Crypto ICOs Explained: A Simple Guide for Investors
Crypto ICOs (Initial Coin Offerings) are a way for blockchain projects to raise funds by selling tokens to investors. For taxes, profits from selling tokens are usually subject to capital gains tax, while tokens received as payment may be taxed as income, depending on your country’s laws.
Early investors often buy tokens at lower prices, hoping they’ll increase in value as the project grows. By December 2022, ICOs raised over $50 billion. But with this growth comes risks, like market volatility and scams. Understanding how ICOs work is key to making smart investment choices.
In this guide, we’ll cover how ICOs function, their benefits, risks, and tips for evaluating them so you can navigate this exciting investment space confidently.
What are Crypto ICOs?
A Crypto Initial Coin Offering (ICO) is a way for cryptocurrency startups to raise money by selling tokens to investors. These tokens can represent a stake in the project or offer some kind of utility on the platform being developed. Investors purchase these tokens for the same reasons venture capitalists back startups—they’re betting on the project’s growth and potential to generate profits.
ICOs first appeared in 2013, with Mastercoin being one of the early examples. However, they really gained attention in 2017, during the cryptocurrency boom. Since then, ICOs have become a popular way for blockchain projects to secure funding without having to rely on traditional banks or investors.
How Do They Work?
Here’s how the ICO process typically works:
First, the team behind the project creates a whitepaper. This document explains what the project is, how it will work, and what the tokens will be used for. Once the plan is ready, they announce the ICO to the public to attract investors.
During the ICO, the project creates and sells tokens using blockchain technology, often on platforms like Ethereum. Investors buy these tokens with cryptocurrencies like Bitcoin or Ethereum, hoping the project will take off and the token’s value will rise.
There are usually different stages in an ICO, like a pre-sale (where early investors get a discount) and a public sale (where most tokens are sold). After the ICO ends, the tokens are listed on exchanges so they can be traded.
This sounds a lot like a typical IPO, doesn’t it? Although they are mostly similar, there are some key differences.
ICOs Vs IPOs
ICOs (Initial Coin Offerings) and IPOs (Initial Public Offerings) are both ways for companies to raise money, but they work differently. IPOs are usually for big companies, require lots of capital, and are often only available to wealthy investors.
On the other hand, ICOs are more open to everyday people around the world, with lower entry costs. ICOs also have a more transparent fundraising model due to their use of blockchain technology. This makes all transactions publicly visible and trackable.
However, while IPOs are highly regulated, ICOs have fewer rules, which can make them riskier.
Why Invest in Crypto ICOs?
Investing in an ICO can be exciting because of the potential for huge returns. For example, Ethereum’s ICO in 2014 let early investors buy ETH for just $0.30 per token. A few years later, ETH peaked at over $4,000. That kind of growth is what makes ICOs so appealing.
ICOs are also great for those who want early access to new blockchain technology and projects. If you’re into exploring cutting-edge innovations, investing in an ICO could be a rewarding experience.
However, ICOs are risky and might not be the best fit for everyone, especially if you’re looking for a safer, more regulated investment.
Risks of Crypto ICOs
While investing in ICOs can bring big rewards, it also comes with significant risks. Here are the main risks you should be aware of before diving in:
1. Legal and Regulatory Risks
One of the biggest risks with ICOs is the lack of clear regulations. Unlike traditional investments like IPOs, ICOs operate in a legal gray area in many countries. This means that both project creators and investors could face legal challenges.
For example, in 2017, the U.S. Securities and Exchange Commission (SEC) decided that some ICOs are essentially securities, which means they must follow strict rules. A well-known case is Block.one, the company behind EOS, which raised over $4 billion in an ICO but was later fined $24 million by the SEC for not registering the offering.
In some countries, like China and South Korea, ICOs are completely banned due to concerns about fraud and instability. This lack of legal clarity can cause sudden project shutdowns or fines, leaving investors stuck.
2. Market Volatility
The cryptocurrency market is known for its extreme price swings, and ICO tokens are no different. Token prices can jump or crash overnight based on market news or even rumors. Take Tezos, for example. After raising over $230 million in its ICO, the token’s price initially surged, only to crash when the project ran into internal legal issues. Read the full story here.
Market crashes can also destroy the value of tokens. During the 2018 crypto crash, many ICOs lost value quickly, and some projects were abandoned altogether, leaving investors with nothing. This means investing in ICOs is highly speculative, and you need to manage your risk.
3. Fraud and Scams
ICOs can be a hotbed for fraud, especially since there’s less oversight compared to traditional investments. Scammers can easily set up fake projects, collect funds, and disappear without delivering a product. This is also known as rug pulls. During its peak, it was reported that over 80% of all ICOs were scams.
BitConnect is one of the most infamous scams, raising over $2 billion before being revealed as a Ponzi scheme. Another example is Pincoin, which raised over $660 million before the founders vanished, leaving investors with nothing. We’ve written about both extensively. Check out here.
To avoid scams, watch out for:
- Red flags like unrealistic promises
- Vague whitepapers
- No clear development roadmap
- Little to no information about the team behind the project.
Check our guide on protecting your crypto assets for more.
A smart way to avoid scams is to stick with well-known platforms. Many ICOs are launched on trusted platforms like Binance Launchpad, CoinList, or Polkastarter. These platforms check out the projects before listing them, which adds a level of security and helps protect investors from scams.
