ICO Investing: An Alternative to Traditional VC
By Hermione Daguin
Initial Coin Offerings (ICOs) give the opportunity for new projects to obtain crowdsourced investments. It’s similar to an Initial Public Offering (IPO) which is where private startup companies put up their private shares for the public to buy. In an ICO tokens are used as a means of transaction and fundraising. Tokens are like share certificates and are exchanged for an amount equal to (or greater) than the amount the buyer gave in Bitcoin or Ethereum for the tokens.
Currently, there are more than a thousand ICO coins available for use. They don’t necessarily each have their own blockchain. Most are built on top of another blockchain. Many use Ethereum which serves as a general-purpose blockchain for different coins to exist on without having to create their own infrastructure. ERC-20 coins are an example.
In ICO investing, first the developers announce their project. Then, they release a white paper. A white paper is a document describing the project and its features. It’s often as long as fifty pages. They’re an academically written paper serving as a marketing tool to potential investors. Potential investors review the white paper to evaluate the merits of a project. Once the project has gained enough support, its creators create their tokens and decide the limit, exchange ratio, and time cap for the ICO. Finally, the creators market and sell the ICO.
To invest in an ICO, investors can choose to buy it when it goes to market or during the “pre-ICO” period. To buy shares when the project has been open in the market, potential buyers need Ethereum coins in a digital wallet like MyEtherWallet. They should get to know the project and its creators and conduct their due diligence. Investing during the “pre-ICO” is similar except that these investors usually have more confidence in the project and serve as angels or VC.
VC, or Venture Capital, is a form of financing from investors to startup companies that venture capitalists believe have large long-term potential. Those investors are usually large institutions or well-off individuals. The investments can come in multiple forms. It can be in money, or any kind of expertise to help the new company.
Investing in new and small companies can be a huge investment risk that may result in huge returns, or very drastic losses. Some liken the investment process to educated gambling. Sometimes, when the new company hits the market, its value skyrockets and the early investors get to reap the benefits. However, in the case of overvaluation, there is often a subsequent market correction.
Why choose ICO investing?
ICO investing benefit both the companies and the investors. In the past, early stage investments were limited to wealthy individuals or institutions such as venture capital firms. However, ICOs allow the common man to invest in early stage startups. They can be extremely rewarding if done properly, but the risk is also immense. Although ICOs have made many rich, they have also hurt many who fell prey to weak or fraudulent projects. Investors must do a good amount of research before they buy any tokens.
One of the risks that make investors have second thoughts is the lack of regulation. Just because an individual or organization writes a white paper doesn’t mean the project is trustworthy. However, ICOs have started to become more regulated in recent years. The SEC (Securities and Exchange Commission) has issued guidance on the proper treatment of ICOs, urging caution and stressing the importance of accountability. Although ICOs have not been around for too long, the decisions of regulatory authorities will influence their trends and trajectory for many years to come.