If there’s been one word on the lips of everyone in finance, it’s cryptocurrency. If you’ve been kicking yourself for not getting in on the ground floor of blockbuster coins like Bitcoin and Ethereum, you might want to consider investing in an initial coin offering (ICO). Be warned, however: ICOs are highly risky even under the best of circumstances and have a high potential for scams.

What Exactly Is an ICO, Anyway?

Imagine this: You’re a Silicon Valley startup with a great idea for a new cryptocurrency system. Perhaps you want to streamline the Parent/Babysitter payment system so that it can be digital and encrypted. What a great idea! Let’s call it BabyCoin.

The only problem is you need people to give you money so you can actually make the currency. Now, you could go to a bank or try getting venture capitalist investors, but what if you could raise money without having to give up any of your ownership of the company? Enter ICO.

Here’s how it works. You create a document essentially detailing exactly how the system would work (usually called a white paper), make a pretty website, and explain why it’s a great idea that could be very useful.

Then, you ask for people to send you money (usually Bitcoin or Ether, but you can also take fiat) and in return, you send them back some BabyCoin. They hope that BabyCoin will get used a lot and be in high circulation, which would raise the value of the currency. 

It’s important to note that, unlike an initial public offering (IPO), investing in an ICO won’t result in you having an ownership stake in the company you’re giving money to. You’re gambling that the currently worthless currency you pay for now will increase in worth later and make you money.

Who Can Launch an ICO?

Anyone can launch an ICO. Right now cryptocurrency as a whole is kind of like the wild west; there’s gold in the hills and the laws around it are new and still being formulated. The Securities and Exchange Commission (SEC) does actively monitor cryptocurrencies and is developing legislation as the industry grows.

Securities offerings do fall under the SEC’s jurisdiction, and this applies to crypto as well. ICOs will need to be registered with the SEC or be exempted from doing so. And the SEC does specify that there is fraud in the sector that may result in people being manipulated out of their money with nothing to show for it after.

Of all avenues of funding, an ICO is probably one of the easiest to set up as a scam. Since there’s little regulation there’s nothing stopping someone from doing all the work to make you believe they have a great idea, and then absconding with the money.

This means that if you’re really set on getting in on that new ICO that your friend Aiden from work told you about, make sure you do your homework. The first thing to do is make sure that the people putting up the ICO are real and accountable. In the Internet age it’s beyond easy to find a stock photo and put together a convincing website, so going the extra mile is important.

Some things to look for include what history the product’s leads have with crypto or blockchain. If it looks as if they don’t have anyone with relevant experience that can be easily verified, that’s a bad sign. Check to see if the ICO is registered with the SEC and if not, is there an exemption per SEC law?

How Do I Start My Own ICO?

The most important thing you want to do is make sure that either you or someone (probably multiple people) involved have worked in and understand cryptocurrency and blockchain. Even if anyone can make an ICO, it doesn’t mean that everyone should. You need to be able to answer questions on the spot about every little detail pertaining to your ICO.

You should also ask yourself if you really think that your business will actively benefit from an ICO. Basically, after reading this article, you should consult someone who can take a look at your specific idea and tell you if it is a slam dunk or not. If it’s not, you might be better off going through safer avenues of funding. 

If you’re determined to move forward, you need a white paper, which is a document that should identify exactly what your currency can offer that has never been done before, or how you’ll make an established idea better than anyone else has. This document should be engaging, informative, and very, very detailed, like the white paper for Ethereum, one of the most successful ICOs yet.

Like any business, you need to hook your buyer by the end of the first page. Ethereum’s white paper takes the time to explain what blockchain is, and then goes on to detail how they intend to build on the progress that Satoshi Nakamoto made and create something exciting.

They do all of this by the end of the first page. Now, does every single white paper need to include an unabridged history of blockchain including the time that guy paid 10,000 bitcoins for a pizza? Probably not, but it should be understandable to someone without any knowledge of how these systems work.

Marketing Your ICO

Now that you’ve got your white paper, you need to advertise. You have two targets that you’ll be trying to reach: people with knowledge of how cryptocurrency and ICOs work and people with basically no idea. You’ll want to identify the people that would be most excited by your new venture since they’ll be more eager to give you money if it means a deal for them.

In the case of BabyCoin (again, hypothetical) maybe we’d reach out to some popular mommy bloggers/vloggers and see if they would be interested in producing some content to showcase why BabyCoin is the biggest innovation in babysitting since The Babysitter’s Club.

Just make sure they disclose the nature of the deal to advertise for you: the SEC released a warning to investors stating that it is illegal for celebrities to use social media to endorse ICOs without disclosing what compensation they received.

You’re also going to want to make your programmers and leads available to answer questions on social media like Reddit and Twitter. You should also consider submitting your ICO to some listings that run databases of what they perceive to be quality ICOs. This is how you get people involved in the crypto-community excited about your product, which will hopefully trickle through the Internet.

Great! So the word is out about BabyCoin and people are psyched, all that’s left to do is determine the token pricing and distribution. You also might want to have a prototype in order just to prove you know what you’re doing. Get your website and exchange set up and good luck.

What’s With All These Celebrity ICOs?

If you’ve seen your favorite actors and entertainers like Jamie Fox and Ghostface Killah encouraging their followers to invest in a hot new ICO, you might want to take a closer look.

Boxing superstar Floyd Mayweather, Jr., and DJ Khaled once promoted Centra Tech, an ICO that raised $30 million at the end of 2017, but Centra was ultimately called a scam in court and the two celebrities had to settle with U.S. regulators. Three Centra Tech founders have pled guilty to ICO fraud.

How Do I Determine Which ICOs Are Good?

Just make sure to do your homework. You need to be way more careful than you’d be when investing in an IPO. Read the white paper, research the team members, and make sure they have a history in cryptocurrency.

You can also use trusted websites like Coinschedule.com, which only chooses ICOs that they have reviewed and consider to be legit and exciting. While you shouldn’t fully trust any website offering a listing, they can be quite useful.

Is Someone Going to Regulate ICOs?

The SEC classified tokens from ICOs as securities in December of 2017, with SEC Chair Jay Clayton saying at the time that they had proved that ”a token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”

This means the SEC is gearing up to crack down on ICOs that they deem to be misleading investors. The first strike came on Dec. 11, 2017, when the SEC halted Munchee, a California company with a food review app. Munchee was attempting to raise money to create a cryptocurrency that would work within the app to order food.

This is the first instance of the SEC issuing a cease and desist for an ICO for unregistered securities.

The Bottom Line

In the end, ICOs are a new way of raising money, and everyone is trying to adapt to the new ways without losing money. If you think you’re able to make a killing on a promising new ICO, just make sure to do your homework beforehand. Cryptocurrency is all about high risk and high reward, and ICOs are no different.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns no cryptocurrency in any quantity.