People invest a lot of money in ICOs. But most people have no idea what an ICO actually is and where the money flows. Because ICOs are so popular, people invest a lot of money without looking at the facts. They just “hope” that this new coin or project will be the new Bitcoin or Ethereum. In this article we will explain ICOs and if you should invest in them, how money is raised and where the money actually flows.
1. What is an ICO?
ICO stands for Initial Coin Offering. This is the first time coins or tokens are for sale to the public. An ICO is used to raise money to fund the project of the related coin or token. For example, Ethereum started as an ICO. At this time of writing, Ethereum is the second largest coin with a market cap of 27 billion dollars. At the time of the Ethereum ICO, you could buy one Ethereum for just a few dollar. Now, one Ethereum is worth a few thousand dollars. So you can image that ICOs are very hot at this moment. People “hope” that the next ICO will be just as successful as Ethereum so they become rich. Unfortunately, this is very unlikely. You should be very cautious when investing in ICOs.
2. How do ICOs raise money?
You could compare ICOs with a Kickstarter project. If you are not familiar with kickstarter, kickstarter is used to raise money for new projects. That does not mean every project will be successful. You should treat ICOs the same way. ICOs do a lot of marketing before they reach the ICO date. At this date, their coin or tokens are released to the public. The public can then buy these new coins or tokens. Most of the time you can buy these tokens with Bitcoins or Ethereum. You can send your Bitcoins or Ethereum to a specific wallet address. In return you will receive new coins or tokens. At Icodrops.com you can see a list of all ICO release dates for the upcoming months. Every ICO raises money in their own unique way. And you should know exactly how these ICOs raise money. Because if you have no clue where the money flows, you will probably have no idea what you are buying.
2.1 ICO whitepapers
The first place where you should look is in the whitepaper of the concerning coin. You can find the whitepaper on the website of the developper. If you cannot find the whitepaper you should stay far away from that ICO.The whitepaper is the most important information you have about the ICO. Most white papers are full of crap. Long exciting stories about how good their new token will be. You should read between the lines. Is the new project really that innovative? Can it be used in the real world? Does it have any technical data to back their claims?
You should read the full whitepaper and understand everything. Because if you don’t know everything then you have no clue what you are actually buying. And this is the most common mistake an investor can make. And this is the main reason Warren Buffet is the best and wealthiest investor to this date. Because Warren Buffet only buys stocks when he is 100% sure of what he’s buying. He does not buy anything he does not understand. And this is the best advice you will get: only invest in what you know. That does not mean that every stock he buys will be successful. But knowing what you buy is the difference between “hope” and real expectations. You will sleep much better if you exactly know where you invested your hard earned savings in.
2.2 Where does the money go?
So where do all these millions of dollars of ICOs actually go? This information can also be found in the whitepaper or on the website of the ICO. If you cannot find anything about the money flow you should not invest. Let's take a look at the Monetha whitepaper. At page 36 and 37 you will find information about the token sale:
This is very important information because you can see where the money will flow after the ICO takes place. In this case, 40% of all money/tokens will be used to create and fund the project. And 60% of the tokens will be available to the public. As you might have noticed, they mentioned a soft cap of 7 million dollars. The hard cap is still to be announced. But since this ICO already took place we know that the hard cap was 95.000 Ethereum. The hard cap was reached within 18 minutes (!) when the ICO went live on 31 August 2017.
But notice that they mentioned a soft cap in dollars rather than Ethereum. On august 31 the average Ethereum price was around 380 dollars. Monetha raised 28000 Ethereum to reach the soft cap. So they actually raised ~ 3 million dollars more based on the soft cap in the white paper. But they did mention in the whitepaper that this amount is subject to change. At this time of writing, the price of Ethereum dropped to ~ $280:
That means they already “lost” ~ 3 million dollars in just a few days. In this case, the hard cap was 95.000 Ethereum. That means Monetha raised ~ 36 million dollars in total within 18 minutes. But with the current price of Ethereum, this dropped to ~26 million. So where did the 10 million dollars go?
