Article contributed by Fritz Charles, Founder and CEO, Coin Gamma.
2017 saw the rapid growth of ICOs. In an effort to categorize this new fundraising mechanism, you will find many publications and market participants using the ICOs and IPOs terms interchangeably as if they are substitutes for each other.
This is incorrect. The only similarity between ICOs and IPOs is that they are tools for new or existing companies to raise funds.
Here are a few ways in which they are quite different:
Equity Status
IPO is equity, ICO is not equity. When an investor purchases shares in an IPO, they have ownership in the company. As an owner of the company, you may have rights to the dividends and to voting.
An ICO, however, does not give you ownership of the issuing company. You get a coin or token in the new company or ecosystem. What does this coin/token give you? Well, it depends on the ICO. There are two types of ICOs: a. Project ICOs or b. Currency ICOs. Project ICOs issue tokens that can then be used within the company’s ecosystem. Kik, the Canadian messaging app, issued a token that will be used within its messaging app. Developers that build apps on the Kik platform can be rewarded with tokens depending on how well their apps perform. In contrast, currency ICOs bring a new currency into the ecosystem. Buyers of these ICOs assume that the usage of the currency will increase. Ether is the most successful example of this type of ICO.
Stage of the Company
Most ICOs are issued from companies at the infancy stage; some have products or prototypes, while many others are simply an idea. The ICO’s aim is to fund the project. An IPO has a fully vetted business that has been a going concern. Companies that issue IPOs typically have gone through rounds of funding, have a proven business model and have audited financials. The ICO market, being unregulated, has no audited financials. A better comparable to ICOs is angel funding or crowdfunding.
Participation
Individuals cannot participate directly in IPOs. Only institutional investors, such as hedge funds or mutual funds, and retail clients of the investment banks can do so. The only way to be a retail client of an investment bank is to be a highly wealthy individual (Net worth > $5mm). The average investor cannot participate in an IPO and therefore misses out on a huge driver of wealth creation in the equity market. Many ICOs, on the other hand, are open to anyone who wants to participate. This allows all individuals who are passionate about a product to get into it on the ground level and play a part in its early creation. This is changing, however, due to the threat of impending legislation.
Size
ICOs are usually done at the infancy stage, which would make the investment stage more equivalent to angel investing. Angel rounds are traditionally under $1mm and allow the founders to build and test on an early prototype. With ICOs, we have seen funding rounds of over $100mm. $100mm at the infancy stage is enormous. One must ask if a founding team secures $100mm without providing any progress, will they still be incentivized to reach their milestones? A current ICO, Telegram, is raising $1.6 Billion. Investors in this Telegram ICO include Sequoia Capital and Benchmark.
Speed and Regulation
IPOs need auditors, bankers, a road show, and approval from the SEC. These companies are highly regulated, must be audited, and must pay taxes. ICOs are a free market. ICOs need a whitepaper. That’s it, just a paper that outlines the project and how the team plans to use the funds. If an investor buys into an ICO and the team disappears with the funds, they are out of luck. Naturally, this leads to a ton of risk as the vetting process must be done by the ICOs buyers by themselves. That said, IPOs are not foolproof as public companies can be fraudulent, as evidenced by Enron.
Funding Source
IPOs are funded by Fiat currency (like Euro or US Dollar), while ICOs are only financed by an existing cryptocurrency, such as Bitcoin of Ethereum.
Marketing and Communication
The founders of a company that is making an Initial Coin Offering can communicate how and whenever they want. It is common to see the founder of a company that is doing an ICO communicate actively across social media, indulging in host meetups, and attending conferences. In the case of an IPO, this is impossible, especially in the United States. Under American Securities law, there are two mandatory quiet periods. One is after the company files for an IPO and awaits the SEC’s approval and the second one is during the first ten days following an IPO’s first day of trading. During this time, company insiders are not allowed to discuss or promote the IPO.
At the time of this writing, regulators have been hands-off with the ICOs, but this can change soon. On February 6th, 2018, SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo met with Congress to discuss cryptocurrencies. While this meeting revealed that both Chairs were quite optimistic on crypto on a high level, SEC Chair Clayton made it clear that the SEC is unhappy with the proliferation of the ICO market. He believes that many ICOs are blatantly attempting to skirt security laws by calling their issuance tokens or coins versus securities. In response, many ICOs are not allowing American investors. Given the number of offerings, there are still many options for the American investor.
After the SEC develops firm rules for ICOs and their issuance, we may see ICOs develop more of the characteristics that mirror the IPOs. That said, ICOs are here to stay and can serve as a reliable source of funding, liquidity, and wealth creation. If you plan to participate, focus on the particulars and do not depend on IPO frameworks to make investment decisions.
Fritz Charles is the founder of Coin Gamma, a crypto data and content company that provides reliable information about the crypto and blockchain space. Prior to launching Coin Gamma, his professional experience spanned finance, technology, and media as he worked at Lehman Brothers, Barclays Capital, National Basketball Association (NBA), and Interactive Corp (IAC).
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