Up until July of 2017, the total dollar amount raised in Initial Coin Offerings (ICO) was a staggering USD $1,252,676,352.
That’s over a billion dollars raised within a span of 7 months. With a total market capitalization of over USD $100 billion, the cryptocurrency market has attracted the attention of many, from traders wanting to make a quick buck to experts that are concerned with its lack of transparency. The explosive growth of ICOs has clearly polarized the industry, with critics associating the phenomena as a bubble waiting to be popped, while proponents justify the use of such ICOs as a revolutionary innovation that will change the very fabric of our economy.
What’s an ICO?
An initial coin offering (ICO) is a means of crowdfunding, through the creation and sale of a digital coin or token to fund project development. Before moving on, it’s good to understand the differences between cryptocurrency coins and tokens.
In order to understand the features of ICOs, it will be more pronounced to compare it with something similar in the financial market, called an Initial Public Offering (IPO). IPO refers to the public sale of the shares of a company for the first time, with the purpose of collecting funds for business expansion and development. Let’s look at the differences between a cryptocurrency ICO and a stock IPO.
1. Regulatory Oversight
As part of the mandatory requirement to register with the regulatory authority, a legal document – called a prospectus – must be created by any company looking to issue an IPO. The prospectus represents a legal declaration of its intention to issue its shares to the public, and must meet certain standards of transparency. It must include key information about the company and its upcoming IPO, so as to assist potential investors in making an informed decision.
ICOs are not bound by any legal requirements to issue any form of legal documentation. However, a document in the form of a white paper is often conceived by the developing team to outline key information of the project, such as its purpose and mechanics. However, it’s important to note that there is no standard for an ICO whitepaper; any project could construct a white paper with the ability to include or exclude any information they deem fit.
2. Track Record & Credibility
There are a host of requirements that a company has to fulfill before listing its shares through an IPO, including having a minimum earnings threshold and a good track record. The process requires professional accounting firms to verify accounts, investment banks to act as the underwriter for the deal as well as liaising with exchanges to fulfill certain requirements. These processes act as a natural filter for credible companies to issue their shares to the public. In addition, most companies thinking of going public have been funded by institutional investors (which includes angel investors, private equity firms, venture capitalists, etc) that have done rigorous due diligence on the viability of the business.
Since ICOs do not require adherence to any regulatory framework and legal protocol, a majority of them do not have a track record and only have a white paper to back up their project. While some have a working prototype (in alpha or beta stagecos), most projects only have a conceptual framework manifested through their white paper. This makes assessing their fundamentals almost impossible; your due diligence is focused towards the project’s future expectations rather than its past history since there’s none. This is the main reason why investing in ICOs is extremely risky. It’s true you can extract some form of credibility by looking at the project developers’ experience or renowned individuals backing the project, but you can never actually know whether the project will work.
The stocks acquired through an IPO represents an ownership stake on the future earnings on the company. Stocks can be divided into different classes such as common stocks, preferred stocks or a hybrid. The utility of holding stock is the entitlement of the shareholders in receiving dividends and having a vote in the shareholders meeting.
Unlike an IPO, acquisition of ICO coins does not grant ownership of the project. There are many ways that investors of the coins may reap future benefits, and that depends on how the coin is structured. Generally, a cryptocurrency’s value directly correlates with its perceived utility. Some coins generate value by conferring a stake in the future revenue of the projects, while some coins equate its value to usage within its ecosystem; the more adoption the coin gets, the higher its value will be.
4. Duration of Offerings
Traditional IPO issuance can be a lengthy process, due to the requirement of legal and compliance processes. From getting approval through the regulatory authorities to the IPO itself, it can take up to 4-6 months.
The entire ICO process is much shorter in duration. The duration depends on the nature and timeline of the project itself. Once a white paper is conceived and a smart contract for the crowdsale is finalized, the crowdsale can begin. The length of the crowdsale can be dependent on reaching the maximum hard cap, or a fixed sale duration, which usually lasts a month. However, hyped-ICOs can mostly be over pretty quickly.
5. Access to Offerings
IPOs are often allocated only to institutional investors such as investment banks, mutual funds and endowments. Sometimes, only a small portion is allocated to normal, retail investors. This means that unless you’re in the big boys club, it will be extremely hard, if not impossible, to acquire shares at the IPO. We can only buy the stocks once they are traded on exchanges.
Literally anyone can participate in an ICO; all you need is the base currency of either Bitcoin or Ether, and you can convert them into the ICO token. This level playing field breaks the “oligarchistic” nature of traditional fund raising, empowering the masses to participate in investments that can potentially earn them multiples over their capital. This democratization is a huge appeal to many, since it gives “power back to the people” instead of a close-knit club of elites.
What the Future Holds
Although ICOs aren’t currently regulated, many governments are taking a closer look. It’s only a matter of time before regulatory constraints are set-up to supervise the industry. All it takes is one fraudulent ICO to precipitate the process of regulation. For now, the best way for investors to protect themselves is through performing intensive due diligence before investing in any ICO. We’ve come up with a fundamental analysis checklist specifically for cryptocurrency.