Which ICOs have you invested in lately?

ICO: Opportunities and Risks of Initial Coin Offerings

Lana Iliev, November 5th, 2020

In 2018, startups worldwide raised significantly more money through ICOs than young companies in Germany received through the traditional venture capital market. The new form of financing brought in a staggering $ 16.7 billion. In contrast to € 4.6 billion in venture capital, which was collected in Germany in 2018 using conventional channels.

That rightly raises questions: What is an ICO? Why are they bringing in so much capital? And above all: What opportunities are there for investors here? However, one thing should be said in advance: Investors have already lost immense amounts of capital through ICOs in recent months.

1 | What is an ICO?

A I.initial C.oin Offering (ICO for short; alternatively IPCO for Initial Public Coin Offering or Token Sale) is a form of financing for business models based on blockchain technology.

Startups or young companies that want to put such a business model into practice sell so-called tokens for fiat money or established crypto currencies in order to generate capital.

The promised use of the tokens for the buyer can vary. From the investor's point of view, however, the aim is always to participate in the future economic success of the company by owning the token.

Similarity to established financial instruments

In particular, the ICO is based on the principle of IPO (Initial Public Offering, IPO for short), based on the initial securities issue of a company. However, since they are often used to raise capital for the first time, it is closer to using them Venture capital (also venture capital or venture capital) as compared to stock market capital.

Venture capital is made available to a young company by an investor (business angel) as a start-up aid. In return, the investor participates in the future profit of the company in the form of profit sharing.

Due to the large number of investors, some of whom only invest very small amounts of money, an ICO can best be described as (in certain forms) less regulated method of crowdfunding describe.

2 | What types of ICOs and tokens are there?

Originally, ICOs were intended to bring new cryptocurrencies onto the market. Initially, so-called utility tokens were offered for sale cheaply, which could later be traded as coins of the new digital currency.
If the value of the tokens rose above the initial value, the buyers shared in the success through price increases. However, at no time did the financiers receive rights to the supported project. The first sale of such a token was carried out by Mastercoin in July 2013.

Unmanageable variety of possibilities

In the meantime, however, ICOs are no longer exclusively used to finance new cryptocurrencies, but mainly startups that want to become active in the blockchain area. There are also a few ICOs of established companies.

In such cases, the tokens sold cannot be traded as cryptocurrency. So new ways had to be found, how investors can participate in the possible company profit. Tokens thus increasingly advanced to a kind of digital voucher. The possibilities of their use are now numerous and new variations are constantly being added.

For example, tokens can be exchanged for services or products such as storage space at a later point in time. But voting rights, company stakes or the right to profit distributions, as is common with stocks, can be guaranteed at an ICO via Smart Contacts.
ICOs have been enjoying growing popularity since 2017 and new forms are constantly emerging, so that the offer has now become quite confusing. This infographic gives a good overview of the different types of ICO.

3 | What are the advantages of an ICO?

With a blockchain, both the stock exchange and official financial authorities and their strictly regulated processes for raising capital can be circumvented to some extent. So far, there is no uniform legal basis for ICOs, as ICOs are still quite new and, due to their international character, are difficult to define legally at the national level. In Germany, however, there are already security tokens that require a securities prospectus with approval from BaFin.

Nevertheless, ICOs have immense advantages, especially for young companies. Due to the low bureaucratic effort, ICOs enable simple, fast and cost-saving capital raising. In addition, the investment opportunity can be made easily accessible to a broad mass of potential interested parties. ICOs also allow companies immense flexibility and the minimization of their own financial risk, because equity is often not necessary without regulatory regulations.

How is the return?

Investors on the other hand are using high return opportunities enticed, because successful ICO role models have already brought in horrific sums.

One example of this is the Ethereum ICO in 2014, with which the cryptocurrency Ether was launched. A total of $ 18 million was raised with the tokens for $ 0.40 each. In January 2018, an ether was traded for up to $ 1,250. ICO investors who sold at this point could look forward to an absurdly high-sounding return of 312,400%.

But not all ICOs are doing so promisingly. The Bancor ICO, which raised $ 153 million within three hours in June 2017, has now lost over 80% of its original value. This also means 80% loss for the participants in the ICO.

In the past, in some cases extremely high profits were achieved through ICOs and this explains the current hype. However, these success stories seem to be an exception and outweigh that immense risk for investors.

4 | What are the risks?

