Guides

Beginner’s Guide: How does an ICO work?

This article is the second part of the ICO guide for beginners.
In our previous article, we explained what an ICO is, and how it is different compared to traditional crowdfunding.
If you haven’t already, be sure to read the introductory article: Beginner’s Guide: What is an ICO?

For you to make rational decisions while investing in any ICO, it is crucial that you understand how an ICO works.

Trust and smart contracts in an ICO

You may have heard that blockchain technology is a trustless system? This is only partly true. In the case of decentralized blockchain transactions, there is no reliance on another contracting party or a third party. And yet, it’s not a correct statement either, because you’re still reliant on trust. It’s just that you trust in technology instead of humans.

After sending a transaction on the blockchain, verification is taken place by the decentralized network (x number of active nodes confirming it against previous operations). As soon as this happens, the transaction will be locked into the main block of the blockchain – and cannot be changed or tampered with, ever. There are also transactions called smart contracts, where you write a contract at the top of the block. Logical programming and cryptography then run the arrangement.

This is how you use smart contracts in an ICO. When you sign up for your investment (usually in the form of larger crypto such as ether or bitcoins) you enter into a smart contract with the organizer. This means that as soon as the ICO diligence is over, your tokens will automatically be transferred to you.

The smart contract follows what is called if this, then that logic, which just means that it is sequence-based. ‘If A, then B’ you can call it as well. Thus, your investment is secured by a contract on the block, which can not be changed or tampered with. However, please note that this is not the same as guaranteeing a return when investing in an ICO. Nevertheless, you can feel confident that the investment agreement (x number of value certificates for x number of dollars) will be observed.

Public Transaction Capital Book and Value Books

All transactions settled on smart contracts associated with the ICO you have chosen are entered in the public transaction ledger. The contract can look as simple as this:

1: Emily has invested 1 ether (ETH) in the project, which corresponds to 1000 tokens
2: The ICO is over May 5th
3: 10 days after May 5, all investors receive their tokens
4: May 15, 1000 tokens is sent to the wallet Emily has attached the investment to

The entire sequence is programmed into the smart contract, and thus in the transaction ledger. So you run no risk of your investment disappearing – there is digitalized automation in it, and you will, therefore, get paid for what you have been promised.

Tokens are basically ‘value books.’ They act as a promise showing how much the project you invested in owe you after the diligence is over. These certificates give you more than just access to the cryptocurrency. Most often, you become co-owner of the decentralized network, thus helping to make decisions according to the cryptocurrency structure and rules.

Payments after an ICO have been completed

As we saw in the example sequence, you will get paid after the ICO is finished. Most often you will also receive an email confirming the wallet address you wish to have your securities bills transferred to. Keep in mind that you are now dealing with a brand new cryptocurrency, which probably does not appear on the big crypto exchanges.

However, you have also become the proud owner of value books, or ‘shares,’ in a brand new cryptocurrency project. Although the evidence may not be worth so much in the beginning or can be used to something specific, you still have partial ownership.

Many, of course, invest in ICOs for the sake of ROI (Return on Investment. But do not forget that as an investor at such an early stage you also help develop a whole new project. Therefore, it’s essential that you have faith in the project you are investing in.