Initial Coin Offerings (ICOs)

Austin Knight: Welcome to Decrypting Crypto, series 1, episode 6, where we’re gonna talk about what an initial coin offering is.

I’m Austin Knight. I’m here with my co-host, Matthew Howells-Barby. Matt?

Matthew Howells-Barby: Hey Austin. Hey everyone. This is a topic we’ve been waiting to get into. ICOs have been so hot over the past year. Everyone wants to jump on them, from companies to investors to individuals, but within this episode what we’re gonna try and do, is actually explain what the hell an ICO is.

We’re gonna give you a pretty solid example of what an ICO actually looks like to bring this to life.

And more importantly, we’re gonna compare what an ICO versus an IPO is whilst trying to limit the number of acronyms we use throughout this entire episode.

And on top of that the final thing is, probably the most contentious one, is more around the scam side of things in ICOs, which is probably where blockchain technology and the crypto-space is getting most of it’s negative press right now.

So, Austin, let’s jump in. What is an ICO?

Austin Knight: Yeah, so an ICO, or Initial Coin Offering, is a process that is used to raise capital in an exchange for the issuance of tokens.

So, say that you want to start a cryptocurrency and you need to get funds built into that so that you can get this thing running.

You’re gonna have an ICO. You’re gonna initially offer those coins to the public.

Investors are going to use cryptocurrency to buy tokens in an ICO, and this is very similar to buying shares in a company, but without the actual equity.

Matthew Howells-Barby: Yeah, that’s a key point. And let’s kinda bring this to life a little bit, ’cause I know there was a few bits a jargon that we used in there that some people just won’t understand. But one thing I do just wanna highlight here is, when you invest in an ICO, you do not get shares in the business. Right?

What you get is a portion of the token, or the cryptocurrency that that project uses.

Let’s say you invested in the Ethereum ICO. You’d buy Ether, the token that operates, or the coin that operates on the Ethereum blockchain.

So let’s give a little example here of an ICO. Hypothetical for now.

Say me and Austin come out of this long session of recording podcast episodes and we’re like, hey, we’ve just come up with this new awesome idea. And it’s this blockchain based social network.

Let’s call it Bitter. Blockchain, Twitter, funny joke, correct? So we want to launch Bitter, and we’re like, okay, we’re gonna throw out some tokens in an ICO because we don’t even have a product yet. We need to build Bitter. And we need capital to do that.

We’re gonna build this on an existing technology like the Ethereum blockchain, and what we’re gonna do is, we’re gonna offer out anyone the opportunity to buy a hundred of our Bitter coin, let’s say for one Ether. That’ll be the price. Right?

So let’s say if 1,000 people invested in our ICO, buying a total of 20,000 Ether, that would roughly equate to if we just say that one Ether is worth, at the time, 1,000 USD, make math easy on both me and Austin right now, that would probably work out to around 20 million dollars that we would raise.

That gives us a lot of capital. When I say we would raise 20 million dollars, 20 million dollars worth of Ether.

So now, me and Austin are like, awesome, we have a bunch of cash that we can use to develop Bitter.

And not only that, as an investor into this, if you bought some of our tokens via the ICO, as this project gets better, and the individual tokens that we have, so the Bitter token or the Bitter coin, as that grows in value, the amount that you invested will grow in value.

Not only that but you can use that token on our social media platform itself. So you could do things like hey, you can exchange it for services or you could trade with other members of our Bitter social media.

And this is being done a lot recently. So, this is like a hypothetical example. This one interesting thing is like an ICO launched in 2017, really high profile one called File-coin. Think about File-coin almost like trying to be the drop box of the blockchain.

They raised 257 million dollars worth of crypto from the ICO in just over one month.

Austin Knight: Unreal!

Matthew Howells-Barby: That is, that is a lot.

Do a lot of these projects need that much funding? I don’t know.

But the cool thing here that I do like, let’s just park the whole, do they need this much money, is this the right thing to do. If we think about this in terms of how this usually works. Let’s say it wasn’t Bitter and it’s Twitter. Right? Private company, not run on the blockchain at all.

And they’re raising some funds to get their project up and running in the early 2000s.