The hard cap is very important. Without a hard cap, the owners of the new token can raise millions of dollars they probably won’t need at all. Let's assume there was no hard cap for the Monetha crowdsale. If they raised 95.000 ETH in just 18 minutes, they could potentially raise hundreds of millions more by extending the hard cap. Also notice that 15% of the generated tokens will go to the Monetha team. You should make your own conclusions about the hard cap. Does the Monetha project actually need 36 million dollars? Where does this money go exactly? According to the Monetha whitepaper:
What will happen to the money if their budget estimates are not accurate? Do you have enough information based on the white paper? Is the information in the whitepaper accurate enough or are they just assumptions? You should do your own research. For example the Monetha whitepaper mentions the following:
“At the same time, it gets harder and harder to make transactions on Bitcoin: according to www.blockchain.info, the “Average Confirmation Time” to confirm a transaction was 316 minutes as of June 13 and “Cost per Transaction” was approximately USD 4.” Although this is semi true, this is just a moment in time that is subject to change. Since the first of August, SegWit has been implemented on the Bitcoin blockchain. And there are also plans to increase the blocksize. As you can see on blockchain.info, the confirmation times are much lower in the beginning of August 2017:
Later in August, spikes on the network did happen. But they only represent the average for that particular time frame. What's the point of all this? Do your own research. Are the claims just assumptions or out of context? You should never believe anything in a white paper. Only if they can back up their claims. As you noticed in the Monetha ICO they “lost” 10 million dollars because the price of Ethereum dropped from $380 at the time of the ICO to $280 in just four days. So did they actually raise 36 million dollars? That is only true if they sold every single Ethereum they received right away. That is probably not the case. Besides, what would happen if the price of Ethereum went up instead of down? What if the price of Ethereum went up to $450 dollars in just a few days? In that case they now have almost 43 million dollars. That is way above the hard cap. Do you think they will pay you back the difference? This is just an example and could happen with any ICO.
3. What can you do with tokens generated by an ICO?
When buying tokens in an ICO you backup the project. That means you think the project is a good idea. Or you just want to make money by trading the new tokens on exchanges. Before you buy tokens in an ICO you need to make an investment plan. What are you going to do with the new tokens? There are a few options:
- Hold the tokens for a few months/years
- Trade them on exchanges
- Use the tokens for real world applications
Most people just buy tokens/coin during an ICO and use them for trading or holding. Some people “hope” this new coin will be the next Bitcoin and Ethereum. Others use the new coins for day trading and take advantage of the unknowing investors who are buying and selling in panic. You should know that some coins won’t be available for trading. Besides that, the exchanges a coin will be listed on can be limited. Big exchanges won’t list any coin without a good reason. Thus you should do your research before you buy coins in an ICO if you want to trade them on exchanges.
Only a few percentage of people will use the coins for real world applications. Coins or tokens are used on the network for specific features. For example, Storj tokens are used for various features on the Storj network. But these tokens can also be traded on exchanges.
4. ICOs might be illegal
ICOs are actually not legal in some countries. Recently, China has made all ICOs illegal. Even projects (in China) who already raised millions with an ICO might get into legal trouble. You have no single legal right when buying tokens or coins during an ICO. There are some examples where the website of the ICO was hacked and millions were stolen. Even though it looks like some outside hacker stole this money, it could also be someone on the inside of the project. That is why you should do very thorough research before you even consider buying into an ICO. Who are the persons behind the ICO? Can they be trusted? Do they have any experience with other projects?
With an ICO you basically give some people (you don’t even know) money to build some software. They might have bad intentions or the project is just a scam and will never be used in real life. You should know that most ICO’s are just copycats of existing coins and bring zero value.
5. IPO vs ICO
In the regular stock market, IPOs are the equivalent of ICOs. IPO stands for Initial Public Offering. With an IPO, stocks of a company can be bought by the public for the first time. A privately held company turns into a public company. But the fundamental difference between ICOs and IPO’s is that with an IPO you buy a little piece of the company. With an ICO you own nothing. You only buy worthless coins and you are dependent on the market prices on exchanges. Why? Because every single cryptocurrency project out there is so volatile, you can’t use it for anything unless you want to gamble with your money. Every single project out there is just speculation on things to come. That becomes very clear when you look at the current (9/4/2017) correction in the market:
These are all very different projects. Some have great potential but does that even matter? NEO and OmiseGO are affected by the recent ban on ICOs in China. But why did Ethereum drop from $380 to $280 in just a few days?
