A Closer Look At Key Differences
Initial Coin Offerings or ICOs are what everyone is talking about in the cryptocurrency world and even the mainstream media. It’s even more buzzworthy right now for potential investors than Bitcoin or Ethereum, the darlings of the cryptocurrency world.
In 2017 ICOs raised approximately $5.6 billion according to Forbes Magazine, which is a tremendous leap from just 101 million in 2016. In 2018, some analysts expect upwards of $18 billion will be raised for ICOs.
Is An ICO the same thing as An IPO?
ICOs sound a lot like IPOs (Initial Public Offerings) – but they are immensely different.
Despite the massive amounts of money being feverishly channeled into ICOs, surprisingly most retail investors have little to no understanding of this novel fundraising process.
The ICO fundraising cycle typically begins with the company producing a white paper that describes the product or service they vow to create. Investors then buy coins or tokens that guarantees access to the ICO’s finished product or service.
ICOs are different than IPOs because they occur at the infancy stages of the company’s lifecycle. While IPOs are typically are issued by established, profitable organizations. The only time IPOs were released and weren’t established was during the 1990s infamous Dot Com Bubble. ICO projects are in the growth phase and have not made money yet and may even be in the pre-revenue stage as well.
The white papers ordinarily do not disclose the ICO company financials and tend to be inconsistent and unstable. IPO prospectuses contain carefully audited financial statements and follow well-established regulatory procedures. Consequently, the due diligence process with ICOs is uncomplicated and concise. It can be done without the armies of bankers, lawyers, and auditors typically required of IPOs.
Since it’s a simpler process, ICOs also have less transparency and fewer regulations. ICOs also offer nothing essentially as a guarantee to protect investors money.
The shares in IPOs represent equity in the firm and votes to shareholders. But, ICOs generally represent tokens sold at a discount and are considered an asset, not security. This allows ICO entrepreneurs the power to maintain complete control over their growing company.
Finally, while IPOs involve being listed on an exchange – meaning companies need to satisfy various requirements including issuing audited quarterly financial statements and other disclosures – ICO listing requirements are almost non-existent.
There are several other differences between the IPOs and ICOs, but the in short-term ICOs are way riskier than IPOs.
Just because ICOs are risky does not mean that ICOs are a complete waste of time, energy, and money.
Can ICOs Be An Alternative to Venture Capital Funding?
Since ICOs are a usually at the early stages of a company’s lifecycle, they could potentially be a useful alternative for Venture Capital (VC). But it’s not as simple as it seems to be a replacement, there are a lot of potential implications for investors of ICOs.
The fundamental purpose of the VC industry is investing in start-ups, and a majority of the companies will fail. It is a very high-risk business to be in, the few that succeed do so astronomically and usually more than compensate for the many investment failures – think of Google and Facebook.
SoftBank’s $20 million VC investment in a small Chinese e-commerce start-up named Alibaba in 2000 grew to roughly $58 billion at its IPO fourteen years later. This gamble was an unreal 300,000% return on investment.
This seems like the classic story where the rich get richer with these investments, but why do they get to be the only ones who benefit from this fantastic opportunity? Shouldn’t the 99% get a shot too? But the answer to this question is more complicated than it seems at first glance.
First, ICOs typically do not have a working product. This hard reality makes investing in them even riskier than a regular start-up investment. VCs also demand a “proof of concept” and an experienced and knowledgeable management team.
Second, VCs often get a seat on the board as a part of their investment, allowing VCs to advise as well as monitor the company (their investment). They also provide the necessary connections to ambitious and energetic but often green entrepreneurs.
ICO companies do not entitle their investors to add any input in how their company is run, even though they provide cheaper and quicker funds compared to VC investors.
Finally, unlike an illiquid VC investment, ICO tokens are typically liquid. This liquidity gives an easy exit strategy for ICO investors. However, this liquidity can also lead to shortsightedness as investors may pressure companies to focus on short-term results at the expense of more significant long-term benefits.
So while ICOs are an exciting new way to invest in entrepreneurs it can’t replace Venture Capital or even be a viable substitute. ICOs are definitely booming and it’s an exciting time for everyone in the space. Just make sure before you put your money into anything that you do your own due diligence and never invest more money than you can afford to lose.
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