Markets

Should You Invest in ICOs?

By Alex Lielacher

Recently, Bitcoin has managed to establish itself as a viable new alternative asset class that has ignited investors’ interest. The price of bitcoin has held up well above the $1,000 mark for most of 2017, even surpassing the value of an ounce of gold.

Bitcoin’s price performance and returns potential has also sparked investor interest in other, lesser-known cryptocurrencies in the hope that they will perform in a similar way to bitcoin. After all, if you had bought bitcoin when it was trading at around $100, you would have increased your investment tenfold, while if you had bought bitcoin in the early days when it was worth less than a dollar, you would have seen a 1,000-fold return on investment.

To generate this kind of return, you need to get in early on new promising cryptocurrencies and the best way to do that is to purchase these new digital tokens during their initial coin offerings (ICOs), when they are first issued.

What Are ICOs?

ICOs, also known as crowdsales, are a new way of financing for startups in the blockchain space that involves issuing a new digital currency or token to early backers of the project in exchange for bitcoin, fiat currency or other established digital currencies.

It is a decentralized way for blockchain startups to fund new projects without having to go through more conventional funding routes, such as equity crowdfunding or peer-to-peer loans.

ICOs are somewhat similar to initial public offerings (IPOs), but the difference is that the digital currency or token that the investor receives is not an actual share in the startup. Instead, the digital token acts somewhat as an indirect share in the company whose value is linked to the performance of the blockchain project that issued the token, and is determined by traders trading the token on cryptocurrency exchanges.

While ICOs provide blockchain startups with an innovative and accessible way to fund themselves, they also provide investors with an opportunity to generate very lucrative investment returns in a relatively short period of time.

The first initial coin offering was held by Mastercoin in mid-2013, and it raised over 5,000 bitcoins at the rate of 100 MSC per BTC. In the years to follow, ICOs gained in popularity and prominent blockchain projects, such as Ethereum, opted to hold them. Ethereum raised $18 million in mid-2014 through the sale of its cryptocurrency ether to fund the development of its smart contract and decentralized applications platform.

In 2016, the ICO market experienced a boom, with blockchain startups managing to raise over $200 million through the issuance of digital tokens. At the current rate, it looks like this figure will be exceeded in 2017.

Opportunities

Investing in initial coin offerings provides investors with the opportunity to potentially earn exuberant returns within several months. Investors in the 2014 Ethereum ICO, for example, saw the price of ether increase from $0.30 when the token first started trading in August 2015 to exceed the $10 merely eight months later, in March 2016. In April 2017, the price of ether exceeded the $50 mark.

Another example of a successful ICO is Iconomi. The decentralized cryptocurrency fund management platform raised over $10 million in fall of 2016 issuing its ICN token at a price of $0.1257. In March 2017, ICN reached a high of $0.65, which marks a five-fold increase in price in less than six months. It is very seldom that these types of returns are found when investing in stocks or bonds. Combined with the fact that there are no barriers to entry when it comes to investing in ICOs, the high earning potential is what is luring investors toward this new asset class.

But, as with all investments that possess a potentially high return, ICOs also come with a very high level of risk that one should not disregard when choosing to venture into this new asset class.

Risks

First, ICOs are effectively entirely unregulated, because financial regulators are still figuring out how to classify digital tokens and this new method of fundraising. That means that there is no legal recourse for investors to take if funds are lost.

This brings us to the next concern: operational risk. Should the issuing startup make an error in their coding or in the processing of the funds they have raised, all invested funds can disappear. Alternatively, cyber theft of digital currency could also occur, which would leave investors empty-handed.

Third, there is the unfortunate risk of fraud, which has been an issue in the early days of the ICO market. ICO scams, where founders of the issuing startup simply take off with the invested funds, have been an unfortunate occurrence in the past. Hence, adequate due diligence is necessary when assessing whether to invest in an ICO or not, to ensure that it is a legally operating entity with skilled and capable developers leading the project.

Finally, as with any financial investment, there is market risk. There is obviously no guarantee that the blockchain project that is issuing the digital token will succeed and that the value of its token will, therefore, increase. Several new cryptocurrencies that have sprung out of ICOs have underperformed despite raising a substantial amount of funds for the issuing startup.

The country of China, for instance, recently banned companies from raising money through ICOs. This could be a pretense for more international crackdowns.

Invest Cautiously, Anticipate Risks

Investing in ICOs is an excellent way to diversify your portfolio and to potentially generate exuberant returns that surpass what any traditional asset class can offer. However, the potential for high returns comes with a high level of risk. Operational issues at the issuing startup can lead to lost coins, the blockchain project can underperform and the new digital coin can become worthless. Regulations surrounding ICO investing can change and have negative affects on your investment. There is always the potential for fraud or cyber theft. Hence, it is extremely important to diversify your ICO investments and not to invest too much in any crowdsale, as the risks of losing your funds is very high compared to traditional asset classes.

Nonetheless, if you are willing to take risk, you can potentially increase your investment three- to five-fold within a matter of months, as many successful ICOs have demonstrated.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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