The rewards can be huge, but so are the risks. When blockchain platform NEO launched its Initial Coin Offering (ICO) in end-2017, it had each 'coin' or 'token' priced at $0.03. Those tokens are now trading around $73.25, which amounts to a gain of 2,46,067 per cent in a few months. Yet Cryptonetix, a digital currency which held its ICO around the same time, has since seen a 95 per cent loss of value. The problem is that while ICOs are much the same as Initial Public Offerings (IPOs), in that they are both intended to raise funds for a company or project, the former are not held under the aegis of a stock exchange and do not come with any of the due diligence certificates, company resolutions and red herring prospectus that exchanges make mandatory for the latter. All they usually provide is a whitepaper setting out their objectives and the comfort that they use of blockchain technology, the indelible digital ledger that guarantees security and transparency (See Win Some, Lose Some).
The mode of payment is also laid down - it could be regular currency, or Bitcoin or any of the other cryptocurrencies. This means that the principle of caveat emptor - or the risk being entirely the buyer's - applies with a vengeance in ICOs, more than with any other asset class.
And yet, the popularity of ICOs only keeps rising. In 2017, which can be considered a breakout year for ICOs, 210 ICOs were launched worldwide raising $3.88 billion. Since then, 2018 has been even better - the first four months saw 171 ICOs raise $5.94 globally. "ICOs will break previous records in fund raising," says Anuj Khanna, CEO of UK-based management consulting firm, Peak State Consulting. Many have welcomed ICOs as a means of attracting funds from sources that were not investing in such projects before. "The amount raised through ICOs is great for business growth and the economy," says David Sapper, Chief Operating Officer, Blockbid, Australia's first fully regulated cryptocurrency exchange. "Capital that would be unthinkable for start-ups is now readily available through ICOs."
As this new asset gains traction, it is attracting established names too. Initial ICO investors were tech geeks out to change the world. But now, it has caught the eyes of the guys in black suits too. "Last year, mostly unknown start-ups went for ICOs," says Khanna. "This year we'll see innovation and better known companies approaching the ICO market."
NEO -known as AntShares when it began in 2014 - is the first open source blockchain currency from China. It is backed by Microsoft and the Chinese e-tailing giant Alibaba, but its success is surprising given the Chinese government's apparent dislike for cryptocurrencies. NEO uses smart contract applications, but with the addition of decentralised commerce, digitised assets and identification. Another blockbuster was Ethereum, with its cryptocurrency Ether. In 2015, Ether was sold for $0.31 per token, but now trades at $713, second in value only to Bitcoin. There is also Spectrecoin, which promises complete privacy, much to the worry of governments clamping down on illegal fund transfers. A Spectrecoin token, which cost $0.001 when it began in November 2016, is now worth $0.64. Stratis, Ark, Lisk and Storj are some other ICOs that have brought early investors a fortune.
While the risk of investing in an ICO is clear, there are some advantages too. Liquidity is higher, since the coins can be traded any time, unlike traditional venture capital investments. Again, most investors in ICOs are strategic, not merely financial - they have an interest in the product or service for which the funds are being raised. Many start-ups too are eschewing traditional venture capital for ICOs.
There is no sure way of spotting winner ICOs. The whitepapers do provide details of their projects, and while these are often in a technical language, it is imperative to understand and evaluate them. "The main takeaway is the feasibility of the project," says Alexey Burdyko, CEO, Play2Live, the first decentralised streaming platform that uses blockchain technology. "Is it solving a problem now, and will it be solving a problem a few years down the line as well?" Investors must consider if the product is required and has a potential market.
Almost as important is the competence of the team. "The experience and expertise of the development team are primary risk factors," says Akash Kawale, analyst at cryptocurrency consultancy Hacked.com. Investors should ensure the whitepaper clearly sets out who the team members are and their domain experience. Investors should also conduct their own due diligence, asking questions about whether work on building the project has begun or not and what has been accomplished, whether a prototype is available for demonstration, whether future milestones have been set, before putting in their money. They should find out what experts are saying about the project on general forums such as Reddit, Slack, Telegram, and Medium, and specialised ones like Bitcointalk. "Any worthwhile ICO will be transparent about its progress," says Burdyko.
Like a number of other countries, India too has been suspicious of the entire cryptocurrency environment - the Reserve Bank of India has banned all the entities that fall under its purview from transacting in cryptocurrency. But people investing abroad can use the $2.5 lakh annual limit to invest. Before investing, it is thus important to find out in which jurisdiction the product or service for which the ICO seeks funds will operate, whether it is legal there and has complied with all regulations. Finally, it is well known that the failure rate of start-ups, no matter which sector they are in is high - and the same holds true for ICOs as well. "It is important to remember that even in the traditional technology space, 90 per cent of start-ups fail," says Kawale. "People should only invest in ICOs the money they are prepared to lose."