How to Reap Profits on an ICO

Initial coin offerings (ICOs) are not as popular as they once were. The reason for this is apparent—offering a token to public investors in exchange for funding is a security offering, and it must be registered with the Securities and Exchange Commission in the U.S. or the appropriate regulatory authority in other countries.

Initial coin offerings still occur in private funding rounds, which do not require regulatory registration, so it's important to know what to look for if you're interested in investing in these projects and qualify to invest in them.

Ensure the ICO Is Legal

The first step in validating and valuating an ICO is to ensure it meets legal requirements in the jurisdiction in which it is offered. In the U.S., an ICO seeking funding from the public must be either registered or have an exemption on file with the SEC.

If the ICO does not have its registration or exemption posted, you should be able to find it using the SEC's EDGAR database search function.

Some projects might not be looking for public funding, only holding private investor rounds and accepting capital from venture capital funds, private equity funds, hedge funds, or other accredited investors. Projects that accept funding from sources other than these types of funds are likely to require registration.

Research the ICO

The cryptocurrency world is full of uncertainty, and the risk swings both ways. Many investors and developers are optimistic about the potential of digital currency or blockchain developments to disrupt the technology space. However, fortunes have been lost on fraudulent schemes and ill-conceived ideas. ICOs are a prime example: for every successful token launch, there are multiple that have produced nothing but hype and vaporware.

Although this tenet is one of the oldest in the financial world, it bears repeating. You should always conduct your due diligence before supporting a new company. For novice investors, it's easy to succumb to herd instinct or fear of missing out (FOMO). When it comes to ICOs, there are at least four things to consider: the white paper, the team and its partnerships, the business case, and tokenomics.

Analyze the ICO White Paper

It's essential to thoroughly read and analyze the white paper of a prospective investment. This is a document that outlines the aims and strategies of that project in detail. Some projects might have stratospheric ideas but lack a practical approach for achieving those goals. Others may lack crucial details that leave you wondering whether the project is truly feasible.

In addition to the whitepaper, the team should give you an analysis of its financials, which should lay out all of its costs and thoroughly explain how it will use the funding it receives. This is commonly referred to as a pitchbook, which can be a presentation on a screen, document, or other media.

A white paper should include a basic roadmap that lays out a set of concrete goals and a clear and reasonable timeline for achieving them. It should also include a succinct vision statement; companies without one may lack sufficient focus to achieve real success.

A thorough white paper and pitchbook do not always guarantee success, but incomplete, hastily written, or otherwise problematic ones can be a sign of trouble. Glaring issues with spelling, formatting, or grammar can also be red flags.

Become Familiar with the ICO Team

Next, take time to research those leading the project, as well as any partners or advisors. This is one of the most important factors in evaluating a startup: many of these types of projects are developed by very intelligent programmers, coders, and others, but often, they have no experience growing a business. Thus, there should always be team members or partners with business experience who can steer the project around the various pitfalls new businesses face.

This blockchain and cryptocurrency industry has many incubators, which are successful companies that invest in young companies to help them grow. This could be a good indicator as they might be backed by very experienced and successful entities.

Learn the ICO's Business Case

Research as much as possible about the ICO, its business model and financial structure, target market, regulatory environment, and competitors. This is another common pitfall: many startups struggle because they have incorrectly analyzed their market or failed to do so. Markets with similar companies tend to reward the first-movers unless a new business emerges that really wows investors.

A market analysis that outlines all of the above should be included in the startup's pitchbook. If this is missing, the business may have overlooked a very important first step. If it is trying to launch an ICO in a saturated market, there should be something very unique about it that sets it apart from the competition or its chances are drastically diminished.

Learn the ICO's Tokenomics

ICOs conducted by legitimate companies generally fund their projects by selling tokens that allow access to a network or service or grant governance or ownership rights. Like shares issued by a company, investors buy the tokens, hoping they will gain value after a successful network launch.

To understand a token's potential value, you need to understand how and why it will be used. If there is a clear reason for people to own and use the token, and there is a value that can be placed on the reason, it may have a better chance of attracting attention and stabilizing after a successful launch. If the main use for a token is market speculation, with no other purpose behind it, it may not be worth investing in.

It's also critical to know how tokens are distributed. A company holding an ICO should clearly state the maximum coin supply, as well as the number of tokens allocated to founders, early investors, partners, and the company itself. In some cases, there may also be lock-up agreements that prevent the tokens from being sold immediately after the ICO.

Successful offerings need to strike a balance between fair distribution and budgeting for the future. If a small group of owners controls a large share of the supply, there is a risk to other prospective investors that the price could fall when these owners decide to sell. On the other hand, if a company does not reserve enough tokens in its treasury, it may run into trouble paying future expenses. While there is no single model for token ownership and distribution, you should look for a plan that balances long- and short-term considerations.

The Bottom Line

ICOs remain a profitable investment given the right circumstances. As with any investment, it's essential that you study the ICO and its team members. Familiarize yourself with the research done beforehand, analyze the white paper, become familiar with its target market, regulatory environment, and any likely competitors. By taking those actions upfront, you can more easily spot suspicious projects or hone in on solid investments.