You may have heard the term ICO or ICO cryptocurrency, but do you really know what it means?
Initial Coin Offering (ICO) is one of the hottest trends in investing right now, but relatively little is known about it. However, it’s one of my most asked-about topics these days, both from my students and others.
Here’s a comprehensive guide on ICOs to help you gain a better understanding about what they are and how they work — then you can decide for yourself if it’s a good way to diversify your portfolio.
It’s important for you to know that while this emerging investing trend offers many opportunities, the government is still working to create the best set of standards and rules to regulate the system, which means that there’s an assertive level of risk involved.
First, I’ll cover the basics about what an ICO is (and what it isn’t) …
What Is an ICO?
An ICO may also be called an IPCO, or Initial Public Coin Offering. Both acronyms are used interchangeably.
But what does initial coin offering mean, exactly? Basically, an ICO is a way in which funds are collected for a new offering of a cryptocurrency.
Why collect funds in this way? Mainly because new ventures can use an ICO cryptocurrency campaign to get around some of the rules and regulations involved in the traditional fundraising process that are often required by traditional financial outlets like banks or venture capitalists.
Before we dive too deep into the world of ICOs, let’s make sure that you understand the vocabulary involved with them. I’ll use some of these terms throughout the post, so familiarize yourself with them now and refer back here when needed.
Blockchain: An ongoing digital journal or ledger in which cryptocurrency transactions are recorded publicly. This ledger cannot be altered; every purchase and transfer is recorded and does not require external verification. As WIRED notes, “Many firms are already using the blockchain to trace and record ownership, and to cut out middlemen.”
Cryptocurrency: A digital currency that uses encryption techniques as a regulatory method. This allows for the generation of units and verified fund transfers that can operate without a central bank involved. Bitcoin is arguably the most famous cryptocurrency.
Crypto Key: Short for cryptographic key. Basically, this is the string of bits employed by the cryptographic algorithm wherein cipher text and plain text can be transformed from one into the other. The key is the method through which cryptocurrencies remain secure and private. It’s the core of cryptocurrency transactions.
Crowdfunding: The practice of obtaining funds for a venture or project by raising small amounts of cash from a large number of people. It’s an alternative to receiving a large loan from a traditional financial institution. Generally, the investors have a tiered system of returns, and depending on how much they invest, they may receive a product or service in return. Usually, the fundraising is done via the internet.
Market Capitalization: Also referred to as the “market cap,” this is the value of a company traded on the stock market, calculated with a specific formula. It’s calculated by multiplying the total number of shares by the present share price. You can read a more detailed post on market capitalization here.
Venture Capitalist: An investor who supports companies or startups in various ways. It could be through providing investment capital for the venture, or supporting small companies that want to expand.
Whitepaper: A sales pitch. Whitepapers are marketing documents used as tools for potential clients to learn more about a particular offering or service. They’re often used to promote ICOs.
How Do ICOs Work?
Typically, the trajectory of an ICO goes like this: A cryptocurrency venture wants to raise money, so they set up a plan that they market via whitepapers, which state the details of the project, what’s needed to make it happen, what the project will offer, and the amount of funds necessary. They also specify details such as how many tokens the founders will keep, what type of funds you can pay with, and how long the campaign will remain active.
Rather than reaching out to established venture capitalists, ICOs market to individual investors who can invest in small or large amounts.
Throughout the campaign, supporters can buy the crypto coins, which are referred to as “tokens.” It’s somewhat similar to investors buying shares of an IPO (Initial Public Offering) in the stock market.
If the funds received do not meet the goals set forth in the initial prospectus, they are returned to the supporters and the ICO is determined to be unsuccessful. If the required funds are met, the project goes live.
The Economist published this great definition of blockchain ICOs:
“ICO ‘coins’ are essentially digital coupons, tokens issued on an indelible distributed ledger, or blockchain, of the kind that underpins bitcoin, a crypto-currency. That means they can easily be traded, although unlike shares they do not confer ownership rights. Instead, they often serve as the currency for the project they finance: to pay users for a correct prediction, as does Gnosis; or for the content users contribute. Investors hope that successful projects will cause tokens’ value to rise.”
Bitcoin and Ethereum
Perhaps the most famous (and among the most successful) ICO project to date was Ethereum. This project, involving coin tokens called “Ethers,” proved extremely profitable to early investors, and brought a ton of attention to ICOs as a potential profit generator.
The Ethereum project debuted in 2014, and its ICO eventually raised a staggering $18 million in Bitcoins. The offering went live in 2015, and by 2016, Ethers had a value as high as $14, and the market cap was measured at over $1 billion. It doesn’t take a math genius to figure out that the initial investors made some incredible profits.
What’s The Difference Between an IPO and an ICO?
