The importance of raising capital to grow a business is a fundamental tradition that began long before the rise of ryptocurrency and blockchain technology. But you’ve likely seen headlines about initial coin offerings (ICO), whereby you receive newly created digital units of value — coins — in exchange for an investment.
While an ICO may sound like an initial public offering (IPO) — they’re both intended to attract investment, after all — they are fundamentally different in a few important ways.
Here’s what to know about ICOs and IPOs.
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What is an ICO?
An initial coin offering — more commonly called an ICO — is a way for crypto startups to raise money. In most cases, a company organizes the ICO prior to allowing any trading on its coin, using it to raise capital to get off the ground. In 2017 alone, crypto companies raised more than $5 billion through ICOs, illustrating just how popular they have become with blockchain enthusiasts.
However, these funding campaigns do not support traditional fiat currencies. Instead, they request investment in the form of an established cryptocurrency, more commonly bitcoin (BTC) or Ethereum (ETH). In return, investors receive the newly created token specified in the ICO, which at some point becomes tradable on a public exchange.
Filecoin (FIL) delivered what’s become one of the most successful ICOs, raising the equivalent of $257 million at the time of the sale in late 2017.
What is an IPO?
An initial public offering, or an IPO, is the process of transitioning from a privately owned company to that of a public one, with shares listed on a stock exchange.
A recent example of a company that’s issued an IPO is Facebook, which listed its company on the New York Stock Exchange in 2012, raising $16 billion in capital by offering 421.2 million shares. Investors can sell their shares at any point, with the value of those shares determined by the financial performance of the company.
ICOs vs IPOs: What’s the difference?
While an ICO might sound like an IPO, only involving digital (rather than fiat) currency, you’ll want to note a few crucial distinctions before taking the plunge into crypto.
How funds are raised
Going from a private company to a public entity is a highly stringent process, requiring applications that go through a set of regulatory hurdles. The process includes an independent audit, analyses of past financial performance and, ultimately, a decision from the Securities and Exchange Commission as to whether the IPO can more forward.
But ICOs are different from the start: Nearly anyone can organize one — all that’s needed is a website and a white paper. A crypto company determines the amount of money it needs to raise and, because we’re dealing with an unregulated market, moves forward without the red tape required for an IPO.
Investment instruments involved
When private companies decide to go public, investors purchase shares using real-world money like US dollars, euros or yen. This process allows the company to access its capital once the offering is finalized.
Contrarily, due to regulatory restrictions, ICOs can’t involve or accept fiat currency. Instead, they most commonly request either bitcoin (BTC) or Ethereum (ETH) to fulfill the ICO. These coins are then traded for real money on an exchange, allowing the crypto company to spend the funds it’s raised as capital.
When investors purchase shares in an IPO, they effectively buy a stake in that company. With their investment comes voting rights proportional to the number of shares they’ve bought, and they could also be eligible to receive dividends.
In the world of ICOs, investors do not have any stake in the business’s operations. The token they’ve purchased rises and falls in value on the back of market forces, but they don’t actually own a slice of the company that offered the ICO.
Due to the regulatory oversight afforded to IPOs, it’s unlikely that the company is involved in illicit activity. Investors can remain confident knowing that regulators perform enhanced due diligence to ensure the legitimacy of the organization previous to any listing.
Unfortunately, ICOs offer no such guarantee. Some crypto projects are nothing more than a scam, with the company in question not even intending to fulfill the promises made in its ICO white paper. An example of such a “pump and dump” scheme, DeCloud fooled investors into parting with the equivalent of $1 million in a recent ICO and subsequently went missing after it raised its capital.
Did you know?
Grey area of regulations in the US.
In general, the US government hasn’t yet stepped in to regulate what many consider a simple fundraising scheme. But it appears that lawmakers and regulators — including the Securities and Exchange Commission — are taking steps to get involved.
However, it remains to be seen how the government can enforce regulation of ICOs, due to the anonymous nature of blockchain technology.
In reality, the only commonality between ICOs and IPOs is that they give businesses a way to raise capital. IPOs are highly regulated by the US government, whereas ICOs are not. A result is that they’re limited to companies within the crypto space.
It appears that the Securities and Exchange Commission and other lawmakers are keeping close watch on ICOs, which means there’s always a chance that soon, we’ll see the introduction of legislation banning them altogether.
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