Now, the everyday person cannot just go and invest into Twitter and own a part of that business. It’s accredited investors that could potentially take part, or venture capital funds. You need to have roughly a million dollars worth of net worth to be able to even qualify to be a part of this.

And when we go kind of back to a more socio-political point of view, it’s like the rich getting richer, the poor getting poorer. This creates less opportunity for the everyday person to benefit from the wealth of these kind of companies, right?

Austin Knight: Absolutely.

And it’s a bureaucratic process to get a company to a point where they can even allow investors to buy shares in their company.

This is where we start to see the differences between an ICO and an IPO. So an ICO being an initial coin offering, that’s the cryptocurrency version. And an IPO being an initial public offering. That’s like the NASDAQ stock market, your company has grown to a certain level and now you’re allowing it to be publicly traded.

Matthew Howells-Barby: Where the everyday person can buy stock.

Austin Knight: Exactly.

Matthew Howells-Barby: Right? People can now buy shares in Twitter, because they can go through to probably the NASDAQ that Twitter are on, and they’ll go through the stock market, buy shares in Twitter, and then they own them.

But a lot of the time, by the time a company has listed themselves on the stock market publicly so that anybody can buy shares, a lot of the wealth has already been created, right?

Usually, when a company has an IPO, all of the early investors make their millions. And then the public can like, fight it out for the rest of the growth that happens after that.

ICO, it’s flipped on it’s head. So you have an initial coin offering, that usually happens before a product is even made, which is kind of quite scary, right? But at the same time is quite exciting because you can get in early onto projects.

And an initial public offering, an IPO, always near the end or a much more mature stage of a company’s lifecycle, and that’s because there are huge amounts of regulations and requirements in particular to file an IPO, an initial public offering.

Austin Knight: Yeah, for example with the NASDAQ you have to have aggregate pre-tax earnings in the prior 3 years of at least 11 million dollars, and the prior 2 years of 2.2 million dollars, and no one year in the prior 3 years can you have a net loss.

So hope that you’ve got, you’ve gotta have a super healthy business, to get to the point where you can have IPO, and the reality is, there are plenty of business that are perfectly healthy at a much smaller stage, that would pay great dividends to the public market, but we just can’t do it with the way that things are set up right now.

Matthew Howells-Barby: Yeah, and then the ICO model has really come into turn, in all honesty, the stock market on its head, and really say, hey, you know what? Everyday people wanna be part of the profit making stage of these companies. They wanna be a part of this from an early stage, even if it’s just to be part of this community.

And more importantly, at least on a basic level, to have access, to be able to do this.

Now, that comes with its risks. There’s a reason why there’s so much regulation for initial public offerings and ultimately it’s to try and protect everyday people investors and people who are investing in these companies.

And, I mean when you look at the regulation side of things, any IPO investor must go through KYC laws, Know Your Customer. So you have to have registered all your details with a stock broker, you have to have given over person identified information.

ICOs are self-governed. And there’s a reason why nearly all ICOs accept other cryptocurrency as payment, so you usually use like Ether or Bitcoin to buy in, because you do not need to abide by KYC.

Austin Knight: So getting around that piece of the equation.

Matthew Howells-Barby: Exactly. I have seen some projects that are popping up where it’s like, hey, we’re gonna accept Fiat currency to buy in. In fact, you may have heard Telegram, there’s been a lot of news about Telegram, the huge messaging app. Kind of like a WeChat competitor, is considering an ICO. And rumors are, they’re only gonna do it via Fiat currency and they’re gonna abide by KYC rules, just to try and fit into this regulation.

Austin Knight: Interesting.

Matthew Howells-Barby: Yeah, but that said, like ICOs are completely self-governed. It doesn’t mean that they are completely immune to regulation, right?

Austin Knight: Yeah, for example, China recently banned ICOs.

Matthew Howells-Barby: Yeah.

Austin Knight: And that caused a huge ripple throughout the entire community.

Matthew Howells-Barby: No pun intended on ripple.

Yeah, I think that’s definitely the case, and we’re seeing more and more news stories pop up around like huge regulation happening within ICOs because in all honesty, governments are scared to death of this.