If ICOs are beginning to sound a lot like crowdfunding to you, then you’re on the right track. But an ICO also bears similarities to an IPO, or initial public offering, where a private company goes public with offering its stocks to the public.
In a nutshell, ICOs are like IPOs and crowdfunding combined. But an ICO retains its own unique characteristics, too.
As with crowdfunding projects, in an ICO campaign, early adopters hope to gain benefits from investing in the endeavor. Like IPOs, a stake in the company is sold in order to raise money for the operations during an ICO. But it’s important to note that in the case of an IPO, there are extremely stringent regulations, and the company in question will be subject to reporting requirements that must be made public. This is not the case with an ICO.
Unlike a traditional IPO, however, ICOs have individual supporters backing them — more like crowdfunding. But unlike traditional crowdfunding, investors aren’t hoping for a product or service in return for their investment. Rather, they’re banking on the volatility of the market offering them a return on their investment.
Which ICOs Are Best for Investors?
The world of ICOs is still very much in its infancy. Unlike the stock market, where more and longer-term data is available, you don’t have much history to investigate with ICOs. As such, it’s harder to determine the best ICOs to invest in.
First and foremost, you must determine if an ICO is for real. There are horror stories out there. For example, a startup called LoopX recently raised $4.5 million during their ICO, only to suddenly go dark, pulling a disappearing act with their investors’ cash.
As such, the same basic tenets hold true that I suggest for choosing the best stocks: Do your research, study the market, and try to mitigate risk as much as possible by backing up your decisions with data.
I urge my students to never believe “hot tips” in the stock market. The same holds true with ICOs.
What Type of ICOs Are The Most Successful?
The motivation for most investors in an ICO is to buy cryptocoins in hopes that the offerings become successful after the launch. The higher the cryptocoin value goes up, the more they profit. In this way, it’s really not different than what types of stocks are successful.
So, ideally, the most successful ICOs are those that you discover in the early stages that go up in value so that you can profit.
That said, it’s essential that you have flexibility with your investment. You must have a plan on how to get out if needed, and determine if it’s even possible to sell your position once you’ve invested.
How do you figure that out? To help determine what types of ICOs are the most successful, look to the past (as limited as it may be). Evaluate what “worked” with successful ICOs in the past, and try to find similar characteristics in new offerings.
How Do You Find Good Upcoming ICOs?
How do you separate the wheat from the chaff when it comes to ICOs? Ultimately, by thinking for yourself. I’ll give some more specific tips on tracking ICOs in a minute; but first, heed these warnings…
Don’t Fall for Promotional Pumps on the ICO Market!
Not so long ago, the world of penny stocks was rampant with pump-and-dump schemes. Today, ICOs are subject to the same fraudulent behavior due to the lack of regulation. Don’t fall for “hot tips” or promotions sent by self-serving parties. Due diligence is vital: Look at the business plan, research the owners, and examine who else is investing in the project.
Look for ICO Success Stories
Learn about previous ICO campaigns that went well, and evaluate what made them work. This will help you determine successful stories in the future.
Why Should I Invest in an ICO Right Now?
Adaptation is key to survival in the stock market. There are many who say that learning to trade on the crypto markets is vital to remaining relevant as a day trader.
Undoubtedly, it’s a market sector that’s exciting and experiencing a lot of growth right now. The huge swings in the market mean that as a trader, you have plenty of opportunity to profit. However, like anything else in life, it’s unwise to get into this type of trading without learning about it first.
While ICOs are exciting, you should only begin investing if you feel like you’ve gained a solid understanding of this specific market.
My Suggestions to ICO Investors
Right now, ICOs are still somewhat like the wild west: exciting, yet dangerous. Here are some of my words of advice if you want to pursue investing in ICOs …
Don’t Take a Hit-and-Run Approach
The so-called “hit-and-run” strategy is used when a person or firm enters a market while it’s hot, and then leaves the market when it cools down. Unfortunately, the ICO sector doesn’t have much of a proven track record yet, so it’s hard to know if it’s at its height of heat, or if it’s cooling down. We just don’t know enough yet. So don’t take a hit-and-run approach.
Don’t Sell Short
Once again, there’s simply not enough data. With penny stocks, I only sell short when I see that a stock is following a pattern that I consider proven. With ICOs, there isn’t enough information out there yet to determine when selling short might be a wise idea. If you don’t have a theory for how an investment will go, you’re basically gambling.
Don’t Trade Only ICOs with Volume
Like with stocks, you should look at more than just the volume of an ICO. Volume should only be part of your research. To make the best decision, you need to look at the company in question, catalysts, and other factors.
A mental stop is pretty much what it sounds like: making an internal decision about when to get out of a trade or investment. Having a plan in place and employing mental stops when investing in ICOs can help you reduce potential losses, and can also help you keep a level head so that you don’t hold on to an investment for too long.
