be inquired about the suspicions.

Some ICOs have been busted using actor’s photos on their team page, others have been caught faking emails and “defrauding themselves” while claiming it was hackers, and you name it. There are all kinds of creative scams and you should be alert when it comes to investing your hard earned money. The main aspect to keep in mind about ICO’s is to look for real people and real institutions behind the offering. Is the team verified? Do the people really exist? Who are they? What is their background? Do they have the experience and know-how advertised? Does the project have a long term prospect or does it reek of a hit and run? Asking basic questions can go a long way in preventing ICO fraud.

ICO’s are an awesome new phenomenon brought by cryptocurrencies. Being able to become a partner in a project across the globe is both exciting and very powerful concept that leverages worldwide democracy. As with all powerful and disruptive technologies, some care must be taken to join good projects and avoid the bad ones. ICO’s are here to stay and as this crowdfunding modality gains popularity, expect more regulations and laws to govern the space, giving investors more legal protection and formal ways to guarantee a proper investment experience.

Illustration Credit: Draglet GmbH