4. Security Concerns
ICOs can also be targets for hackers. Since they involve transferring funds through the blockchain, there’s a risk of phishing attacks or hacks during the token sale.
In 2016, hackers exploited a flaw in The DAO, an Ethereum-based project, and stole $60 million worth of ETH. Another example is the CoinDash ICO, where hackers changed the deposit address during the token sale, redirecting $7 million to their own wallets (and later returning it as well).
To protect yourself, only invest through secure platforms and double-check all transaction details. Using hardware wallets or trusted software wallets can help keep your tokens safe.
How to Evaluate an ICO
Now that we’ve covered the risks of crypto ICOs, let’s explore how to minimize them. You can do this by evaluating ICOs using these four key factors.
1. Research the Team
A solid team is key to any successful project. Check if the developers, advisors, and founders have experience in the crypto or tech world. For example, Ethereum’s ICO was trusted partly because of its co-founder, Vitalik Buterin, who had a strong background in the space. If the team is anonymous or lacks experience, it’s a red flag.
2. Read the Whitepaper
The whitepaper is the project’s blueprint. It should clearly explain the problem the project is solving, the technology behind it, and how funds will be used. Again, a good example is Ethereum’s whitepaper, which outlined its vision for a decentralized platform. If the whitepaper is vague or overly complex without a clear plan, you might want to steer clear.
3. Check Community Engagement
A strong, active community can signal that the project has real interest and support. Projects like Chainlink had a highly engaged community, which contributed to their success. If the ICO lacks a community presence on social media platforms like Twitter or Telegram, it’s a sign to be cautious.
4. Understand Tokenomics
Look at the token’s supply, demand, and how it will be used. Binance Coin (BNB), for instance, is valuable because it’s used within the Binance ecosystem, creating demand. Assess whether the token has real utility and whether the supply is capped or inflationary, as this affects future value.
Taxes on Crypto ICOs
In most countries, ICO tokens are treated like property or assets. This means you typically don’t pay taxes when you buy tokens, but if you sell or trade them for a profit later, you’ll owe capital gains tax. In the U.S., for example, the IRS taxes these gains just like they do with stocks. The tax rate depends on how long you hold the tokens. Selling within a year could be taxed up to 37%, while holding them longer may reduce the rate to 0%-20%.
However, if you receive tokens as part of a job or contribution to an ICO, these tokens may be taxed as income. This is common for developers or advisors who are paid in tokens. Some countries also tax tokens from airdrops or rewards given out by the ICO.
Check out our country-wise crypto tax guides to learn how ICOs are taxed in your jurisdiction.
Keep detailed records of all your ICO transactions—when you bought and sold, and for how much (use Bitcoin.Tax to automate this for free). Tax authorities like the IRS are cracking down on crypto investors who don’t report correctly, so it’s crucial to stay compliant.
ICO Regulations Around the World
ICO regulations can vary a lot depending on where you are. Here’s a look at how some key regions handle ICOs:
1. United States
In the U.S., the SEC (Securities and Exchange Commission) often considers ICOs as securities. This means many ICOs must follow strict rules, like providing detailed disclosures. Projects that don’t comply can face fines or even get shut down as mentioned in the example of Block.one earlier. U.S. investors are suggested to only invest in ICOs that are SEC-compliant.
2. European Union
In the EU, there’s no single regulation for ICOs, and each country handles things differently. Some countries, like Malta and Switzerland, are more welcoming. Switzerland’s Crypto Valley in Zug, for instance, provides a legal framework for ICOs, making it one of the best crypto hubs. Overall, the EU has warned about ICO risks but hasn’t implemented strict regulations across the board.
3. China and South Korea
Both China and South Korea have banned ICOs because of concerns over fraud and financial instability. China made ICOs illegal in 2017, and South Korea followed shortly after. However, South Korea has hinted that it may reconsider its ban and introduce a more controlled system in the future.
Future of Crypto ICOs
Blockchain technology is shaking up industries like finance, healthcare, and supply chain management. ICOs will continue to offer investors a chance to get in early on these exciting projects and potentially earn big returns.
Countries like Singapore and Japan have set up clear rules for ICOs, making it easier for larger, institutional investors to join in.
As more governments create regulations, the ICO market is expected to become more stable, bringing in more money and wider participation. This could help build a stronger and more sustainable market.
In the future, the growth of ICOs will likely depend on finding the right balance between innovation and regulation.
FAQ
When did ICOs start?
ICOs started back in 2013, with Mastercoin being one of the first. But they really took off in 2017 during the big crypto boom, when lots of projects began raising money through token sales.
Are ICOs still profitable?
ICOs can still be profitable, but they come with risks. Some investors make big returns if the project succeeds, like in the early days of Ethereum. However, not all ICOs succeed, and some lose value. It’s important to do thorough research before investing.
How many ICOs are successful?
The success rate of ICOs varies. While some, like Ethereum and Binance Coin, have been hugely successful, many others fail to deliver on their promises. Overall, only a small percentage of ICOs achieve long-term success, so it’s important to research each project carefully before investing.
Are ICOs decentralized?
Yes, ICOs are usually decentralized. They use blockchain, so projects can raise money directly from people without involving banks or middlemen. This makes it open to anyone around the world. However, some ICOs may have to follow certain rules, which adds a bit of centralization.