Don’t Trade Large Positions
When you’re first starting any new trading endeavor, you have to walk before you run. ICOs are no different. Don’t take large positions to start, because while your wins could be big, your losses could be too.
Create an ICO Alert
There are many ICO alert sites online. They allow you to search within specific parameters for ICOs that suit your needs or desires.
Create Your Own Cryptocurrency ICO List
Just as you track stocks and trades, you should also track ICOs. Create a spreadsheet and monitor ICOs so that you can begin to notice trends over time.
Get Enrolled in a Trading Course
Expand your knowledge. By improving your trading prowess, you’ll be better equipped to make good decisions with ICOs and with other types of investments. Day trading classes are a huge investment in your career, and their positive effects should not be underestimated.
My Trading Challenge is an ever-evolving program that allows traders to grow and learn with me as their teacher and mentor. I send alerts and write blog posts on relevant subjects like this to keep my students adaptable and on top of market trends.
Advantages and Disadvantages of Investing in ICOs
Here’s what you can gain from ICOs, and what you could lose. This will help you determine if this investment type is well suited for you.
The Risks of Investing in ICOs
Perhaps the biggest risk involved with ICOs is that they are new, unproven, and largely unregulated. Until recently, there was no involvement or regulation from authorities such as the SEC. This means that there’s plenty of room for improper behavior on the part of promoters and even the entities offering the ICOs. Yes, there have been successful campaigns; however, there have also been issues with fraudulent behavior in this relatively new market.
ICOs as a Mechanism for Scams
While there are certainly ICOs that are on the level, some have, unfortunately, been full-blown scams. Investors should always be wary and do their homework before putting their hard-earned cash into a campaign.
ICOs as a Bubble
Plenty of people want to get in on the action with ICOs — but does this mean it’s creating a bubble? It’s hard to say for sure. However, the more attention that ICOs get, the more likely it is that regulation will come crashing down. While this may reduce the opportunity for such huge profits, it will also keep investors safer, so it may not be such a bad thing for the bubble to burst just a little bit.
Are ICOs Legal?
Ultimately, the answer is yes — for the moment. Long term, though, the answer is maybe. The fact is, ICOs reside in a sort of grey area of legality.
On one hand, it may resolve in time and the grey area could just be because they’re new, barely-regulated financial assets right now.
However, the different classifications of tokens creates confusion. Some tokens are considered equity tokens, which means that they’re designed to appreciate in value. This makes them a lot like a financial security.
In other cases, the tokens are considered utility tokens, which means that they give their owners access to a protocol or network. In such cases, these tokens would not be classified as financial securities.
Sure, some people are purchasing tokens to gain access to an underlying platform. That’s similar to how some people are buying stocks to invest in specific companies. But many tokens are purchased as investments of a speculative nature.
Again, this is similar to why many people buy penny stocks: for speculation about the value of the stock versus investing in a specific company because they believe in the product.
Recently, the SEC issued a decision designed to clarify the difference between security and utility tokens. An ICO must pass the Howey Test. If it passes, it must be treated as a security. In that case, it is subject to SEC restrictions.
The Howey Test
Created by the Supreme Court, the Howey Test determines whether certain transactions qualify as investment contracts.
If they do qualify, then, following the Securities Act of 1933 and the Securities Exchange Act of 1934, these transactions are held to particular registration requirements and disclosures.
The test seeks out the following information:
- Is it an investment of money?
- Is there an expectation of profit following the investment?
- Is the monetary investment in a common enterprise?
- Do any profits come from the efforts of third parties, such as promoters?
Of course, this test opens the door to some different interpretation. For instance, the “money” has been expanded to include other assets other than money.
While this decision does help clarify the difference between security and utility tokens, there are still plenty of boundaries that probably still need to be set up. Until then, entrepreneurs are bound to continue taking advantage of this untested market in hopes of making profits.
The rapid surge of ICOs has inspired regulation from a variety of sources overseas, as well. For instance, in 2017, the People’s Bank of China officially banned ICOs, citing that they are disruptive to financial stability.
Additionally, the Central Bank resolved that tokens cannot be used as currency on the market, and banks cannot be connected to ICOs. Following this decision, Bitcoin and Ethereum both took a nosedive, with international implications.
Recently, Google, Facebook and banned all advertisements relating to ICOs.
ICOs offer both opportunity and risk. They’re an exciting, emerging sector of the market that offers the potential for incredible profits.
It’s important to remember, though, that since ICOs are relatively new, there isn’t much data or history that can be reviewed to help reduce risk or determine what factors have historically helped them reliably succeed.
If you’re interested in pursuing ICOs, be sure to learn as much as you can and do your research to mitigate risk as much as possible!
Have you invested in ICOs?