ICO vs IPO - What is better for companies and shareholders?
The advent of ICOs (Initial Coin Offerings) have been making headlines and gaining massive interest these days. They’re said to be the revolutionary funding method to replace IPOs (Initial Public Offerings) with the use of blockchain technology and cryptocurrency. While there’s no doubt that ICOs have proven to be an excellent way of generating capital, could they really replace IPOs? To answer this question, we must analyze all aspects pertaining to these funding methods.
What are the main differences between an ICO and an IPO?
ICOs and IPOs are very similar for they are both lucrative methods of funding for newly established companies in which the public funds the project in exchange for something. However, one of the most important differences between the two is what the investor receives in exchange for funding. In the case of an IPO, the accredited investor is entitled to equity in the company (a company’s assets minus its liabilities) and voting power relating to the company. While in an ICO, the ordinary investor will claim ownership and usage of the token issued in the ICO but will not have any equity or voting power in the underlying company. These points mentioned are the most important distinctions between an ICO and an IPO, but there are 6 more differences as well. See them below.
An ICO typically occurs at a very early stage in the company/project. Often before it has any working products or services and is in need of working capital to bring their unproven concept/idea to life. Therefore, ICOs are riskier and should demand a greater return on investment than IPOs. In comparison, IPOs happen at a later stage in the company’s development. They will often already have a working product that’s generating revenue and require long-term capital and development rather than working capital.
Another major difference between an ICO and an IPO is regulation. Where as ICOs are largely self-regulated through smart contracts on the blockchain, and IPOs are highly regulated by government regulatory agencies such as the Securities and Exchange Commission (SEC). Therefore, it is generally safer to invest in IPOs rather than ICOs. However, there have been scam IPOs in the past. Just because they are regulated does not mean investors are safe, as an investor you must proceed with caution and do your due diligence.
3. Listing Requirements
An ICO can be commenced without their underlying token being available on exchanges. Meaning investors can invest in an ICO, receive tokens, and it they are never listed on an exchange they can never sell their crypto tokens. IPOs on the other hand must have their shares already listed on an exchange. This ensures a cooperation between the two and gives the investor piece of mind.
4. Beneficiaries (Middlemen)
ICOs have managed to operate far more efficiently than IPOs by cutting out the need for middlemen (exchanges, brokerages, underwriters, regulators, etc.). Therefore, an ICO can be far more profitable which benefits the investor and the company/project doing the ICO. IPOs in comparison must payout up to 4% to brokers and various other fees and percentages to the middlemen involved.
One area in which many ICOs have failed to better themselves from IPOs is the allocation of investments. For instance, some ICOs have an unfair distribution of their crypto tokens because “whales” buy most of the coins which then distorts the price and allows for market manipulation. IPOs on the other hand allocate their shares via various viable methods which are approved by regulators and ensure a fair asset share distribution.
6. Investor Type
For an investor in participate in an IPO, they must follow and meet the strict requirements outlined by regulators and brokers. This includes being compliant with KYC (know your customer) and AML (anti money laundering) laws. On the other hand, many of the ICOs do not have any requirements and any one with access to the internet can participate. However, this does seem to be changing in recent ICOs and impending regulation is pushing for these requirements.
Inner workings of an ICO and an IPO
Now that we know the main differences between these lucrative funding methods, how exactly are they commenced and carried out? First off, let us discuss IPOs as they were the first method of public funding for companies.
An IPO is conducted once a relatively new company has a working product or service but requires additional funding to reach their long-term goals. The company receives this funding by selling investors shares in the company in which investors must hold for a period of 90 to 180 days after the company goes public. Once this period is over the investor can sell their said shares on an exchange or hold on to them for a longer term investment.
As for ICOs, they are conducted at a very early stage in the company/project’s development and are commenced with the purpose of generating working capital to bring their idea to life. The new project generates this funding by selling their underlying crypto token which is based on the open source and decentralized blockchain. The crypto token sold to investors in the ICO will be exchanged for another cryptocurrency such as Bitcoin or Ether. The investor will then hold their ICO crypto token in a compatible wallet and will need to wait until the duration of the ICO is completed, or till some time after to sell their crypto tokens. The duration of an ICO can vary greatly from minutes to days, to months at a time. As well, often times the crypto tokens purchased in the ICO will be locked up for a predetermined period of time until they can be sold. However, this is not always the case and the lockup time varies in duration. Just as with buying shares in an IPO, once the investor is allowed to sell their crypto tokens, they can do so on an exchange.
What the future holds?
The way in which companies raise capital through investor funding has come along way in recent years with the likes of crowdfunding campaigns and ICOs. For all we know, company funding via IPOs could very well be a thing of the past sooner than we think. ICOs present numerous benefits over IPOs such as their vast outreach, efficiency, decentralization, and large interest. While there are negative aspects of ICOs in which IPOs do not have, these things will soon be worked out with the advent of regulation and growth in the industry. All in all, the future looks bright for ICOs.