What Is a Crypto ICO (And How Is It Taxed?)

An Initial Coin Offering (ICO) is a common way for new crypto projects to raise funds but in an unregulated market, there are risks. Learn everything you need to know about crypto ICOs, including what ICOs are, how ICOs work, how to avoid ICO scams and how ICOs are taxed in this guide.

What does ICO stand for?

ICO stands for Initial Coin Offering. It's the crypto equivalent of an Initial Public Offering (IPO). It may also be referred to as an initial coin launch, a token sale, or a coin sale.

There are also Initial Dex Offerings, or IDOs. These are similar to ICOs, but held exclusively on decentralized platforms.

What is a crypto ICO?

A crypto ICO is a popular fundraising mechanism for new projects in the crypto market. Similar to an IPO, where a company offers shares to the public for the first time, ICOs offer a newly launched token or coin to investors for the first time.

Investors can buy into ICOs to receive the new coin or token issued by a given company. The types of coins and tokens available are vast. Investors may receive a utility token that helps them use a specific product, a governance token that gives them a say in how the new company is run or they may simply receive a new coin and hope that it appreciates in value.

ICO vs. IPO

Although we've compared the two above, there are some key differences between ICOs and IPO, including:

• Tokens vs. Shares: Instead of offering shares in a company, in an ICO, a new cryptocurrency or token is sold to early backers. This token often grants its holders certain benefits, which can range from ownership rights in the project to access to services provided by the platform.
• Regulation: Historically, ICOs have been less regulated than IPOs. This has allowed for faster and more open capital raising but has also led to scams and fraudulent schemes. As a result, various governments around the world have started to implement regulations around ICOs to protect investors.
• Investment Purpose: People who invest in ICOs typically seek either a return on investment as the token's value increases or access to a particular utility (like a service or product that can be redeemed using the token).
• Accessibility: ICOs can often be accessed by a broader range of people compared to IPOs. Whereas IPOs might be restricted to accredited investors or those with a certain financial status in some jurisdictions, ICOs have often been open to anyone with internet access and cryptocurrency.

How do crypto ICOs work?

The typical ICO process includes:

• Whitepaper Release: This is a detailed document that explains the project's vision, the problem it aims to solve, how it will solve it, the team behind the project, tokenomics, and other details.
• Token Sale Phases: These might include a private sale (restricted to select investors), a pre-sale (with possibly better terms or bonuses for early participants), and the main sale (open to the general public).
• Listing: Once the ICO is completed, the token will usually be listed on cryptocurrency exchanges where it can be bought, sold, or traded.

Due to the rapid rise of ICOs between 2016 and 2018 and the subsequent burst of the "ICO bubble" with many projects failing to deliver on their promises or turning out to be outright scams, the reputation of ICOs suffered. This led to the rise of alternative fundraising mechanisms in the crypto space, such as Security Token Offerings (STOs) and Initial Exchange Offerings (IEOs). These are very similar in nature, but tend to be in partnership with a large centralized third party - like a crypto exchange - who has vetted the project more than the average investor.

Are there different types of crypto ICOs?

Yes. Although the end goal of any crypto ICO is to raise funds and encourage investment, there are a few common ways ICOs can be structured. This means different ICOs work slightly differently - which matters for your investment. These include:

Static supply and static price ICO

A company sets a specific funding goal. Each coin or token sold in the ICO has a set price. The token supply is fixed. So for example, a company wants to raise $1 million, so they sell 1 million tokens at $1.

Static supply and dynamic price ICO

A company sets a dynamic funding goal. There is a static supply of tokens. The amount of funds received in the ICO determines the overall token price. So for example, a company launches an ICO and raises $3 million. There is a static supply of 1 million tokens, so each token is worth $3.

Dynamic supply and static price ICO

A company sets a specific funding goal, but no limit to the amount of tokens. The supply of tokens is determined when the fundraising goal is reached. So for example, a company sets a $1 million fundraising goal and reaches it. At the point they reach it, there are 500,000 tokens in circulation, meaning each token is worth $2.

The structure of a crypto ICO should be laid out in a whitepaper, which is made available to prospective investors via a specific site and through promotions. As well as laying out the structure of the ICO, a reputable whitepaper should also include other details about the project, such as:

• The purpose of the project
• How long the ICO will run for
• The future goals arising from the project
• A breakdown of the funds needed to complete the project
• What percentage of the coins or tokens are kept by the company or other invested parties
• What currencies the company accepts as investment - whether that’s fiat or another cryptocurrency
• The terms and conditions of returning funds if the ICO is unsuccessful

Who can launch a crypto ICO?

