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ICO how does it work? Everything you need to know

An Initial Coin Offering, also commonly referred to as an ICO, is a fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for bitcoin and ether. It’s somewhat similar to an Initial Public Offering (IPO) in which investors purchase shares of a company.

ICOs are a relatively new phenomenon but have quickly become a dominant topic of discussion within the blockchain community.

ICOs are easy to structure because of technologies like the ERC20 Token Standard, which abstracts a lot of the development process necessary to create a new cryptographic asset.

Most ICOs work by having investors send funds (usually Bitcoin or Ethereum) to a smart contract that stores the funds and distributes an equivalent value in the new token at a later point in time.

When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for.

During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction.

Although there are successful ICO transactions on record and ICOs are poised to be disruptive innovative tools in the digital era, investors are cautioned to be wary as some ICO or crowdsale campaigns are actually fraudulent.

Because these fund-raising operatives are not regulated by financial authorities such as the SEC, funds that are lost due to fraudulent initiatives may never be recovered.

Many view ICO projects as unregulated securities that allow founders to raise an unjustified amount of capital, while others argue it is an innovation in the traditional venture-funding model.

The U.S. Securities and Exchange Commission (SEC) has recently reached a decision regarding the status of tokens issued in the infamous DAO ICO which has forced many projects and investors to re-examine the funding models of many ICOs.

The most important criteria to consider is whether or not the token passes the Howey test. If it does, it must be treated as a security and is subject to certain restrictions imposed by the SEC.

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