First of all, there is the risk of total loss of the capital invested with ICOs. However, there are a number of other risks that you should be aware of:

Partly missing regulations

The sometimes unclear regulatory situation of ICOs poses a major problem. With ICOs outside of Germany, there is sometimes no investor protection and investors then bear the full entrepreneurial risk. In addition, there are usually no reporting obligations and no regulations on recourse claims in the event of insolvency. In addition, there are often no minimum requirements with regard to project information and issued documents such as the whitepaper and the terms and conditions.

In short: Some ICOs have no tangible investor rights

In the meantime, the American Securities and Exchange Commission (SEC), the Federal Financial Supervisory Authority (BaFin) and the European Securities and Markets Authority (EMSA) are trying to master the problem and are looking for ways to regulate ICOs. So far, however, apart from the regulated security tokens, they have mainly published consumer warnings. BaFin stopped a planned ICO for the first time in February 2019.

Incidentally, the People’s Bank of China completely banned ICOs in 2017, with retroactive effect. South Korea followed suit.
In order to avoid possible future regulations from the outset, providers now often only speak of "Crowdsales"Or"Donations“Instead of ICOs. Particular caution is required here.

Increasing cases of fraud

The often inadequate regulation of ICOs attracts fraudsters in droves. This became evident, for example, when it became known that the encrypted messaging service Telegram was planning an ICO. Fraudsters used the hype surrounding the Telegram ICO and started fake sites with an alleged advance sale of the so-called Gram token. Shortly after the pages were online, they disappeared again, and with them the capital they had collected.

Wired magazine published a list of five signs of an ICO scam:

  1. The team behind the project is completely unknown and has no experience
  2. The white paper describing the project is short and incomplete
  3. The providers promise unrealistic goals and potential returns
  4. Lack of transparency
  5. There is no demand for the product offered

The SEC also tried to draw attention to the numerous cases of fraud in a creative way by initiating a fake ICO itself. The Howeycoin is offered on a website. If the consumer clicks on “buy”, however, he will be forwarded and informed and warned about the fake.

Failing startups

But even with reputable ICOs, investors have now lost massive amounts of capital. Because many of the young companies failed within a very short time.

A study by researchers at Boston College found that over half of around 4,000 ICO startups examined did not survive four months in 2017.

Companies often fail because of software errors or hacker attacks. But a lack of the necessary specialist knowledge can also be the reason. The complex technical nature of ICO projects often requires a sound technical understanding, which the increasingly unprofessional providers often do not have at all.

Another reason is internal discrepancies. In the meantime, some cases have become known in which the founders fell out and the planned project was discontinued without repayment of the ICO capital.

This is what happened with the largest ICO in Germany to date. The Berlin startup Endion AG collected a total of € 100,000 from around 30,000 investors in January 2018 in order to implement the environmentally friendly mining of cryptocurrencies. In August 2018, the Handelsblatt reported that the startup had not made any significant turnover to date because the two founders were at odds.

5 | What does the future of ICOs look like?

There is currently a lot of hype and there are countless rotten eggs in the ICO basket. Nevertheless, sensible investment opportunities could arise in the future - provided that ways of regulation are found and consistently implemented in order to ensure comprehensive investor protection.

The Stuttgart Stock Exchange announced in August 2018 that it would build its own ICO platform to offer investors transparency and standardized processes. To ensure this, the Stuttgart stock exchange wants to work with supervisory authorities.

An Estonian company also developed a crypto-based equity loan, the so-called Initial Loan Procurement (ILP). Here, investors conclude a crypto-based contract by purchasing tokens, which guarantees them a profit sharing.

Crowdfunding as an alternative

Alternatively, you can also invest in crowdfunding. Although no blockchain is required, there are very clear regulations by the BaFin in terms of the legally prescribed investor protection.

From the investor's point of view, the advantages of ICOs are often the small numbers and flexible trading. The real estate crowdinvesting platform BERGFÜRST also offers this to its investors: You can invest from € 10 and offer the investments at any time via a secondary market ("trading platform").

Another argument in favor of ICOs is the broad access to investment opportunities that are usually reserved for large investors. This is also made possible by crowd investing. In this way, you can provide mezzanine capital with BERGFÜRST - that too was only possible for large investors in the past.

Only the potential returns that are promised differ. In return, however, they are a lot more realistic. Investors receive interest on investment opportunities brokered by BERGFÜRST between 5.0% and 7.0% per year - firmly and regularly.

Copyright: Who is Danny

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