Until July 2017, within a short span of seven months, the total volume of funds raised through Initial Coin Offerings (ICOs) amounted to staggering US $1.25 billion worth of cryptocurrencies. The cryptocurrency market, which now has a total market capitalization worth over US $100 billion, has attracted the attention of many investors and traders who want to make quick money. However, many experts are concerned about the security issues and lack of transparency pertaining to cryptocurrency trades and transactions.
The explosive growth of ICOs during the last few years has alarmed many of its critics, who consider the phenomenon just a bubble waiting to burst. On the other hand, the proponents of ICOs claim the development as a revolutionary innovation that will soon change the very fabric of the world’s economy.
The initial coin offering (ICO) is actually a means of crowd-funding. It is a way to create and sell digital or cryptocurrency coins (or tokens), to fund the development of an innovative idea or project. In contrast, the Initial Public Offering (IPO), refers to the public offering of stocks or shares of a company for the mobilization of funds for the development and expansion of the company’s business.
The following are some of the glaring differences between a Stock IPO and a Crypto ICO:
- IPO- In the case of an IPO, it is mandatory for the company to register it with the regulatory authority such as SEC (Securities and Exchange Commission in the US) with a legal document called the prospectus. The prospectus represents the legal declaration of the company’s intention to issue its shares to the public. The prospectus should include certain key information about the company and its proposed IPO, and meet all other standards of transparency enabling the potential investors to make informed decisions.
- ICO– On the other hand, the ICOs are not legally bound to support the issue with any form of legal documentation. However, an ICO often accompanies a form of document called the white paper, which outlines the key information pertaining to the proposed project, such as its purpose and the mechanics of its operation.
Track Record and Credibility:
- IPO– Before listing an IPO, the company needs to have a minimum earnings threshold and a good track record, its accounts need to be verified by professional accounting firms, and the investment banks have to act as underwriters for the fulfilment of the IPO’s promises. Such requirements serve as effective filters to establish the credibility of the companies wanting to issue their shares to the public. In addition, most of the companies going public are being funded by institutional investors (such as angel investors, venture capitalists, private equity firms etc.) who do rigorous due diligence on the liabilities of the concerned business proposal.
- ICO– Contrarily, the ICOs do not have to adhere to any regulatory framework or legal protocol. This is why most of the ICOs do not have any track record to back them up, except a dubious white paper. While some ICO projects may have a working prototype (in alpha or beta testing stages), most have only a conceptual framework outlined in their white paper. This makes it almost impossible for you to assess their fundamentals. Your due diligence of the project, therefore, will be restricted only to its future expectations and none whatsoever pertaining to its non-existent history. This makes investing in ICOs extremely risky. No doubt, the project developers’ experience and reputation can give you some hint, though not about the project’s conclusive viability.
The Benefits of Investing in IPOs vs. ICOs:
- IPO– The stocks acquired through IPO grants you an ownership as a shareholder and a stake in the company’s future earnings by way of dividends. The shareholders also get the voting rights in the company’s AGMs.
- ICO– Unlike an IPO, the acquisition of an ICO does not grant you the ownership of the project. The investors may, however, reap future benefits of their investment depending on how the coin is structured, as the cryptocurrency’s value directly correlates to its perceived utility. Some of them confer stake in the future earnings of the project, while others gain value by means of the cryptocurrency’s role and its usage in the financial ecosystem.
The Duration of the Offerings:
- IPO– The issue of an IPO is an inordinately lengthy process because of its legal and compliance requirements, taking about 4-6 months.
- ICO– The entire process of issuing an ICO is of much shorter duration, depending on the nature and the timeline of the project itself. Once the white paper is conceived, the crowdsale can begin forthwith. The duration of the crowdsale depends on how soon the pre-determined maximum hard cap is reached, usually a month or so. But some of the much-hyped ICOs can be sold out within minutes or even seconds. For example, the ICO for Basic Attention Token (BAT) raised a capital worth $36 million within 30 seconds.
Access to Initial Offerings:
- IPO– IPOs are usually allocated to institutional investors (such as mutual funds, endowments and investment banks). At times, only a small portion of the IPOs are allocated to normal, retail investors. Retail investors can acquire shares of new IPOs only when they are traded openly at the exchanges.
- ICO– Whereas, ICOs are open to everyone for participation where all you need is some cryptocurrency (such as Bitcoin or Ether), which you can convert into the particular ICO token. Thus ICOs open up a level playing field for all investors, breaking down the traditional ‘oligarchistic’ system of fundraising. This kind of democratization of the system empowers the masses to participate in investments that can earn them multiple times their initial capital.
The Risks of Investing in ICOs:
Unlike IPOs, the ICOs are currently not regulated by any government agencies. However, many governments have started taking a closer look at them. It will take only one major fraudulent ICO issue to trigger the process of a series of regulatory constraints to curb the industry. As of now, it is best for investors to protect themselves by conducting intensive due diligence before participating in any ICO.
One blatant sign of identifying a fraudulent ICO scam is that its promoters are unknown or anonymous. If a startup company is promoting an ICO by promising to really deliver a working product, the promoters should be able to back up their promises and claims by revealing their verifiable identities.
Another sign of ICO scam is that the startup’s developers fail to provide a clear case of the valid use of the cryptocurrency tokens that they offer. Unless they define the key purpose of the startup’s platform, the token’s value would not be sustainable in the long term.
When the white paper supporting an ICO advertises overly optimistic claims or an unrealistic development schedule for the project, it shows that they are using deceptive tactics to attract token buyers.