Cutting Through The Bullshit. There are many terms associated with the cryptocurrency world that has become, more or less, very mainstream over the last 4–5 years. Most people now have an idea about what a “blockchain” is and people definitely know what a “bitcoin” is.
Lately, however, one term has been gaining more and more mainstream attention. That term is “ICO” or Initial Coin Offerings and has raised billions for blockchain based start ups. It has been called everything from “revolutionary” to “a Ponzi scheme. Before we get into the meat of this, we need to understand everything that surrounds this astounding phenomenon.
In the real world, companies can always secure funds by approaching angel investors and venture capitalists but by doing that, they would have to give away a share of their equity to them. What companies wanted, was to get a lot of funds without giving away equity and ownership. The only way that they could do that was by going public.
The way companies do this is by holding an IPO aka Initial Public Offering. How does an IPO work?
In an IPO a private company basically decides to put up its private shares up for sale to the general public. Anyone anywhere can buy the shares of the company. Initially, these shares are dirt cheap and if the company hits it big then there is a chance of your shares ballooning up to exorbitant prices. We have all heard stories of the masseuse who became a multi-millionaire after her 500 “useless” stocks in Google matured over time.
So, people started wondering what would happen if we used the same concept and put it on a blockchain based environment. This is what gave birth to the concept of ICOs. ICOs are pretty similar to IPOs but with 3 major differences.
Firstly, the ICO was decentralized with no central authority, secondly, the ICOs lacked the tedious red tape that most IPOs were bogged down by and finally, they were unregulated while IPOs have always under been heavy regulation. Now there was a problem that blockchain based companies were facing when it came to ICOs. In an IPO, the investors got shares in return of their investment. What would a blockchain based company give away in exchange of capital? They had to invent the blockchain equivalent of a share and that was when they came up with the idea of “Tokens”.
An ICO is a sort of mixture of an IPO and a crowd-sale. When you are interested in a particular project in the blockchain, the way you can gain access to it is by sending the developing team some amount of money, which is usually paid in Bitcoin or Ethereum and getting the equivalent amount of tokens in return.
Tokens have gained even more prominence since the advent of Ethereum. Ethereum provides a platform where you can use the blockchain technology not just for making currency, but to make decentralized applications (DAPPS) as well. If you want to use these DAPPS then you will need the tokens that are native to its respective environment. There are two categories that all tokens fall under:
Usage Tokens.
Work Tokens.
Usage Tokens: These are tokens that act as native currency in their particular environment and can be exchanged for other tokens or FIAT money. Ether is a great example of a usage token. In short, usage token is a currency.
Work Token: Not all tokens, however, act as currency. Some tokens are there to give you various rights within their native environment. Eg. If you were a DAO token holder, then you had the right to vote on whether a particular DAPP could get funding from the DAO or not.
Think about this, anyone, with an idea for a project, can gain massive financial backing from a community without being bogged down by politics or endless red tape. The idea that anyone anywhere can get the financial backing they need in an unregulated manner was a welcome idea for all. No longer will investments be reserved just for the uber-rich, anyone can gain the funds to make their dreams a reality.
Firstly, the developers will announce their intention of making the project to generate hype and interest in the project. This step is very important because first impressions are everything.
Then, the developers will create a white paper. A white paper is a document issued by the developers which highlight their project and the specific features of that project that makes it enticing for the potential investors. While it is true that white papers are supposed to be a sales and marketing tool, it is nowhere near as flashy and over-the-top as a brochure or a sales letter. Whitepapers are written in an academic manner and the specific purpose is to entice the investors by showing its potential and features. They are at least 2500 words long and are meant to be purely informational.
After that, they will run the white paper through prominent members in the blockchain community to get their backing. Getting this backing is critical because this is where they will gain the credibility required to carry forward with the project.
Now, they will need to create the tokens which they are going to exchange for Bitcoin or ETH in the token sale. The process of token creation has already been covered above. Developers will have to decide the limit to the number of tokens and the amount that they want to charge for each token. Usually, the price of these tokens is very low at the start of the ICO. Setting a cap on the number of tokens is necessary because having a limited supply of tokens automatically increases their demand (according to the law of supply and demand).
Along with the cap on the number of tokens issued, developers will have to decide a time at which they want to hold their ICO. Selecting the time, and the amount of time it runs for is CRITICAL and this will be covered in detail later on. Along with that they also need to decide on the cap for the amount of money they will be taking in.
Once all these are decided, the developers choose a platform where they can advertise their ICO. Earlier it used to be tough to do so because developers had to convince people to come to their websites to gain more information about the ICO. But now, there are a number of websites which provide the platform for developers to address this particular need.
Unfortunately, because of the unregulated nature of the ICOs and the sheer amount of money to be made in this space, it does attract a lot of scammers. If you are investing in an ICO then you would want some assurances on your end that all the funds that you are going to invest are going to be used in a right way. So what should you be looking into when you are about to invest to make sure that you are not going to get scammed?
The project developers should be able to clearly define the purpose of their project using simple and short sentences. If they are taking too much time and beating around the bush, then that either means: their agenda is not clear or they are hiding something. Both of which are not that encouraging scenarios.
Make sure that the developers are not anonymous. There should be 100% transparency when it comes to their names, business plans, locations etc. You should be able to contact them regarding any and all information that you need to get from them.
There should be a legal framework between the developers and the contributors including terms and conditions set for the ICO.
Lastly, and most importantly, you need to make sure that the ICO funds are being stored in an escrow wallet. An escrow wallet is basically a multi-sig wallet which needs multiple keys to be opened. One of those keys must be held by a neutral third party.
If you keep these 4 points in mind, then you will be able to spot the scammers with relative ease and invest in projects which have real potential.