Combine crowdfunding, startups and the Bitcoin craze, and what do you get? A chance to participate in the exciting world of cryptocurrencies—and possibly lose a boatload of cash—through what are now called "initial coin offerings," or ICOs.
Back up... What’s an ICO?
ICOs sound a lot like IPOs, or initial public offerings, which occur right before a firm's stock is openly traded on a stock exchange. IPOs are generally reserved for special clients, who often (but not always) enjoy generous market gains during a stock's first trading weeks. Similarly, ICOs offer a chance to buy new cryptocurrency at its creation—and there are plenty new ones debuting each month—but they differ from IPOs in a few critical, and pretty risky, ways.
First, buying tokens in an ICO isn’t the same as buying shares of a company; you aren’t part owner, you have no voting rights and the company doesn’t necessarily owe you anything. Also, by the time a company debuts on a stock exchange, it’s typically got years of balance sheets, which are made public in documents submitted to the Securities and Exchange Commission (SEC). It’s also been vetted by a professional brokerage, and its prospects have been fully debated by business journalists. By comparison, ICOs can be launched with just a website.
Why would someone participate in an ICO?
On top of the most compelling reason—the potential for dramatic gains—ICOs offer a new way to dabble in venture capitalism. Proceeds can be used to fund early-stage startups, much like the way crowdfunding works, and the cryptocoins created are generally baked into a company’s product. (Imagine a new airline raising money by selling frequent-flyer points that can be resold or cashed in later for upgrades, free trips and other rewards.)
So new coins aren’t always pure speculation; they can also have a purpose—in theory, anyway. Blockchain entrepreneurs are now raising more money through coin offerings than through traditional venture capitalism.
So, why wouldn't I invest in ICOs?
Turn to a friend and explain what “blockchain” is. If you can't, you shouldn't invest in a company built on the concept. Even if you can explain it, can you fully explain the company you’re investing in through its ICO? Also ask yourself: Are you ready to lose much of what you give them? Because you might.
For one, as with any new market offering get-rich-quick potential, there’s the risk of fraud: Some involve deception by the firm bringing the ICO; others involve hackers who steal coins or trick investors into sending money to the wrong place. There have even been fake ICO site results in Google searches.
The SEC’s expressed concern about ICOs because they sound a lot like an offer of securities, which the agency regulates—but many haven’t been subject to the same level of scrutiny. While some ICOs have described coins as software (or utility tokens) instead of securities—thus avoiding SEC compliance—those days are probably numbered. In July, the SEC issued a warning shot to ICOs.
Anything else I should know?
If you’re still sold on investing some cash you can afford to lose in ICOs, look for ICOs that are in compliance with securities rules and the SEC’s crowdfunding regulations. If an exemption is claimed, the offering should be limited to “accredited investors” who pass net worth requirements. If not, “in the event of fraud or theft…your ability to recover may be significantly limited,” the SEC warns.
Also, keep in mind that most ICO purchases are made via an Ethereum platform, which involves a multi-step process. (In other words: It’s much more complicated than buying shares of stock via a brokerage account.) You’ll likely have to download an Ethereum “wallet” and buy Ether coins, then send the designated amount to the ICO digital address.
Make sure the company fully explains its product and the process for getting your money back. Does the business make sense to you? Are its founders credible? Also ask if the firm has passed an independent cybersecurity audit. Cryptocoins can be (and have been) hacked and stolen. Finally—as with any investment—watch out for red flags like pressure to buy RIGHT NOW and “guaranteed” high investment returns.