Despite a severe market downturn, ICOs continue to remain a popular choice for both small startups and large companies to raise funds. Research points to the fact that there has been almost the same number of Initial Coin Offerings in the first half of 2018 as all of 2017. And this year to date, ICOs have raised more than all of the ICOs in 2017.
These statistics may seem impressive, and in many ways they are, but they hide an often overlooked truth, that is not taken into consideration nearly enough by entrepreneurs and companies looking to conduct an ICO.
Too many entrepreneurs and companies are conducting ICOs without understanding what an Initial Coin Offering actually is and the risks involved. They are learning about ICOs by reading news articles about the “hundred million USD that X project raised in 20 minutes”, and being misled into believing that ICOs are an easy alternative to raising capital.
The truth is that an ICO is not a shortcut to avoid the time and hard work necessary to raise capital. They demand a lot of considerations and come with substantial risks. One of the most significant legal concerns most projects encounter, for example, is whether or not their token falls under securities laws.
ICOs are damn hard work to pull off. Anyone who boasts how easy it is to do an ICO is most likely ignorant of the ICO process and doing something wrong. That or they have some half-baked idea or are just a scam of sorts with no real plan to develop a viable product or service in the future.
What is an ICO?
An Initial Coin Offering is a relatively new kind of fundraising method made available by the development of blockchain technology and cryptographic tokens. Through ICOs, organizations distribute their platform’s native digital tokens in exchange for cryptocurrency (such as ether (ETH) or bitcoin(BTC)) to obtain public capital to fund their product development and business operations.
What this token represents will vary between projects, but in simple terms, it provides a specific set of rights to its holder. Some of these rights could be access to a network or a platform, rights to program, develop or create features for a system, right to cast a vote on governance issues, etc
Here are some questions that you must consider when thinking about doing an ICO.
- Is your technology a platform, really?
- What will your platform add to the crypto/blockchain community that isn’t already being served by someone else?
- Does your technology need its own token?
- Can a digital token be integrated into your business?
- How will you offer your token? — voucher, direct token distribution, or convertible note?
- How will you issue and accept contributions: Bitcoin, Ethereum, or both?
What are the risks of an ICO?
Uncertain regulations and compliance issues
At the moment, the legal framework for running ICOs and the compliance responsibilities that must be adhered to by organizations remain unclear for the most part. The vast majority of jurisdictions are still quite slow adapting to all of the innovations and changes cryptocurrencies have brought, and there is a lot of disagreement on how to regulate them. Because of this uncertainty, both the projects and the investors taking part in an ICO might be (unintentionally) breaking the law without knowing about it.
Complacency due to lack of urgency
Adam Ludwin, Founder of the Chain project once tweeted “An ICO lets you exit before you start.” The fact that some projects are raising so much money with little evidence that their idea is even possible to achieve can be dangerous. Getting all the money upfront can instill a sort of complacency and remove any pressure to deliver.
Bad distribution and excessive speculation
In good blockchain projects, the token is an integral part of the system and a necessary component for the success of the platform. The token holders need to be users of the platform and make use of the token utility for the platform to work. If the token distribution is not appropriate, or the only holders are speculators, the platform will suffer the consequences. Because of this, successful ICOs might still result in failed projects.
Flaws and code vulnerabilities
Smart contracts, the computer code applications running most of the ICOs, are new and still an experimental technology. There are still a lot of vulnerabilities in them, and even contracts coded by experts following best practices may be susceptible to errors (or attacks). A lot of money is being trusted to technologies that are still in an experimental phase where even minor bugs could lead to partial or total loss of funds, for organizations, investors, and users.
Scams and hacks
In addition to the inherent problems found within an emerging technology, the amount of wealth currently distributed in the blockchain space has created a honey-pot for scammers and hackers. Scammers or hackers taking advantage of unaware or uneducated users, and exploiting some of the complexities of the system has become a common occurrence.
Lack of understanding of cryptoeconomics
There are a lot of elements involved when designing a proper system where tokens have a relevant role. In addition to technical knowledge, entrepreneurs and their teams seeking to do an ICO require an understanding of game theory, economics, human behavior, and incentive systems. Without an understanding of these concepts, a token may lack the fundamentals to become a vital element of the system, becoming a completely misvalued asset as a result, and compromising the whole platform’s future.
What are the benefits of an ICO?
Access to a global pool of funds
Because of the inclusiveness and openness inherent to the ICO investment mechanism, projects have the possibility of accessing funds from all around the world and capitalizing on some of the wealth that the early crypto-market space has been able to create.
Generation of initial users and network effects
Token holders usually get rights to participate or use a product or a service, making them a company’s first users. Because they have invested in the token, and therefore the platform, they have an incentive to make the network grow. While this holds true, it is also worth considering that buyer motivations vary. Some of the earlier investors may love your vision and product and want the token for its utility, but there are also speculators hoping to earn some gains by trading your token.
Promotion of inclusiveness
While traditional investments have mostly been reserved for a small percentage of individuals, ICOs allow anyone to participate as an investor in early-stage projects. Anyone can be part of an ICO regardless of factors such as income level, country of residence, connections, etc. (Some regulatory restrictions may exist though.)
Like this article? Please feel free to share it with your network. Here are some other ICO related posts to sink your teeth into.
How to Choose your ICO Advisors, Blockchain, and Cryptocurrency Experts
Also published on Medium.