And I do empathize there. I am of the camp, whilst I don’t love over-regulation, I think that ICOs put a lot of people at risk because a lot of people come into this, it is easy to put this in a way you can create scams a lot easier.

And this, I personally feel like a lot of ICOs really hurt the progression of the cryptocurrency space and the blockchain movement as a whole.

Austin Knight: And undoubtedly the perception as well.

Matthew Howells-Barby: 100%. It’s like 9 times out of 10 when people will say to me, who maybe aren’t as involved in crypto or just getting into it, so that one of the stories they’ve read that scars them has been about an ICO that went wrong, right?

And there are plenty of examples of that.

The one thing we also wanna talk about is the stage here is very different in which your invested into an ICO, and that’s what creates a pretty large amount of the risk. You’re making a very long bet on something happening.

Austin Knight: Of course. So while it’s nice that ICOs allow the average person to get in earlier, they’re also assuming the same level of risk, in fact I would argue more risk, than an angel investor or a venture capitalist would make when they’re investing in a very early stage company.

There’s a reason, again, why some of those regulations exist and why you have to go through a bunch of, a vetting process to be able to operate as a VC or as an angel investor. And it’s because we wanna make sure that you actually know what you’re doing when you invest your money.

Whereas an ICO doesn’t require that you know anything, except for how to give the organization your money.

So you end up assuming at ton of risk when you’re dealing with an ICO, not only because it is very, very early and so nobody fully knows what’s going to happen with the currency, or with the project.

But also because you are not backed by an entire organization like an angel investor or a VC would be.

Matthew Howells-Barby: Absolutely. And it becomes very difficult then, when you look at it from a legal standpoint, right? Like if you have investors, an angel investor, and you have been lied to by the business to try and get you to invest in the company but they have made some claims that aren’t true, there are legal grounds that you could go and maybe sue that business.

It’s a lot different and a lot difficult on an ICO level, even just proving, like, you can think about this, right? Here’s challenge number one: proving that you even invested in it. Because you’ve done this via spending cryptocurrency, that, yeah okay, we can see your public address, but how can we prove that you own that public address that you send that Ether or Bitcoin to.

Austin Knight: It is enough.

Matthew Howells-Barby: Exactly, so this is where it becomes a bit more difficult from a legal point of view.

The other interesting thing here, from an IPO point of view, usually an IPO is the first liquidity that happens for a business. And what I mean by that is, really that’s the first point in which the assets of that business actually become liquid, be able to have a true value that can be utilized.

Whether through trade on the stock market, through selling in an acquisition point of view, so all kinds of these things.

But then, an ICO is like, as soon as those tokens are issued, it’s immediately a liquid business. You can sell and trade the tokens in that economy way before a product has even existed.

I mean, most of the projects that a lot of people hale as being the potential game-changers for the world are in that beta-release, they’re being traded at such a huge price.

Austin Knight: So the way that you can think of this is if you’ve ever been on KickStarter.com, you can invest very early, as an individual, in a kick starter project and they will make big promises.

Some of them will actually happen. Others, a lot, a lot of others will never, there will never even be a working prototype.

So there’s a high level of risk, there’s a lot of research that you have to do on your own, unaided, before you can make a smart decision with something like this.

Matthew Howells-Barby: For sure. And I think the final thing is what you actually own, right? Like if we just think about an IPO, you buy shares, you have equity in the company. You own, you actually own a part of that company.

You buy shares in Twitter, you actually own a part of Twitter. You’re a core part of it.

In an ICO, you don’t own a part of the company. That is, even if there is a company, it could be decentralized, like Bitcoin for example, you actually just own some of the coins.

You don’t need to go through an ICO always to get these coins. You can buy them on an exchange when they eventually get listed there, but the idea is that getting in on an ICO, getting in early, you get a price, that’s the idea, at least.

And then you also get access to the services that those tokens can be used for. Having a token or a coin, we use that work interchanged quite a bit, it’s a very similar thing, the whole focus of it is to be used for a specific utility. And that gets you access to it.

So just to kind of summarize an ICO versus an IPO, there are probably like four key areas. I would day one is the requirements stage, and with an ICO there’s pretty much no requirements required.

For an IPO you’ve got lots. Like minimum yearly earnings, total market cab and many, many more aspects that vary from each of the different stock markets that you will list on.

