For a long time, IPO has been the standard public investment process for startups and businesses going public. Now there’s another exciting albeit risky option: initial coin offerings.
A popular new investment method has popped up in the world of cryptocurrencies.
An ICO, or Initial Coin Offering, is an investment method where cryptocurrency coins or blockchain entries confirm an investor’s stake in and guarantee of profits from the project or business. Typically, the project or startup’s coins are exchangeable for common cryptocurrencies like Bitcoin or Ether.
This is different from an IPO, or Initial Public Offering, where investors receive shares that reflect how much profit is given to shareholders in the form of dividends. The share value itself is based on the company’s local centralized, government-sponsored currency like the U.S. Dollar, for example.
A Game of Letters and Numbers
IPOs or “initial public offerings”, are how private companies transition into public companies. In the case of promising startups, however, IPOs are used to attract startup investments.
Some other key features of the IPO:
- Protected by law in most countries.
- Business profits are easily distributed to shareholders in the form of dividends. As the primary method of profit distribution, no ownership change is necessary (like cost compensation for ICOs)
- Share price value takes into consideration the entire economy.
- Legal in every country where public investment is legal.
Shares of a company are sold to institutional investors who then sell those shares for the first time on a securities exchange. Also referred to as a “stock market launch”, the general public purchases these shares when they are made available. “Going public” is full of its fair share of potential maelstroms and fiascos. Due to the nature of IPOs, investment banking firms often operate as underwriters.
What the heck is underwriting?
Simple: when a firm such as an investment bank raises capital for businesses or governments issuing securities. While many businesses have very successful IPOs like Yext, others don’t fare so well. Companies as big as Facebook totally bungled their underwriting process. So why has a new competitor emerged onto the scene in the form of the ICO?
So why has a new competitor emerged onto the scene in the form of the ICO?
The Differences Between an ICO and an IPO
An ICO or “initial coin offering” utilizes cryptocurrency and crowdfunding instead of underwriting and investors.
How is it different?
Well, the obvious difference lies in crowdfunding vs. traditional investment bank funding or venture capital funding. The less obvious difference is how the “coin” represents a token of ownership in an enterprise just like a stock certificate.
The appeal of the ICO, for many, lies in a potential lack of regulations.
Here’s a quick rundown of the differences:
- Many ICOs can forego a traditional corporate structure meaning the creator has more control over how the business operates.
- Financial data of an ICO can be accessed by anyone whereas an IPO must comply with stock exchange regulations.
- ICOs use blockchain technology similar to BitCoin or Ethereum
- ICOs can retain investor anonymity just as the Blockchain is anonymous.
- ICOs can also forego filing statements with financial regulation offices in their respective countries of operation.
- Just like ordinary cryptocoins, ICO coins can be split up or consolidated.
- Coins are purchased via cryptocurrency exchanges.
- ICOs are not protected by law. They are banned in China.
- Because they’re not protected by a government, there is no set method for distributing profits to coinholders.
- Cost compensation, the primary method of distributing ICO profits, defined by the buying back of coins from investors, changes ownership stake.
- ICO coins value is reflected by the specific project or business rather than the economy of projects like normal shares. In essence, ICO coin liquidation is less valuable than liquidating traditional shares.
- ICO coins for a specific project are separated from the rest of the cryptocurrency chain value.
There are a few more, but these are the big ones. Despite some venture capitalist firms cite “The Howey Test” and other reasons for ICOs not gaining traction in the financial sector.
On the flip side of this digital coin, you have firms such as Pantera Capital in San Francisco going “all in”.
So how can you know which approach will work best for your startup? The key to knowing which one works for your purposes lies in the purpose of your business.
Are you a more traditional company with sales turnover, dividend payouts, and “normal” business activities?
An IPO might work better.
An ICO works for companies undertaking risky business ventures that likely won’t entail paying out dividends. Of course, there are some who allege that the only true difference between an ICO and an IPO is the token showing ownership.
But even that claim is hotly disputed. It may be too early to say one way or another.
Bigger Concerns Abroad & Common Misconceptions
While some American companies are embracing ICOs, governments elsewhere aren’t looking too kindly on the non-traditional currency offering. As we mentioned, China and Korea both banned ICOs this year while Taiwan followed Japan in allowing them–and thoroughly encouraging cryptocurrency economy.
Conversely, Vladimir Putin’s advisor has a $100 million USD-worth ICO on the books for Russian Miner Coin–a Russian Bitcoin mining farm.
As for the notion that ICOs are exempt from regulations, that’s a bit of a myth. They are securities, after all, so they are subject to certain regulations.
The SEC just charged two cryptocurrency firms, REcoin and DRC World, with defrauding investors. There is a precedent for investor protections despite the relative newness of ICOs.
Some individuals may skirt regulations, breaking the rules designed to protect them. But cryptocurrency exchanges are definitely not exempt from regulations. The big question concerns the legitimacy of an ICO for the investor.
They also claim that investors don’t realize this due to the seeming validity of the variables.
coinmarketcap.com houses many currencies. More and more startups utilize blockchain technology. People–even friends–talk about the exciting prospect of ICO crowdfunding, so you buy in. Suspiciously, after your friend cashes out, the value suddenly drops. So you wait to sell, but it never rises back up. Panic ensues, and you sell for enormous losses.
So, is regulation the answer?
Regulating Cryptocurrency: How, Why, & Should We?
ICOs are insidious is because they seem “above board”, but are not (as some claim). There’s a mania and panic cycle as pointed out by The Economist, but how would you go about regulating this?
Investors illegally investing currency won’t happen with dollars. Paper money can be counterfeited, but you can’t hack a $100 USD bill. Did I mention that cryptocurrency can be hacked? Because people hack cryptocurrency exchanges quite a bit.
If you place heavy regulations on the process, then the asset liquidity might diminish. Extreme investor protections could harm the launching of startups.
Still, these concerns of regulation, investor protections, and security haven’t stopped the rise of ICOs. ProSense plans to launch a peer-to-peer virtual live stream platform using blockchain tech with a $30 million USD ICO in November 2017.
Profits, Risk, and Dividends–oh my!
For more traditional companies with sales turnover, dividend payouts, and that engage in “normal” business activities, an IPO might work better. An ICO works for companies undertaking risky business ventures that likely won’t entail paying out dividends.
Does this sound like a startup to you?
Hint: it should ring ALL the bells. Of course, there are some who allege that the only true difference between an ICO and an IPO is the token showing ownership.