In the first half of 2017, the total dollar amount raised for Initial Coin Offerings (ICO) was shockingly over a billion dollars. That’s a mind-blowing figure within a span of just 7 months.
With a market capitalization of over USD $150 billion, the cryptocurrency world has attracted many, from investors wanting to make a quick buck to experts that are concerned with the lack of transparency. The exponential growth of the ICO market has undeniably polarized the industry, with critics associating this growth as merely a bubble waiting to be popped, while proponents justify the omnipresence of such ICOs as a revolutionary tool that disrupts the traditional funding mechanisms of society.
What Does An ICO Mean?
An initial coin offering (ICO) is a type of crowdfunding using cryptocurrencies. An ICO is executed through the creation and sale of a digital coin or token to fund project development. The characteristics of ICOs can be further understood by comparing it with a similar mechanism in the financial market, called an Initial Public Offering (IPO). IPO refers to the public sale of the shares of a company for the first time, with the purpose of collecting funds for business expansion and development.
Let’s explore the differences between a cryptocurrency ICO and a stock IPO.
1. Regulatory Oversight
Private companies that want to become a publicly traded company needs to go through an IPO. The motivations for going public is usually centered around raising greater capital funding from the public to expand business operations. As part of the mandatory requirement set by the regulatory authority, a legal document – called a prospectus – must be conceived by any entity looking to issue an IPO. The prospectus document represents a legal declaration of its intent to issue the shares of its company to the public and must therefore meet a required level of accountability and transparency. The prospectus must include key information about the company and its upcoming IPO, which will assist potential investors in assessing the viability of the company.
ICOs on the other hand, are not shackled by any legalities or regulations to issue legal documentation or forms of accountability. However, a document called a white paper is usually prepared by the developing team to outline key information about the project, including its purpose and mechanics. However, it is important to understand that there is no universally-accepted standard for an ICO whitepaper; any project could conceive a white paper autonomously, with the ability to include or exclude any information they deem fit.
2. Track Record
There is an extensive list of requirements that a company needs to fulfill before publicly listing its shares through an IPO, including having a minimum earnings threshold and a good track record. The process requires numerous third-parties to step in, such as professional accounting firms to verify company accounts and investment banks to act as the underwriter for the deal as well as liaising with exchanges to fulfill certain requirements. These strenuous processes naturally acts as a filter for credible companies to issue their shares in the public market. Additionally, most entities that are contemplating an IPO are already funded by institutional investors (which includes seed investors, private equity firms, venture capitalists, etc) that have engaged in rigorous due diligence on the viability of the company.
As ICOs do not adhere to any regulations or legal protocol, a significant majority of these projects do not have a proper track record and only possess an insignificant white paper to back up their project. While a few possess a working prototype (in alpha or beta stages), most projects are only at the idealization or conceptualization stage. This makes assessing their valuation impossibly hard; the due diligence process is focused on the project’s future expectations rather than its past history since more often than not, there is none. This is the core reason why investing in ICOs is regarded as an extremely risky endeavour.
3. Ownership Utility
The shares issued through an IPO represents an ownership stake on the future earnings of the company. Shares can be divided into several distinct classes that include common stocks, preferred stocks or a hybrid of both. A shareholder’s utility of holding a stock is the rights over the distribution of dividends as well as having a vote in the shareholders meeting.
Unlike an IPO, possessing ICO tokens do not grant token holders an ownership stake of the project. There are many ways that token holders may reap the benefits of owning tokens, and that depends on how the coin is structured. Generally, the value of any coin or token is directly correlated to its perceived utility. Some coins generate value by conferring a stake in the future revenue of the projects, while some coins equate its value to the degree of its usage within its ecosystem; the more adoption the coin gets, the higher its value will be.
An IPO process can be a lengthy process since the regulatory and compliance process is exhaustive. The average approval process of a traditional IPO can take anywhere between 4-6 months.
Conversely, the ICO process is much shorter in duration due to the absence of any stringent legal requirements or processes. The duration, however, is contingent on the nature and timeline of the project itself. Once a white paper is conceived and a smart contract for the token sale is finalized, the ICO can start. The length of the token sale is dependent on the project reaching its maximum hard cap, or a fixed sale duration, which can usually last a month. However, ICOs that generate a flurry of hype can mostly be over pretty quickly.
5. Access to Offerings
The majority allocation of shares for IPOs are often given to institutional investors such as investment banks, mutual funds, and endowments. Most of the time, only a limited portion is allocated to normal, retail investors. This means that unless you’re an accredited investor belonging to the ‘big boys club’, it will be extremely difficult – if not impossible – to acquire shares at the IPO stage. It is much easier to acquire the shares of newly-IPO companies once they are traded on public exchanges.
In the case of an ICO, there are little to no barriers; anyone can participate in an ICO. All you need to do is invest in ICO projects using the base currency of either Bitcoin (BTC) or Ether (ETH), and you can convert them into the ICO token. ICOs thereby circumvent the “oligarchistic” nature of traditional fundraising, empowering the masses to participate in investments that are highly lucrative. This degree of democratization is a huge attraction to many since it gives “power back to the people” instead of a close-knit club of elites.
What the Future Holds
Although currently unregulated, many countries and regulatory authorities are scrutinizing the ICO market. It will be only a matter of time before legislations are carved and enforced to regulate the industry, given the sheer amount of scams and shady projects that have acquired massive amounts of money. For now, the best way for investors to protect themselves is by performing rigorous due diligence before putting their money into any ICO.
Guest Post by: Aziz Zainuddin, Founder of Master The Crypto.