Austin Knight: And while we can criticize them and talk about decentralization, they do, in a lot of ways, serve a purpose.

Matthew Howells-Barby: Absolutely.

Another interesting thing there, when we talk about stock exchanges here, is like, you’ve got things like the New York Stock Exchange, the NASDAQ, all these different things. Within an IPO, you would usually only ever list on one stock exchange. In crypto, there are tons of exchanges. And the goal here is to be on as many of them as possible.

So accessibility is much greater as well.

The second be piece is regulations.

ICOs are pretty much completely self-regulated. IPOs, just on a basic level need to abide by KYC, Know Your Customer laws and this varies from stick exchange to stock exchange, and country to country.

The issuance stage, this is the big one. ICOs are usually super early stage, maybe even before a product is there. IPOs lik, much, much later. Usually at least four years on. And that not a hard set rule, but usually at least that.

And the final piece being ownership. ICOs being a token, plus access to use services.

Whereas an IPO is equity in the business and then ongoing dividends of profits.

Austin Knight: But Matt, aren’t ICOs just scams that will be regulated?

Matthew Howells-Barby: Well I feel like what you’re settin’ me up for here, Austin, is a tirade of Tweets that are gonna come into me, telling that I’m full of crap, right?

Well no, okay, so the first thing is, it’s a Wild West out there. So, be careful, kids. There are a number of legitimate projects that are being run. Kinda what we talked about in some of our previous episodes, right? For every application of launching technology that’s fantastic and amazing, there’s also its evil counterpart.

Now, the other, kind of the younger sister in all of that is just the complete fake project and scam that’s part of this whole family. And I have to be honest, it’s very, very difficult to know whether something is a scam or not. It’s very tough for an individual.

There have been people who are like, have been technologists big influencers in the space, intimately understanding blockchain technology, and have succumb to scams. It’s tough.

The best advice I’ve ever had is this single piece of advice, which is, you should never be in a hurry to part with your cash.

If you ever feel like you’re rushing to get on board with something that you think could be a good thing without necessarily digging deep into it, take a pause. Take a deep breath. Go meditate, whatever you wanna do. Just don’t open up your wallet and start furrowing out your cryptos like Austin drunk at a Brazilian barbecue.

Austin Knight: Luckily I did my research sober.

Matthew Howells-Barby: Right? And that’s the key piece here, is doing as much research as possible. Like most projects have a whitepaper, right?

Austin Knight: You can read the whitepaper on Bitcoin. Written forever ago.

Matthew Howells-Barby: Yeah, and most of them at least launch with that. Go through a bunch of forums, speak to the founders. It’s very accessible. I’ve done this multiple times when I’ve been looking at projects and say hey, do you know what? I’m just gonna drop one of these founders a message on LinkedIn or Twitter or wherever they’ve listed on their website in amongst their ICO proposals. And just be like, hey, what’s the story with this specifically? I don’t understand.

The response I’ve had is surprising. People are very open to talk about a lot of this stuff.

And I think the other thing is, to watch out for, and this is probably one of the reason why I myself and Austin started the Decrypting Crypto podcast, is really scrutinize everything you read online.

So, when you look at, and I’m not gonna name the publications, but some of the major publications within the crypto space, when I go through each of their articles in their feeds where most people are getting their information right now, I’d say maybe one in four of them is a sponsored article, i.e. it was written by a company and they have paid to have it placed within these major publications.

They don’t always make it abundantly clear that these are paid-for articles. So peoples are like, alright, this is cool, oh see what I just read about in publication X, right? That’s like where I’m getting all my news right now.

It’s supposed to be amazing, they say it’s good, so hey, that’s good enough for me, right?

That’s pretty dangerous, right? You shouldn’t even be taking myself and Austin’s advice.

Like, yeah, but myself and Austin have Cryptocurrency, but we are not the spokespeople for that. We are not advisors from a financial point of view, and ultimately the future of the project is largely out of our hands.

One big thing I look at a lot of the time is who are the people getting involved in this project? Who are the advisors. Are they also really the advisors? Can you go ping them a message, hey, are you actually advising these companies or have they just put your face on a website?