Anyone can launch a crypto ICO. There are even dedicated platforms to help investors who may not be as technologically minded launch new tokens.

While this accessibility is a huge benefit of crypto ICOs, it also comes with risks - because not all crypto ICOs are legit.

Crypto ICO Scams

Crypto ICO scams are sadly still rife in the crypto market. Some common crypto ICO scams include exit scams, pump and dump schemes, and ponzi schemes:

• Exit scam: An exit scam occurs when the creators of a cryptocurrency project or exchange collect funds from investors and then disappear without delivering on their promises or fulfilling their obligations. This scam is commonly associated with ICOs and new cryptocurrency exchanges. The creators might promote a new project, gather investments, and then vanish with the funds without launching the project or platform they promised.
• Pump and dump scheme: This is a scheme where the price of a cryptocurrency is artificially inflated or pumped to attract unsuspecting investors, and then sold off and dumped by the perpetrators for a profit. It's not exclusive to ICOs, but it is very common with new and unheard of projects. It's often affiliated with crypto influencers or celebrities, such as Kim Kardashian and Floyd Mayweather among others currently embroiled in legal proceedings over alleged pump and dump schemes.
• Ponzi scheme: Ponzi schemes aren't exclusive to crypto by any means, but the schemes have found new footing in an unregulated market, and ICOs offer a big opportunity for financial fraudsters. A ponzi scheme is a fraudulent investment scam that promises high returns with little or no risk to investors. It pays returns to earlier investors using the capital of newer investors, rather than from legitimate business activities. In terms of ICOs, Ponzi schemes may often have several rounds of funding in order to continually attract new investment to pay previous investors, before being exposed when the funds eventually run dry.

Biggest crypto ICO scams

There are plenty of infamous ICO scams, with some of the most notable including:

1. OneCoin: One of the most infamous alleged scams in the crypto space. OneCoin was promoted as an investment opportunity and raised billions from investors globally. Authorities in various countries have since accused the project of being a Ponzi scheme. The founder, Ruja Ignatova, disappeared and has been charged in absentia.
2. Bitconnect: Perhaps the most famous of all crypto ICO scams is Bitconnect. The Bitconnect ICO raised a colossal $3.45 billion. The project owners promised that Bitconnect would be an open-source currency and guaranteed 40% returns on investments. What they weren't so forthcoming about was that Bitconnect was connected to a high yield investment program - in other words, a kind of Ponzi scheme. Not long after the ICO launched came the claims of illegitimate activities - both from investors and financial regulators. The currency ultimately collapsed and lost liquidity resulting in a complete loss of value for many investors. The value of BCC plummeted, and the company shut down its lending and exchange platform. Legal proceedings against those involved are still on-going.
3. PlexCoin: PlexCoin was a well-known crypto ICO scam. The PlexCoin ICO raised $20 million, which is unsurprising given they were promising returns of 1,354%. Of course, the company couldn’t live up to this and was quickly shut down by the US Securities and Exchange Commission (SEC). Fortunately in this instance, thanks to the SEC involvement, PlexCoin was ordered to pay back the vast majority of the $20 million they defrauded investors of. But many investors who fall foul of crypto ICO scams aren’t so lucky. 

Avoiding a crypto ICO scam might seem as simple as avoiding dubious websites with unscrupulous claims of high returns on them - but it’s not quite the case when these types of scams are promoted by celebrities and influencers alike. So let's dive into some top tips on how to avoid crypto ICO scams.

How to avoid crypto ICO scams

Spotting a crypto ICO scam isn't always easy, but here's some common sense tips to help you avoid losing your investment to fraudsters:

