If you are following the bitcoin and blockchain developments, then you must have heard of the term ICO or Initial coin offering.
This is a short post to touch base on What is ICO and the 4 rules to evaluate any ICO in the market.
Let's begin by understanding how an ICO is done.
First of all, the promoters create a custom coin on top of an existing blockchain such as Ethereum. You do not need to re-invent the wheel here as there are several blockchain platforms and resources available to do this.
Once the new coin has been created on the blockchain, the next step is to define its economics. Similar to the fiat currencies, total supply in the circulation of the currency and the demand-supply (who would buy and sell) mechanism needs to be defined.
Finally, the coin is listed on any of the crypto-exchanges and a price is set for the coin to either another cryptocurrency such as Bitcoin/Ether or a fiat currency. For e.g. I can create a coin called SNOW and list it on an exchange as 1 SNOW = 0.5 USD.
(A number of complexities are involved to do Step 1-3, some of this involves expertise in economics. Due to this new streams such as crypto-economics has started to emerge now)
Now before Step 3 happens a lot of developers/promoters of the coins do a pre-sale of their token at some discounted price (say 1 SNOW = 0.2 USD and they can sell 1 Million SNOWs). This pre-sale is called as ICO, similar to an IPO. The difference is you are not sharing your equity with anyone in ICO.
Now the question is how do you know if an ICO is worth investing?
Blockchains might be promising to change the world but the fundamental rules still apply. How good is the "underlying product" for which ICO is being done? How strong is the need for the product? What is the market size? What is the competitive landscape like? All the original rules apply!
Assuming the product is groundbreaking and the Rule 1 checks out. Now understand what is the utility of the coin? What role does the coin play in the product? Take an example of the Ethereum blockchain and Ethers (The Ethereum coin). At the time of the launch and ICO, Ethereum promoter group promised to provide a network and platform for making decentralized blockchain applications. The adoption of Ethereum has fulfilled that promise. The way Ethereum designed their coin's utility is that: anytime you need to create your own custom coin on top of Ethereum or need to make a decentralized blockchain application, you need Ethers to do that. This utility of Ether is what has driven the demand and thus the price of Ether in USD post the year it was launched (of course there are always some speculative elements similar to any other fiat currency in the play as well)
If rule 1 and rule 2 fail and you see that the coins are being issued with no solid basis of the value of the coin to increase then it is better to take a step back. Do ask the coin promoters this question: How do you expect the demand for your coin to go up? There have been enough Ponzi schemes recently and this could just be another one with an ICO mask.
Finally, what is the underlying blockchain on which the coin works. It could be Ethereum or other similar blockchain networks. Since there is no single governing body in the blockchain, you need to understand that the blockchain software is your only friend. So the robustness of the underlying blockchain software is what greatly protects your coin value. Take a scenario, if there is a hack in the Ethereum blockchain then all the cryptocurrencies running on top of it would be felt less secure, people would be scared to buy those coins which would lead to a decrease in the demand for the coins and finally the coin price. But these are the risks we have been debating since 2009 and here we are in 2017 still waiting for bitcoin or other blockchains to just crash.
Hope this gave you some idea on how to evaluate an ICO. Next time you hear or read about an ICO do run the 4 rules listed above. This should help you find out if the ICO is worth investing in or not.