And just think about what is it that these individuals have to lose if this is a scam, and start from there.

Austin Knight: There are a number of legitimate projects out there though.

Matthew Howells-Barby: Oh absolutely. And that’s where research comes in. I mean, talking about the scam side of things, there’s been a number of high profile failures, and I use the word scam and I’m actually not going to say that this particular case is a scam. I certainly don’t believe it was. The DAO, the Decentralized Autonomous Organization, D-A-O, had an ICO and it made headlines after bringing in around about 150 million dollars worth of Ether from over 1,000 individuals.

Two months later, there was a security flaw in one of the smart contracts of that project, which ultimately meant that hackers stole 60 million dollars of Ether from all the investors.

These are just everyday people, right? Lots of people lost their money. This is something that we’re gonna talk about in more detail in episode 8 when we go into Ethereum because actually, an interesting thing that happened is the Ethereum team made a huge decision to actually roll back time on the Ethereum blockchain and forked the entire blockchain, which created Ether Classic and Ethereum, as 2 separately running coins.

Huge debate around this, but, just to not get into that too much, one of the reasons it happened off the back of this as well, for the DAO to eventually shut down was the SCC actually ruled that the DAO was a security and had to abide by federal US law.

The whole project got shut down. It was, I think a very disappointing thing to happen within the cryptocurrency space to happen at the time, and I think it was very harmful for gaining people’s trust.

So that’s just one of many examples of why people have lost money in ICOs. A lot of people have seen, my friend invested in this ICO and they got 1,000 percent increase within the 3 months.

Sure that might happen, but it also might not, right?

Austin Knight: Absolutely. Be careful. And never invest an amount that you’re not willing to lose.

Very easy to happen.

Also, never hand over your private keys for an ICO. That’s something, if you’ve got people requesting that, don’t do it, don’t click links from emails.

Matthew Howells-Barby: Oh man. Slack as well, right?

Austin Knight: Slack. Beyond the scam of the promise of the products, there are much more direct and deliberate scams that can be tied to these things as well.

Matthew Howells-Barby: 100%. And I think that the key part there is when you invest in an ICO, what will often happen is they will give a public address, so the public address, not private, that you send your crypto to, to invest.

What it does, is when you send your crypto to is, you create a smart contract so that when you send that coin, so let’s say it’s Ether that you send to them or Bitcoin, a smart contr act is triggered so that as soon as they receive your crypto, they will issue your tokens directly to you.

So, you should never be giving them your private keys. It’s always you sending crypto to a public address.

There have actually been cases where people’s websites have been hacked during an ICO, the public address has been changed, please, for the love of God, double, triple, quadruple check everything. Because if there is something that hackers and spammers and people who are doing fishing attacks and jumping on, it’s these ICOs.

The last thing I would say here is, for anyone who watches Game of Thrones, similar to Winter, regulation is coming. And as I’ve said many times before, I think that is a good thing. I think that investors do need to be protected in this stage, but hopefully by now you’ll at least be armed with understanding what you’re getting yourself into.

And we haven’t scared you too much.

Austin Knight: Well it was mostly an episode choke full of tales of fear, it’s true. You do have to be very calculated and careful when you enter into this realm. Because this is the area that has been exploited the most for scams.

So, some things that you can walk away with: an ICO, or an initial coin offering is going to be used to raise capital in exchange for the issuance of tokens. And investors are going to use pre-existing cryptocurrency that they have to buy tokens in an ICO.

It’s similar to buying shares in a company, but without the actual equity. So you’re getting a currency that that project uses, but you’re not getting a actual part of that project. Whereas with a company, you would get an actual part of that company.

This is what makes it fairly different from an IPO. You’re not getting that equity. You’re just getting the coin. There are also very strict requirements to file an IPO and there are virtually no requirements to file an ICO, while if you wanna call it filing, while there will be requirements eventually making their way down the line.

ICOs aren’t all scams. But here are a lot of scams that can be related to them. Ranging from projects that will never launch, so thinking back to that kind of Kickstarter parallel, to very deliberate scams like hacked websites, hacked projects, email links that you can’t trust.

Matthew Howells-Barby: Absolutely, yeah. Be vigilant is the takeaway here.