The first $5000 that Ben Wu invested into cryptocurrency fell by 90%. He was left with a paltry $500 of his savings. Ben Wu went on to famously make over $400,000 in cryptocurrency trading but his story is a stark warning of what can happen when first time traders enticed by jaw dropping returns in the cryptocurrency markets – invest in assets that they do not fully understand.

Over the course of this article, we’re going to develop a framework for finding and analysing upcoming initial coin offerings.

I’m aiming this article entirely at the non technical investor. You should already know what an ICO (initial coin offering) is and perhaps you also understand the basic concepts of Blockchain technology. We will recap on both later on to refresh your memory. Having previously purchased some Bitcoin or an alternative cryptocurrency is also a good starting point.

We’re going to stand on the shoulder of giants here. Some of the smartest minds in investments (Warren Buffett, Benjamin Graham, David Dodd etc) follow the idea of value investing which means buying assets that are underpriced by some form of fundamental analysis.

This is not a blueprint for day trading and it will not teach you how to catch pump and dumps. The objective is to help you so you don’t repeat Ben Wu’s cautionary tail by blindly investing in coins that don’t meet the strict criteria of the process you will develop by the end of this article.

The Initial Coin Offering

Let’s start with a quick recap of what Initial Coin Offerings are. This is by no means an extensive technical overview. Just some mental models that we require to proceed.

Initial Coin Offerings are named after the stock market term Initial Public Offering (IPO) which marks the point at which a company launch their shares on the stock market. The term ‘coin’ is used as historically this was the way cryptocurrencies were distributed but in most cases it now really represents a token associated with the app or business.

ICOs represents a shift from the traditional venture capitalist driven routes available to companies previously.

The excitement surrounding ICOs is underlined by some of the mind boggling returns that have been posted by companies – for example an investment in Ethereum in 2014 would have returned you 110416% on your money!

More importantly, there are rules that prevent ordinary folks like you and me from investing in the likes of Facebook, Uber and other Silicon Valley darlings – the SEC prevents unaccredited investors not earning greater than $200k/year from investing more than $2000/year.

Through Initial Coin Offerings, we now have an open global market where anyone can play, and where the gains and risks are more evenly distributed.

How big is this market?

Anyone who invested in Facebook’s IPO would have pocketed a not-to-be-sniffed at 294% profit within five years. But that’s nothing compared to the pre-IPO investors who were able to turn paltry sums like $10k into $1 million!

Peter Thiel for example made a seed investment of $500,000 which if held until today would have been worth $6.8 billion! That’s a 13.5k gain in case you’re reaching for the calculator…

And yet that’s still nowhere near the astonishing rise in Bitcoin’s price!

Recent ICOs include Bancor which raised $153 million (most of it within 3 hours) and Tezos which raised $232 million (in 14 days). Bancor and Tezos were able to raise similar amounts to the largest funding rounds raised in 2017 by companies like SenseTime in a fraction of the time! To do this at a time when venture capital funding is slowing down (with many seed funding companies going out of business) is truly the most remarkable aspect.

What exactly is a token and what are you buying during an ICO?

In a traditional stock market IPO, when you buy shares in a company – you are actually purchasing a share in the ownership of that company. However this isn’t strictly true in an Initial Coin Offering.

What exactly the ICO token represents, what benefits are obtained from owning the token and how the token’s value is determined economically varies from token to token.

Below is a list of the 4 main economic models used by tokens that have been released to date.

It’s by no means a comprehensive list.

As you might imagine in such a nascent field, creators are continually developing new models and certain projects may use more than one of these models in their offerings.

But we can use it a base way to distinguish the different coin offerings we come across.

App Tokens

App tokens are very well named, as you can imagine they are created to be used within a specific app. For examples of such tokens take a look at projects such as Basic Attention Token (BAT) or Gnosis (GNO).

The project owners can use two methods to ensure that the value of the token is linked to the value of the app.

Let’s use the example of Basic Attention Token (BAT). Bat offer a privacy focused web browser called Brave that you can use as a replacement for Chrome, Firefox etc. By default, all advertisements and trackers are blocked in Brave. The only way for advertisers to reach users using Brave is to make a payment to the user using the BAT token. Users receive BAT for viewing advertisements.

This is an example of the first method that the project owners can use to link the value of their token to their app. Basic Attention Token requires all payment for services within their Brave web browser (advertising fees) to be made with BAT.

So this means if Brave gobbles up Chrome’s market share and becomes the defacto web browser of choice for most people, then the increasing demand should theoretically increase the value of each BAT token as well. Thus advertisers would need to spend more for the tokens to continue marketing their products and solutions to the users.

