Rule of Thumb For ICO Investor: Explore Risks Involved

Initial Coin Offering or ICO is an innovative way of raising funds currently used by several technology startups. It is becoming a popular choice for companies involved in cryptocurrency and Blockchain industries or those who are familiar with the benefits of offering tokens instead of company shares.

Also known as “crowdsale,” ICO is an event whereby a company begins raising funds through the release of its cryptocurrency. Most of the time, a certain company releases a particular number of crypto tokens to be sold to its target audience. Often, Bitcoin is used as an exchange for those tokens, which is how a company earns its capital to be used for the funding of product development. Meanwhile, the members receive their shares.

Developers tool

For more than two years, around $440 mln has been raised through ICOs and the majority of those funds are for developers to fund their initial projects. Through ICOs, entrepreneurs are able to raise funds through various sources. In return, buyers obtain tokens or an amount similar to a company’s stock or share with the hope of a possible increase in the share’s value as the platform becomes more popular.

Before becoming involved in an ICO, cryptocurrency investors and enthusiasts need to consider the risks involved when participating. One of the key things to consider is whether the token being sold through the ICO is safe and secured. Similar to other fundraising and crowdfunding projects, there have been various known ICO scams.

Trouble with regulations

Naval Ravikant, CEO of AngelList, recognized ICOs as a new and interesting way of fundraising, especially for Blockchain-based protocols. Moreover, some investors of Protocol Labs were concerned about the unclear compliance of ICOs with US security laws.

Concerns about ICOs have triggered the idea of creating and pioneering an ICO that would comply with laws and regulations.

Some companies believe the legality of ICOs derives from the utility of the token. For example, let’s say a buyer purchases a club membership for the purpose of using the club rather than based on whether the value may increase or not.

The problem arises for developers and entrepreneurs who are working in Blockchain-based networks. They have to fund their project’s development and if they made a token sale for a certain network that started a year and a half later, they may get into trouble with the regulatory authorities.

Safety of potential returns

Investors are not exempt from the risks, too. Due to these problems, CoinList has put into effect a new agreement known as Simple Agreement for Future Tokens (SAFT). The agreement is similar to other mechanisms often used by early-stage startups in fundraising to get equity without the need to submit debt instruments. Also, SAFT allows developers to launch a token-less fundraising for their network.

Maturing market

In recent years, initial coin offerings have become a hot market for investments to raise funds. In fact, hundreds of millions of dollars was invested in these type of offerings.

ICO coins are basically “tokens” that are usually used as the project’s currency. The success of a project is expected to increase the value of the token, desired by investors to receive a profitable return.

Nowadays, Blockchain companies such as Ethereum make the process simpler for the offerings through a “smart contract” and, consequently, can facilitate their sale quickly by publishing a “white paper.”

Unfortunately, many of these white papers are unaudited and ICOs are not subject to a certain jurisdiction. These issues associated with ICOs are risky on the part of the investor, and they have no assurance and protection if the issuer runs away with the money.

While there’s also a risk of the ICO blowing up, Matt Chwierut of Smith + Crown thinks that “the market is showing signs of maturing.”

As for the money, he said that ICOs are now using “escrow accounts” to secure the money and prevent it from being stolen. Moreover, many companies and firms are undertaking steps to incorporate ICOs into their legal system. Meanwhile, the government and the regulators are still in the process of considering ICOs and their legality.

Due diligence when investing

There are several risks that everyone should know when investing in ICOs. First, the lack of custody and auditing on the project funds that eventually leads to scams. Some funds have disappeared over the past few years. Secondly, there’s no clear pricing mechanism which may lead to overpricing of the project.

Thirdly, investors may expect too much regarding the ICO project’s growth and these high expectations may not be met. Finally, it is hard to control and calculate the potential risks associated with the project and the project’s ongoing process is usually unknown.

There is still much to do to improve the ICO industry and some professional institutions are taking all the measures necessary to regulate ICOs and make them more transparent to all stakeholders.