The uptake of Initial Coin Offerings (ICOs) has seen huge amounts of money driven into cryptocurrency investment. In the 7 short years since ICOs were used to get Ripple off the ground, tens of billions have been pumped in by the public to get various cryptocurrencies up and running. This has meant investors who have traditionally hedged their bets with Initial Public Offerings (IPOs) have had their heads decidedly turned whilst also bringing a whole new generation of people into the world of finance. Which leads us to wonder, what exactly is an ICO, is it worth investing in and can it compete with the more traditional IPO?
What is an ICO?
In simple terms, when a cryptocurrency wants to get a project off the ground, it carries out what is known as a blockchain crowdsale or initial coin offering. In other words, the public can buy up tokens made available by a start-up using cryptocurrency or fiat and the start-up uses this investment to set up their decentralized application (DApp). The process for getting an ICO off the ground can be quite straightforward. Often the new blockchain project simply needs to produce a whitepaper, a document made available to potential investors to help them make an informed decision around whether they want to invest in the idea.
What is an IPO?
Initial Public Offerings, as mentioned, are a more traditional and established form of investment. They work in a similar way to ICOs in the sense that it is a means for a private company to make shares available for the public to invest in, which allows the company to raise capital. The concept has been around right back to the Dutch East India Company in the 17th century when they allowed the public to buy a stake in their operation. IPOs require a number of legal frameworks, a stock exchange and various ‘middlemen’ to allow them to work smoothly. This can be a costly and time consuming process, often taking over a year with many private companies failing in their attempts to make their companies publicly available for investment.
The key differences
As mentioned, IPOs require a great deal of regulation and organisation. Whilst ICOs operate on smart contracts, a computer code which helps to execute an agreement and exists on the blockchain, IPOs require a more complex framework. Government bodies such as the Securities and Exchange Commission must regulate their inception and approve their existence through legal and compliance processes. This requires a legal team and banks, not to mention, time. The IPO then requires listing on an exchange which also costs money, plus if you want to make an investment in it, then you must go through a broker.
Brokers charge an average of 4% per investment that they help to carry out, taking yet another chunk of money out before you’ve even got your hands on the shares. Of course, you also need a PR team to get things off the ground. For the public to know about you, extensive marketing and advertising is essential, and that doesn’t come cheap. All of this costs a great deal which means profits are more limited, as is flexibility. In a poll conducted by PWC, 83% of companies said it had cost them over $1 million to go public. By contrast, all you need to invest in an ICO is an internet connection! Due to the fact they use smart contracts, ICOs are in effect self-governing and do not need the middlemen which are constantly required for IPOs to get started. ICOs can also be invested in from pretty much anywhere in the world, with the exception of a few in the USA. For foreign companies, it is common that for IPOs you will require special permissions to make investments in them.
Of course the flip side of all this red tape with IPOs is the security that is available through it. The issues with scams and abuses that have occured within ICOs has been widely reported and is the downside to their get rich quick aspects. Brokers may cost money but they also act as an independent third party should things go awry. With ICOs it has often been the case that there was no one to turn to.
This was further hampered by a number of cryptocurrencies cutting corners in their haste to make tokens available, often resulting in lax security measures and poor resourcing of security operations. This has made projects sit up and take note, however, with some ICOs now offering tokens as securities within the SEC. What this move has done, has highlighted the flexibility you are getting with tokens versus simply buying stock and has done wonders to show their wider users and practicalities
ICOs have unlimited access to them unlike IPOs traded on the Dow Jones or NASDAQ. Whilst these stock exchanges close at 5pm and for the weekend, ICOs never stop and are available 24/7. Furthermore, ICOs do not have to be listed on exchanges at all and can be available for investment before they’ve even put on an exchange. The tokens you are investing in aren’t necessarily even a product yet, it may simply be a proof of concept. But tokens aren’t just stocks, they are a digital asset. The agreements which are hardwired into them can be used to execute instructions.
These agreements are unmanipulated and non impacted by human influence, which gets into the core of what ICOs are all about. They are designed to be community owned and managed in a decentralized manner. It has only been recently that decentralized governance has been possible on this scale. CEO of Never Stop Marketing, Jeremy Epstein asserts: “With blockchain systems, we have the potential for the coordination of large groups without compromising the agility and resiliency of decentralized communities.” This allows a token owner to make their opinions known, depending on the smart contract, on the future direction of the blockchain and do so without a centralized body interfering with the governance.
One area it is argued that IPOs have begun to succeed in where some ICOs fall short is in allocation. IPOs can prevent ‘whales’ from buying up huge amounts of stock whilst some ICOs can see one or two investors taking up a huge proportion of tokens and manipulating the price. IPOs prevent this through regulation and a fair share asset distribution.
ICOs offer a means into a far more community based and transparent world of investment. They provide greater accessibility and flexibility compared to their older brethren. Many will still baulk at the idea of investing in blockchains as they find them confusing and volatile. It is easy to forget that they have been around for a mere seven years compared to IPOs’ rather more cemented 400.
But what this shows is an incredible amount of progress for something so decentralized to become so well organised in such a short amount of time. Whilst there are still some legitimate concerns around their security and regulation, not to mention the sheer volume of ‘zombie chains’, ICOs offer efficiency, huge return potential and the opportunity for autonomy that IPOs can only dream of.