The project owners can also burn tokens; this can be pre-advertised as part of the fundraising process or simply done when payments are made (i.e. the payment fees are destroyed). Burning destroys the coins permanently and decreases the overall supply of the token. Thus the remaining tokens increase in value.

The alternative method to link token value is by distributing a percentage of the revenue/profits to token owners. This is usually done via smart contracts which are described more in the section below on DAOs.

Decentralised Autonomous Organization (DAO) Tokens

In a traditional company you have shareholders who have some degree of ownership and input into how the company is run.

With blockchain technology (notably Ethereum which pioneered this concept), it’s possible for a company to use computer programmes called Smart Contracts to manage their finances and allow token holders to vote on the future of the organisation and on changes to the smart contracts themselves.

These organisations care called Decentralised Autonomous Organizations (DAO).

The smart contracts are written to automatically distribute funds, providing voting rights etc according to predefined rules. These rules are enforced by the blockchain.

If you purchase a DAO token, you normally receive a percentage of revenue/profit as a token holder. Thus you get a psuedo-share in the organization but without the legal ownership of owning a real company stock.

Coin and Blockchain Platform Tokens

Most of the ICO projects that are launched do not need their own blockchain network. They piggy-back off existing technology such as Ethereum.

However some projects introduce new features (e.g a new hashing algorithms), technology or concepts which requires them to build and launch their own coin.

Like Bitcoin, these coins will have a limited supply (or fixed growth supply) and the value of those coins will rise with increasing demand.

There may be opportunities to mine the coin. As mentioned above in App Tokens, the project owners may also periodically burn (destroy) coins.

Tokens backed by Assets

There are also tokens that are designed to represent the value of an underlying asset such as real estate or precious metal.

There has to be a degree of trust between the company and the token purchasers that the token actually does represent the value of the underlying asset.

At the very least before investing in such a token, it would be prudent to investigate whether there’s any legal regulation and protection available.

What is the process of an ICO? How long does one take?

Now that we know what ICOs are, let’s examine the process of an ICO and see what’s actually involved.

The Pre-Announcement

The project owners write a small pitch to investors in which they explain the project and the purpose of the ICO. The target audience is communities where cryptocurrency investors gather such as BitcoinTalk’s altcoin announcement forum or on Reddit.

The purpose of the pre-announcement is to gauge interest from the community and receive feedback. Project owners can incorporate questions about their business model, perceived risks and so on into their plans and finalize an offer at the end of this process.

Bitcoin was announced by Satoshi Nakamato through a whitepaper and most ICO projects pay homage to this by producing a similar document which explains the project.

The Offer

As mentioned before what the token represents, what rights it bestows upon token holders and how it’s value is determined varies. The project owners detail all of this information in “The Offer”.

As a rule of thumb, this document will contain the following information.

• The price of the token – pegged to fiat or the project owners will state what other existing currency such as Bitcoin or Ethereum they will accept.

• The duration of the campaign – how long the sale will last for.

• The initial supply and distribution of the token – how many tokens will be sold and the distribution of the token: how much the founders will keep to themselves and how much is made available to the general public.

• How much the company is looking to raise, whether the token sales will be capped – capped offerings reduce the risk to investors, the project owners sell a fixed number of tokens at fixed price on first come first serve basis. They could also sell an unlimited amount of tokens at a fixed price with no cap.

• Pricing stages – some sales provide a discount for a limited period to encourage early participation.
  Whether the owners will be vested or a planned vesting schedule – as a show of faith, founders, employees and other insiders can opt for a vesting schedule which releases tokens to them after a certain period.

• A roadmap or development plan

• How the funds will be used and allocated

• Whether tokens have voting rights or other privileges and how these are governed.

The offer will also stipulate the period after which the company begins to pay it’s obligations to investors – to pay dividends, or burn tokens and so on.

Once the offer is signed, the project owners will announce the start date for when tokens will be made available for sale. An active PR campaign for the project begins and we’ll cover some of specific actions during the campaign such as Air Drops in the section below.

For a sample of an offer, take a look at FileCoin’s offer. To date FileCoin has raised $257 million.

Discounts and lock-up periods
A recent trend involves project owners rewarding purchasers that commit early by giving them discounts on the price of their tokens. The caveat being that they are locked up from selling those tokens for between 3-12 months. The benefit to the project owners is stabilising the price of their token after the ICO.

Exchange Listing

Whilst some token holders will want to hold or accumulate more tokens over time in the hope that the value of these tokens will increase over time; others may want to trade their tokens and the final stage of an ICO is for the project to release their tokens so that they can be traded freely on Cryptocurrency exchanges such as Bittrex, Poloniex, Coinbase and so on.