The concept of ICOs is lightly understood by many people in the blockchain space. Not only is it a relatively new term, but it’s also rarely used outside the blockchain and cryptocurrency world.
In a nutshell, ICOs are a new way for startups in the crypto world to raise capital. In other words, ICOs are the new capital generation strategy that has replaced venture capital. They’re very similar to IPOs (Initial Public Offerings), an alternative method that many startups use to generate their capital.
Key terms you should understand
To understand how ICOs work and how they’re created, it’s essential that you have a good understanding of these key terms that are repeatedly used in this guide.
- Blockchain: This is a digital ledger in which digital transactions of any cryptocurrency, e.g., Bitcoin and Ethereum, are recorded chronologically and publicly. It's a digital record, that is duplicated across a network of computers, and that can be programmed to store transactions of anything that is considered valuable; such as financial transactions.
- Tokens: These are the coins offered to investors in an ICO and are somewhat similar to the shares bought by investors in an IPO. They can also be called crypto coins.
- Cryptocurrencies: They are a form of a digital virtual currency that relies on cryptography for security and anonymity. Unlike conventional currencies such as dollars, cryptocurrencies aren’t created or controlled by any central authority (such as a bank or government.)
With these terms in hand, you’re now ready to dig deeper into the creation and value ICOs.
How are ICOs created?
The main goal of an ICO is to sell tokens to willing investors.
To begin with, the team behind the startup develops a cryptocurrency based on their idea and a considerable amount of market research. While (or after) building a prototype of their product, they evaluate its worth; based on the current market need and a careful evaluation of supply and demand.
Traditionally, the value of a product under creation was determined by central authorities, such as the government. However, in the crypto age value is defined and measured by a small group of people.
After determining its value, the team behind the product creates a specific number of tokens that they’ll offer buyers. For instance, the team can decide to produce 100 million coins, each with a value of $0.1. The total value of coins should be proportional to the worth of the project and the capital it needs to raise.
After value determination and token creation, the team makes a pre-announcement of the project, which is then closely followed by the publication of an ICO whitepaper. The whitepaper (or any other document with a project summary,) gives every detail about the project. Some essential components of the ICO whitepaper include a developmental roadmap, business model, team members, who’ll use the cryptocurrency and an explanation of how the users and the community will benefit.
After the pre-announcement, the team offers the public a contract. The contract describes the lifecycle of the cryptocurrency, the amount they aim to raise, terms of the transactions and the projected deadlines for significant milestones (e.g., the launch of a prototype.) The contract also describes the coin to be bought, the rules governing token/coin usage, and the rights/benefits the investors will enjoy.
The token sale period is usually broken down into multiple stages, with every step having an exact starting and ending date.
Due to the high number of ICOs being launched, every successful ICO needs a solid marketing strategy and a strong team to do the required legwork. The marketing team uses every method they can to publicize the ICO on social media, cryptocurrency related communities, and forums. They aim to reach as many potential investors as possible.
When the marketing phase is done, the token sale commences. To incentivize potential buyers, most teams offer discounts that decrease as the time progresses. This ensures that early bird investors enjoy the most benefits.
What’s the value of ICO tokes?
When buying the coins, investors can pay through a variety of methods. The tokens can be exchanged for other more successful cryptocurrencies such as Bitcoin, or conventional currencies such as dollars.
Each token represents an amount of the cryptocurrency being introduced. When an investor buys 1000 ICO tokens, he/she owns 1000 coins of that cryptocurrency. To understand why any member of the public would buy the tokens, you should understand that once the project is launched and becomes successful, the dollar value of the cryptocurrency will rise.
Since the tokens bought during launch are counted as normal coins of the cryptocurrency, their value rises as well. That means that for the investor who bought 1000 coins of the cryptocurrency at $0.1 a pop, each coin they own is now valued at the current value of the cryptocurrency at any stage.
Many investors will sell or trade their coins once the coin’s value rises to a certain threshold. However, smart investors may continue holding on to their coins, or buy even more coins, if they’ve done their own analysis and determined that the cryptocurrency shows promise, and will continue growing in value.
How does investing in an ICO generate profit for you?
As noted before, all cryptocurrencies have a very low dollar value when they’re introduced. Let’s take our cryptocurrency from above, whose value at the time of the ICO was $0.1 per coin. If I’d bought $1000 worth of tokens/coins during the ICO, I'd have owned 10000 coins. If the cryptocurrency performed as well as Bitcoin did, its value may be hundreds of times the initial value. But since no cryptocurrency has beaten Bitcoin's prices to this day, let’s say our hypothetical cryptocurrency is now valued at $150 per coin.
Assuming I was a patient investor and held on to the entire stash of 10000 coins I bought initially, it’s time to see how much I’ve made. At the price of $150 per coin, my 10,000 coins are now worth 1.5 million dollars. In the amount of time I’ve waited, my investment of $1000 has made me more than a million dollars in return.
Should you invest in ICOs?
Although you’ve heard of hundreds of cryptocurrencies that have experienced some level of success, there are many more coins that were not successful, and their investors incurred loses.
Investing in ICOs is just a matter of doing your research to determine which coins show the most promise and investing in them. In March 2010, Bitcoin’s value was $0.003 a coin. Today, it's valued at $8240. Had you invested $5 in Bitcoin at that time, you’d now own around 1667 coins. Given today's value of $8240, your coins would be worth 13.7 million dollars.
Lastly, the time it takes for a cryptocurrency’s value to soar is very essential. Put simply; it’s not very worthwhile to invest in a cryptocurrency that will make you a million dollars in a decade while you could’ve made similar profits in a few months on another currency.