It does not matter how great a project sounds or looks. All cryptocurrencies are controlled by miners, whales and investors. They are all bound together. When the price of Bitcoin falls, all cryptocurrencies will fall. In the regular stock market it's adviced to stay away from IPO because you have zero information about the past financial situation of the company.
6. Should you invest in ICOs?
If you look at ICOs or IPOs from the standpoint of value investing, you should stay miles away from ICOs and IPOs. And the reason is quite simple: you have no clue what you're buying. You basically give people you don’t know money to build something. With an IPO or ICO there are no track records. You have no idea if these people can actually build big businesses with millions of dollars. Actually, most ICOs just exist to grab as much money as possible. Because if the project fails, they don’t lose any money. You (and many others) gave them millions to build something. If they fail, you got nothing and they still have millions.
There is a reason why countries like China and the USA are banning ICOs. You are at great risk of losing all your money. That does not necessarily mean that will happen. There are also great projects around that can actually change the world. The best example to date is Ethereum. You should also be aware that a large amount of ICOs are so called pre-mined. That means that the developers already have a lot of coins in possession before the public can buy them. They can use these coins to manipulate the market. Be very careful when investing in ICOs. Don’t buy something because you think it's great. You should look at yourself in the mirror and specify every detail of the project to yourself. Never invest money in ICOs based on opinions from others.
You can use the following checklist to determine if you should invest or not:
- Is there any hard cap?
Without a soft or hard cap, the owners can potentially raise millions of dollars they don't need. It’s very doubtful that any ICO needs millions of dollars in the first place.
- Do you understand every detail of the project?
You should know all details about the project before you invest. Where are the tokens used for? How does the network operate? Can you mine the coins/tokens? Are there any wallets available? Etc.
- Research details about any person involved in the project
Who are the owners and developers of the project? Can they be trusted? Do they have any former experience with blockchain technology? Can they handle millions of dollars? If you can not find information about the owners you should not invest.
- Where does the money go after the ICO takes place?
It should be very clear where the money will go after the ICO takes place. How much percent of the coins/tokens goes to the owners or team members?
- Always be sceptical until proven otherwise
Most people are greedy. Everybody wants to be rich. Don’t invest because you are greedy. Be sceptical about every project until proven they actually have some great ideas. But they must backup their ideas with actual data otherwise it's just marketing. Most white papers are full of crap. Making claims they can’t back with real data. Or they pull data out of context.
- Are they truly unique?
With hundreds of ICOs popping out of nowhere, there are many projects that all want to do the same thing. There might be ten ICO that all want to provide some way of online storage based on blockchain technology. Probably only one or two will be successful. You should research if there is any other company out there trying to do the same thing. An ICO for a new type of online gambling might sound great. But if there are already ten of those company’s around, you should be very sceptical about their intentions.
- Is the white paper up to date and full of details?
A badly written white paper is a very bad sign. The white paper should be full with all kinds of details. Backed up with data you can verify. Most white papers consist of all marketing talk and features that don’t even exist. Keep in mind that they still need to develop the project. They want your money. Read between the lines.
- Join the community
Most ICOs have a community of some kind. Most of the time this is a slack or discord channel. You can also find information on forums like bitcointalk.org or reddit. If you follow this checklist before you invest any money, you have a great chance of finding the real gems in the pool of mud. Just think about it this way: all they want is your money. Let them give you a good reason to give it to them.
- Are coins premined?
Sometimes the owners of the project claim coins or tokens before the ICO takes place. This is called pre-mining. This basically means they might claim millions of dollars for themselves. Without the intent of funding the project with this money. Be very cautious if large amounts of coins or tokens are pre-mined.
How you think about this?