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ICOs and IPOs: The major differences, regulations, and results

A new class of money requires a new class of crowdfunding. We explore the differences between ICOs and IPOs, and unpack the regulation governing both, as well as their results.

$5.6 billion USD. That’s a fair amount of money.

It’s also the amount of cash that new ICO (Initial Coin Offering) projects raised throughout the year of 2017 alone.

Compare that sum to the estimated $196 billion USD raised in IPOs (Initial Public Offerings) in 2017, and it becomes quite clear that despite the fact that cryptocurrencies aren’t even ten years old, investors and think-tanks alike have rushed to fill the gap first opened by Satoshi Nakamoto’s Bitcoin white paper – marking a rapid expansion for cryptocurrency markets.

ICOs have become an elusive term for those peering in from the outside of the cryptocurrency ecosystem. Amidst the cries of ‘hodl’ and ‘spedn’, the new and uncharted territory of token sales has not only confounded present tax legislation, but has further elicited a mixed response from international communities – with some moving to prohibit ICOs outright, and others leading the charge to become ‘cryptocurrency havens’.

Ethereum Classic callisto fork

So, what’s the difference?

Let’s rewind and start at the beginning. New investors may or may not be familiar with the humble Initial Public Offering – the first sale of a stock issued by a company to the general public.

Firms are traditionally considered private, wherein shareholders might consist of a small number of early investors. While a company is private, the general public cannot typically invest unless they are involved in the operations or growth of the firm itself, or are able to directly approach the owners of the said company.

When a private company prepares to transition to a public company, it gains the potential of drawing in thousands of new investors (and subsequently, new capital), and can more easily facilitate acquisitions and mergers through issuing stock. However, this is weighted against regulations which ensure that public firms account to a strict set of legal procedures, form a visible board of directors, and are beholden to financial regulators.

While investors placing their trust (and funds) in private companies might enjoy a good return on their initial investment, both the valuation and trade of shares can be difficult. Investing in a public company secures liquidity (where buyers and sellers can interact with each other through a stock market, and know the exact value of their shares).

Taking a company ‘public’ can bring with it prestige, a lower cost of capital, and can assist in hiring new talent to assist in operations through what is called ‘liquid equity participation’ – where employees can benefit from shares in the company themselves.

Initial Coin Offerings, then, are an emulation of this procedure that lend liquidity and exposure to new cryptocurrency projects.

Typically, new cryptocurrency projects launch on the market with a specific aim or focus that leverages blockchain technology to address a specific opportunity in a market space. In some cases, this can involve the creation of a blockchain and a tokenized asset to assist with trading, the facilitation of that blockchain, or transfers with other financial assets.

In some cases, new cryptocurrency projects rely on an existing blockchain (such as Ethereum) and issue a tokenized asset through that system instead.

ICOs offer a direct offering to market participants around the world. When a cryptocurrency project prepares for a public launch, it signals its intention to launch a pre-sale, wherein interested investors are able to purchase tokenized assets in exchange for Bitcoin, Ether, or in some cases, fiat currency such as the US Dollar at a discount ahead of direct investors.

What typically follows thereafter is a public sale, wherein investors from around the world are able to exchange a relevant cryptocurrency or fiat currency for tokenized assets.

Similarly to a company ‘going public’ and listing its assets on a stock exchange, cryptocurrency assets can be listed on a cryptocurrency exchange – whereafter general investors are able to trade tokenized assets freely after an ICO has closed.

ICOs typically establish goals in terms of raising a certain amount of Bitcoin or Ether, and an ICO can fail if it does not attract its pre-determined amount.

ICOs differ from IPOs in the sense that owning a tokenized assets does not grant ownership of a cryptocurrency project. While the stocks issued in an IPO draw their value from the profitability, exposure, reputation, and trading impact a public firm has, tokens issued in an ICO generally draw their value from where they find real-world utility, ‘staking’ income from the future revenue of a project, or their usage in an ecosystem.

While IPOs can last between four to six months thanks to a lengthy compliance process, ICOs can occur over a vastly reduced timeframe. In some cases, given intense interest, ICOs have concluded in mere seconds.

dutch court rules bitcoin has transferable value

What do regulators say?

ICOs exist in a new and mostly unregulated environment. IPOs, conversely, exist in a highly regulated terrain that is usually overseen by one or several financial regulators who apply scrutiny and due diligence to firms before they can issue public shares.

Typically, IPOs are subject to evaluations that ensure that relevant firms have a minimum earnings threshold and a reliable track record. Typically, auditing firms verify accounts, investment banks serve as an underwriter for deals and further liaise with exchanges to ensure that companies wishing to go public are compliant to begin with.

Though their applicability may differ from country to country, ICOs largely do not require adherence to regulatory protocols and are able to facilitate all processes without excessive oversight – for better or worse.

Whereas IPOs are subject to proven track records, most ICOs publish little more than a white paper (detailing the mechanisms and proposed robustness of a new project), website, and a working prototype before proceeding to attract funding from general investors. Typically, interested investors are expected to assess a concept’s future applicability, adoption, use-case, and viability rather than examine the past track record of the project or the directors at the helm of the initiative.

This volatile scenario has lead to a public (and not undeserved) reputation that ICOs are inherently risky investments and may not constitute a good avenue for long or short term financial gain.