• DYOR: Dive deep into the project's whitepaper. Ensure it's comprehensive, makes sense, and isn't filled with jargon just to sound impressive. Investigate the team behind the project. Check their professional backgrounds on platforms like LinkedIn. A legitimate project will typically have team members with verifiable online histories.
• Community engagement: Look into the project's community engagement on platforms like Telegram, Reddit, or Discord. Genuine projects will often have active communities. Be cautious of overly positive sentiments or signs of orchestrated efforts to promote the token.
• Check for transparent development: Genuine projects often have open-source code repositories on platforms like GitHub. A strong, active development history is a positive sign.
• Regulatory compliance: Determine if the ICO is following regulatory guidelines for your country. Some ICOs might prohibit participants from certain countries due to local regulations.
• Beware of unrealistic promises: Be cautious of projects promising guaranteed or excessively high returns. If it sounds too good to be true, it probably is.
• Token utility: Understand the purpose of the token within the ecosystem. Does it have a genuine utility, or does it seem like it's just being used to raise funds?
• Independent audits: Check if the project has undergone any third-party audits, especially for their smart contracts. This can help identify vulnerabilities or potential malicious intent.
• Escrow: For ICOs that raise significant sums, check if funds are being held in escrow. This ensures that the team only receives the funds once certain milestones are achieved.
• Beware of aggressive marketing tactics: If a project is using aggressive marketing or pushing for urgency, be cautious. This can be a tactic to push individuals to make impulsive decisions.
• Check token distribution: Understand how tokens will be distributed. If a large portion is allocated to the team or certain partners, this might be cause for concern.
• Seek external opinions: Engage in community discussions or consult with trusted individuals in the cryptocurrency space to get their perspectives on the project.
• Check for previous work: Has the team delivered successful projects in the past? A track record of success is a good indicator, though not foolproof.

Remember, the best tip for any investment is a simple mantra - if it sounds too good to be true, it probably is.

Examples of succesful crypto ICOs

Just because crypto ICO scams are prevalent doesn’t mean all crypto ICOs are a scam. Quite the opposite in fact, some crypto ICOs have been very successful. Some examples of successful crypto ICOs include:

Ethereum ICO

Way back before ETH was one of the most popular cryptocurrencies around, Ethereum launched an ICO to raise funds to develop their smart contracts capabilities. ETH tokens initially sold for $0.31 each during the ICO. At the time of writing - just one ETH is valued at $3,812.

Ark ICO

Ark is a decentralized digital currency platform that aims to integrate non-native cryptocurrencies onto its own blockchain. ARK coins were initially priced at $0.04 during the ICO launch and later reached a peak of $11 - providing an incredible ROI of more than 35,000% for early investors who sold at the peak.

Cardano ICO

Cardano launched its ICO in January 2017 - promising to use the funds raised to develop smart contracts and Dapps capabilities. The ICO raised more than $62 million with each token priced at $0.02. ADA is now priced at $1.33 at the time of writing - with many expecting it to hit new heights in the future.

How are crypto ICOs taxed?

If you are one of the lucky ones to invest in an ICO and reap the high returns - we’ve got some bad news for you. In many countries, ICOs are taxed. How they’re taxed all depends on whether you’re launching an ICO or whether you’re participating in an ICO as an investor. Let’s break it down.

If you’re launching an ICO, most tax offices will view this as a kind of Income. So you’ll pay Income Tax on all proceeds, regardless of whether you use fiat currencies or cryptocurrencies for funding.

For investors, it’s a little more straightforward. The vast majority of tax offices around the world haven’t yet issued guidance on ICOs - however we can follow the tax treatment of IPOs as guidance. In most countries, this means you’ll pay no tax at the point you invest in an ICO. It’s only when you later sell, swap, spend or gift your coins or tokens from an ICO that you’ll pay Capital Gains Tax on any profits.

The amount of tax you’ll pay depends on where you live and how large your gain is. You can calculate your gain or loss from an ICO easily. Just subtract the price of the coin/token when you acquired it from the price of the coin/token when you sold it. If you traded your coin/token for another crypto - use the fair market value of the coin on the day you traded it in your chosen fiat currency to calculate this instead.

Calculate crypto ICO taxes with Koinly

Koinly helps crypto investors around the world do their crypto taxes in no time at all. All you need to do is sync the wallets, exchanges or blockchains you use with Koinly using API or import your transaction history using CSV files. Once you’ve done this, Koinly will calculate your crypto capital gains, losses, income and expenses for you and generate a tax summary. You can then download a complete tax report - ready to submit to your local tax office.

When it comes to crypto ICOs, all you need to do once you’ve synced your transactions with Koinly is find the specific ICO transaction and enter your cost basis (how much you bought the coins/tokens for). From here, Koinly can then calculate any subsequent capital gains or losses from selling, swapping, spending or gifting your coins or tokens. Learn more about how to tag ICO transactions in Koinly.