What is an ICO in crypto? Initial coin offerings explained

Bitcoin (BTC) captured global attention in 2018 when its price surged to nearly $20,000 per coin, a record-breaking move. But while Bitcoin dominated headlines, another category of digital assets quietly took center stage: initial coin offerings (ICOs).

In the same year, ICOs collectively raised $14 billion as investors flocked to capitalize on emerging cryptocurrency protocols. For some, these investments gave ICO crypto investors early access to what are now some of the most valuable cryptocurrencies, often at steep discounts. Unfortunately, not all ICOs delivered on their promises – many investors fell prey to scams and fraudulent projects.

While ICOs can provide unique opportunities to participate in new cryptocurrency projects, they also carry inherent risks. In this guide, we’ll explore what ICOs are and how they work, highlight their advantages and disadvantages, and provide tips for identifying potential red flags before you buy into the latest ICO cryptocurrency.

What are ICOs? Explaining initial coin offerings

Initial coin offerings (ICOs) are a fundraising strategy where crypto startups sell digital tokens to early investors. The primary aim of an ICO is to secure enough capital to achieve technical milestones, form key partnerships across the web3 ecosystem, and generate awareness for the project. Building a community of dedicated supporters is another crucial objective for many ICO campaigns.

Tokens sold during an ICO often serve specific purposes within the project’s protocol or decentralized applications (dApps). In addition to their utility, many ICO tokens provide added benefits like governance voting rights or opportunities to earn passive income through staking or liquidity pools. 

How stock IPOs and cryptocurrency ICOs compare

Buying initial public offerings (IPOs) in the stock market shares some similarities with investing in ICOs. In both cases, investors provide funding to support growth – whether through company shares or digital assets. However, there are differences in how IPOs and ICOs work, as well as the benefits they offer investors.

Ownership rights

One main distinction lies in what investors gain:

• IPOs: Investors receive partial ownership in a company through shares (or equity). This comes with legal rights and protections.
• ICOs: Most tokens don’t include ownership rights, except for a niche category called “security tokens.” Instead, ICO tokens typically serve as a virtual currency on decentralized blockchains. Some tokens may offer voting privileges or other ecosystem benefits, but they lack the same legal standing as equity. 

Regulatory environment 

Another significant difference between IPOs and ICOs is the level of regulation:

• IPOs: IPOs must meet rigorous regulatory requirements set by centralized authorities like the U.S. Securities and Exchange Commission (SEC) to list on public exchanges such as the New York Stock Exchange (NYSE). These standards reduce the likelihood of fraud but mean IPOs involve more established companies that have already demonstrated financial stability.
• ICOs: Tokens classified as “utility tokens” are designed for specific use cases within their ecosystems. This categorization avoids stricter regulations, making ICOs more accessible to retail investors. That said, the lack of oversight increases the risk of fraud and scams.

How does a crypto ICO work?

There’s no one-size-fits-all structure for launching an ICO, but many emerging crypto projects follow a similar progression. Whether developers opt for private or public token sales, most ICOs move through these five stages:

1. White paper publication 

A white paper serves as the cornerstone of any ICO, detailing the "what, why, and how" behind a crypto project. This document explains the problem the token aims to solve and the technology developers plan to use. It also provides critical tokenomics data, such as the cryptocurrency’s total supply, inflation rate, and distribution model.

To build trust, many white papers include background information about the development team. While some projects operate anonymously, transparency in this area can strengthen credibility. The white paper typically concludes with a roadmap outlining measurable goals, estimated timeframes, and how funds raised through the ICO will support these milestones.

Promoting the ICO is vital to attracting early investors. Many projects share their white paper on platforms like X or crypto-centric sites like CoinMarketCap and ICO Drops. Early engagement efforts often include building communities on Discord or hosting "Ask Me Anything" (AMA) events to address questions and clarify project details.

2. Token creation and ICO date 

After publishing the white paper, the next step is creating the token and setting a timeline for the ICO. Developers typically choose between building a standalone blockchain or using existing networks like Ethereum (ETH) or Solana (SOL) to create their tokens via smart contracts.

Once the token is developed, it undergoes bug checks and security audits to ensure reliability and safety. With the token ready, developers set an official ICO launch date and shift their efforts to marketing, generating buzz through social media campaigns, partnerships, and community-building initiatives. 

3. Private or public ICO sale 

ICO sales allow investors to exchange established cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH) for newly issued ICO tokens. These fundraising events typically follow one of two structures, private or public, but both aim to fund the development of the project while catering to different types of investors:

• Private ICO sales: Targeted toward high-net-worth individuals or institutions, private sales restrict participation to pre-approved investors. This exclusive approach allows ICO teams to raise funds from a smaller, select group before releasing tokens to the public.
• Public ICO sales: Open to anyone with a compatible wallet and accepted cryptocurrency, public sales are accessible to the broader crypto community. These events may occur directly on a project's official website or through centralized and decentralized exchanges.

4. Token distribution and vesting schedules

Investors typically receive their ICO tokens in one of two ways:

• Immediate distribution: Tokens go directly to a self-custodial wallet or exchange account as soon as the ICO purchase is complete.
• Delayed distribution: Tokens are released only after the project achieves specific milestones, aligning with the project's development goals.

Some ICOs also implement vesting schedules that restrict early investors from accessing their tokens for a set period. Enforced by smart contract code, these schedules prevent large-scale investors from immediately selling their holdings, which could destabilize the market and erode confidence in the project. Vesting schedules not only reduce the risk of fraud but also encourage a long-term commitment to the project's success.

5. Project development

With funds secured from the ICO sale, the development team begins working toward the initial milestones outlined in the project’s roadmap. Investors closely track the team’s progress to see if they meet targets within the projected timeline and deliver on their promises.

To maintain transparency and community trust, projects often host ongoing "Ask Me Anything" (AMA) events, sharing updates about successes, challenges, or adjustments to the roadmap. In cases where a cryptocurrency includes governance protocols, such as decentralized autonomous organizations (DAOs), token holders can participate in shaping the project’s direction by voting on proposals or initiatives.

Advantages and disadvantages of ICOs

ICOs can provide developers with easy access to funding while giving investors early access to promising technologies. While some ICO launches, like Ethereum (ETH) and Cardano (ADA), have resulted in exceptional gains, they’re not necessarily for every investor.

Pros of ICOs

• Potential for high returns: ICOs give investors the chance to back innovative projects at their earliest stages. If an ICO cryptocurrency succeeds, it can offer greater upside than established digital assets. 
• Global accessibility: Public ICOs are open to anyone with cryptocurrency and internet access, breaking down geographical and financial barriers. Blockchain’s P2P nature allows participants worldwide to invest in groundbreaking projects. 
• Liquidity for early projects: ICO funding provides crucial liquidity for developers to achieve milestones, grow their ecosystems, and foster vibrant communities. 
• Decentralized fundraising: Unlike traditional IPOs, ICOs bypass centralized financial institutions. Smart contracts enforce ICO rules, offering security with greater efficiency. 

Cons of ICOs 

• High-risk investments: ICO tokens are highly volatile and not ideal for risk-averse investors. Their lack of track records increases their unpredictability. 
• Limited due diligence: ICOs often lack sufficient historical data, making it harder for investors to assess the project’s likelihood of success. White papers provide some transparency but may not be enough to gauge reliability. 
• Scam risks: ICOs are susceptible to fraud, with some bad actors using pump-and-dump schemes to exploit investors.
• Minimal investor protections: Unlike stocks, ICOs lack robust legal safeguards. Their decentralized nature puts them outside the jurisdiction of most governments, leaving victims of scams with limited recourse.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.