This alone has drawn the attention of financial regulators, who have sought to bring stability to an intensely volatile financial arena where investors could alternatively profit tenfold, or lose their entire opening investment.

Different nations have taken different approaches in this regard. China, for example, has drawn press coverage for its authoritarian decisions in prohibiting easy access to ICOs, and has even taken steps to ban access to international ICO sites behind it’s ‘Great Firewall’.

Conversely, several nations have recognized potential in the emerging cryptocurrency ecosystem. Malta has pledged its intent to become ‘ICO-friendly’ and has drawn draft regulations that would determine how investors can interact with new tokenized assets and could accordingly be taxed.

Some investors, however, have eschewed the need for regulations in the cryptocurrency ecosystem, given the libertarian ideology proposed by many projects and the fact that cryptocurrencies themselves offer a peer-to-peer monetary system that could effectively do without a financial ‘middleman’ in the first instance.


Why is it so difficult to regulate ICOs?

Given that IPOs are conducted in a highly regulated environment, nations around the world have proposed documentation that outlines how investors can interact with public stocks and can accordingly file tax returns based on their profits or losses when interacting with such investments.

Given that banks and other financial regulators are involved in this process, auditing transactions and investments are made easy – and fraud can usually be detected. Usually, in the case of fraud, financial regulators will ensure that IPOs are conducted freely and fairly, and that a public board of employees at a firm are held accountable should any incident occur that is contrary to law.

Cryptocurrencies, thanks to their pseudonymity (where participants are not expected to transact under their legal names or other identifiable handles) make this process difficult. Tracing the flow of an investment between a user and an ICO can hence be obscure, meaning that it can be difficult for financial regulators (or investors themselves) to calculate what taxes they may or may not owe depending on their profits or losses.

Given that cryptocurrency assets are inherently new in the wider financial ecosystem, defining what specific tokens are, and what role they play, is made even more difficult.

Typically, one of the most central debates surrounding ICO regulation is whether tokenized assets constitute utilities or securities.

Usually, utility tokens are expected to give the right of product usage, settle usage fees, or can be used to deliver benefits shares. Inherently, it is expected that utility tokens do not derive value from corporate entities but instead are reliant on activities within a cryptocurrency platform.

Security tokens, conversely, represent a digital asset that is expected to serve as an investment (or share), in a common enterprise wherein one expects to derive a profit based on the efforts or reputation of a third party or company.

The duty of financial regulators is to determine tax applications depending on whether an investor’s tokenized assets constitute utilities or securities. Given that securities hold value outside of the cryptocurrency product they stem from, the designation traditionally means that such investments can be subject to tax.

The overall predicament is complicated, however, by the fact that cryptocurrency assets can be inter-operable (meaning that one asset may be eligible for use or trade on another platform), and it can be difficult to determine whether a token has enjoyed its value simply because its use case within a platform has increased or become notable, or whether it has become prized as a ‘share’ of a cryptocurrency initiative and is traded accordingly.

How have IPOs and ICOs performed?

During 2017, the global number of IPOs raised to its highest number since the financial crisis of 2008. A reported sum of 1,700 firms succeeded in raising $196 billion USD internationally. Accordingly, S&P’s 500 index charted a 23% gain for IPOs during 2017.

The New York Stock Exchange stands at the leading venue for new IPOs based on proceeds – taking the reigns from Hong Kong, which dominated the market space in 2015 and 2016.

The largest IPO listing was taken by Alibaba, which was accordingly valued at $25 billion USD, while several other notable players climbed the charts. In the US, Snap Inc – the owner of popular mobile app Snapchat – raised $3,9 billion USD, while Pirelli – the famous Italian tire-maker – raised €2,4 billion EUR.

ICOs, comparatively, succeeded in raising $5,6 billion USD in 2017 – up from $240 million USD in 2016. According to Mangrove Capital Partners, the average return for ICOs was 12,8% x USD investments, 7,7% for ETH investments, and 4,9% for BTC investments.

The largest ICO listing was taken by Filecoin – a decentralized data storage solution that raked in $257 million USD. Accordingly, Tezos – a decentralized, digital blockchain initiative raked in $232 million USD, while EOS raised $185 million USD.

Matters have not been entirely rosy for ICOs, however – despite the vast sums raised through public sales, it is estimated that some 46% of all ICOs launched during 2017 have ‘failed’ – with failure being determined as the inability to attract funding, the cessation of communication from project founders, or the sudden and / or immediate closure of projects before, during, or after their ICO.


What’s in store for ICOs?

2018 looks set to offer both opportunity and challenge for ICOs.

According to research, 40% of all ICOs launched thus far into 2018 have failed – despite the fact that by March, ICOs had succeeded in raising a staggering $1 billion USD for the third month in a row; meaning that 2018’s ICOs thus far are thought to have passed some 50% of the total amount of money raised during all ICOs in 2017.

Regulatory wheels are turning, however, and the decisions of key financial regulators might well upend that progress. Crucially, it remains to be seen how the US SEC, European Blockchain Partnership, and Chinese regulators will endeavor to clarify and legislate tokenized asset offerings.

What remains clear, however, is that ICOs – combined with their reflexive relationship with the price of Ether, and the price of Bitcoin – will continue to represent both an enticing and volatile option for investors for several years to come.