Everything you need to know about initial coin offerings (ICOs)

An initial coin offering (ICO) is like a fundraiser for cryptocurrencies. People invest money to develop a cryptocurrency and in return, they receive new tokens as rewards. ICOs take the money raised and use it to develop the coin. When the initial coin offering is launched, full technical documentation is published describing the nature of the project, the need it will fulfil once completed, how much money it needs, how many tokens the developers will hold, what funds will be accepted and how long the campaign will last. During this campaign, backers buy tokens using cryptocurrencies or fiat money.

Let's assume that the project manages to raise enough funds within a certain period of time (a successful ICO). In this case, the funds raised will be used to achieve the project's goals. However, if the project fails to raise the minimum amount of funds (a failed ICO campaign), the funds may be returned to investors. This type of campaign became popular in 2014 when it was used to develop ETH. Since then, there have been hundreds of other initial coin offerings to raise funding.

Many people compare ICOs to initial public offerings (IPOs), and in some ways they are similar. Indeed, initial coin offerings are the cryptocurrency industry's equivalent. However, the goals and situations of the two are usually different. ICOs tend to be more of a fundraising mechanism, while IPOs are used for established companies looking to sell some of the company's ownership to raise funds. If you buy shares in an IPO, it means you own a certain percentage of the company's stock. In contrast, if you buy tokens in an ICO, it doesn't necessarily mean you own a portion of the project.

How are ICOs regulated?

Initial coin offerings are regulated differently depending on where you are in the world. For example, in the United States, ICOs are completely legal. However, the Securities and Exchange Commission (SEC) uses what is known as the Howey test to determine whether or not an ICO is a regulated offering of value. EU rules also largely mirror the US approach.

The Howey test determines whether a transaction is considered an "investment contract" and therefore subject to securities laws and regulation. If an ICO is deemed to be an investment contract under the Howey test, then it can be regulated like any other public stock, registered and must strictly follow securities laws.

Essentially, all of this means that even if ICOs are not regulated in everything, the SEC can step in. Take the Telegram incident as an example. Between 2018 and 2019, the Telegram group raised $1.7 billion in an ICO. However, the SEC objected to it due to alleged registration failures on the part of the development team. In March last year, a court in the Southern District of New York issued a preliminary injunction. It required Telegram to return $1.2 billion to investors and pay a civil penalty of $18.5 million.

What are the risks of an ICO?

Like almost everything in the cryptocurrency market, ICOs undoubtedly carry risks for both buyers and organisers. Despite the growing number of regulators trying to regulate cryptocurrencies, the market remains largely unregulated. You have no one to help you if the ICO you invested in turns out to be a scam or if the project fails. On the other hand, ICO organisers can get trapped through financial regulations.

Risks to investors:

• Sometimes the hype can outweigh the real value;
• You risk investing in a scam or pump and dump system;
• Sometimes it can be difficult to get a full understanding of an ICO before investing;
• The price of tokens can be purely speculative and there can be large fluctuations;
• Sometimes there is a lack of transparency about the progress and problems of the project.

Risks for organisers:

• Ignorance of the rules may result in additional fines, costs or penalties. You have little or no information about token holders;
• You are liable if the security of the project is compromised and investors end up getting hurt.
• Interest in ICOs has been declining since 2018.

Both buyers and organisers face risks that need to be carefully weighed before investing money or labour.Fraudulent initial coin offerings are indeed common, but that doesn't mean that all ICOs should be avoided. There are still some great projects out there, and you just need to do your research and find out if an ICO is trustworthy or not. If you find a good project, you may have a chance to enter the market early and, if successful, make a big profit.