“ICO” is the hype term of the blockchain space, right now. These “Initial Coin Offerings” (also used interchangeably with a Token Generating Event and / or Token Distribution Event), have brought in tens of billions of dollars over the past few years, and while the market is slowing from this dizzying high-point, interest remains intense. ICOs basically function as early-stage attempts at crowdfunding in which any investment is rewarded with a sort of digital coupon that eventually entitles the owner to something from the company that ran the ICO.
How do ICOs differ from IPOs?
But that model sounds very much like another one used by traditional businesses looking to acquire early-stage funding: an IPO. An “Initial Public Offering” is the first-ever chance to purchase stock in a company as it enters the stock market, and they’ve existed in one form or another ever since the Dutch East India Company first sold part ownership to raise funds. So how is the modern ICO similar to the much older and better-understood financial institution of the IPO? How are they different? And why do those differences matter so much, in a crypto space?
Security Vs. Utility
The first major difference between an ICO and and IPO is that the fundamental premise of an IPO is absent from an ICO. Basically, IPOs are all about buying partial ownership of a company, entitling the investor to certain rights and to regular pay-outs of company profits called dividends. These sorts of investments are called “securities,” and being the backbone of the global economic system, these securities are extremely heavily regulated by the Canadian Securities Administration, the US Securities and Exchange Commission, and many more bodies around the world.
On the other hand, buying blockchain tokens by investing in an ICO does not entitle you to ownership in the company selling those tokens. That would make the tokens securities, and the blockchain space is too new and under-developed to participate in such a heavily regulated market as that. There is significant work being done to evolve the “security token” space to the point that blockchain companies could sell actual security tokens in their ICOs, but like all large-scale legal change, progress has been slow. If and when that does happen, an ICO could be structured to be theoretically very similar to an IPO -- but that has no happened, thus far.
In a modern ICO, the product is typically a “utility token.” These tokens generally entitle holders to services within a particular blockchain environment, and while they may represent real value they do not represent an investment that will produce ongoing financial returns. Do you want to learn more about tokens? Be sure to check out our previous blog post, What is an ICO.
Old vs New
Many of the biggest practical differences between an IPO and an ICO come down to the relative ages of the practices. IPOs are extremely well-understood financial maneuvers, and they’ve become one of the most highly regulated out there. Purchasing a stock from an IPO comes only after the company selling itself has passed a series of mandatory security and financial checks. This helps protect buyers from the sort of blatant fraud that plagued the ICO business, at least in the beginning.
That’s because ICOs are far less regulated than their cousins in the stock-market, companies have been known to disappear shortly after the initial round of fundraising comes to a close. That’s becoming less common, however, as investors become more savvy and harder to fool with made-up concepts.
Short vs Long
An IPO can take 6 months or more to reach completion, owing largely to the laborious oversight associated with each sale and with the IPO in general. This gives investors ample time to appraise the opportunity and make a decision -- while ICOs tend to be much shorter, often becoming mad dashes to invest before the opportunity is gone. This means that ICOs are much more about making bets based on projected success, rather than about waiting to see how a company does in the early stages of an IPO and making further decisions from there.
Thus, ICOs are associated with both greater losses and greater gains than IPOs, as we would expect; greater risk almost always means greater possible reward.
Open vs Closed
IPOs are mostly the realm of professional investment bodies like banks and hedge funds, meaning that the average “retail” investor can’t participate. ICOs, on the other hand, are all about retail investment. Blockchain technology has made the availability great enough, and the minimum levels of investment low enough, that virtually anyone can become an ICO investor -- for better or worse. In many cases, investment barriers are there to protect inexperienced investors from risking money they should put into more stable, long-term funds, and many ICO investors have suffered for the absence of those limitations.
Additionally, once a company is listed on major stock exchanges, it usually remains listed -- meaning that the shares can be liquidated at any time. Blockchain tokens bought through an ICO will not necessarily be tradable through an exchange, meaning that investors have a harder time redeeming their investment, should they need to do so.
Overall, ICOs are a more volatile and unpredictable financial opportunities than IPOs -- but that’s why they’re so exciting. Investors looking for enormous possible returns have largely turned away from IPOs, which are now so well-understood that they rarely defy expectations. With an ICO, however, investing can be exciting, once more.