Most of you are probably pretty well acquainted with the concept of IPOs, or ‘initial public offerings’. They’re one of the most popular ways for investors to get in early on the next big thing – and to have an opportunity to invest their money in a business that they think is about to seriously start to grow. But how does this differ from the latest phenomenon – the Initial Coin Offering, or ICO? What are ICOs, and do they represent a good opportunity for investors? There’s a lot of debate in this area, but first let’s quickly define what IPOs are in order to see how ICOs are different.

So, what exactly is an ICO – and how does it differ from an IPO?

An IPO is essentially the first chance that the public will have to invest in the stock of a private company. This could be the next big tech start up (just like Google once was) – a business that people expect will grow quickly, partly thanks to the new capital that the IPO has provided. Investors buy a stake, and hope to get a big return. An ICO meanwhile has a similar purpose – to raise much-needed funds for a new venture – but this time the venture itself is a new crypto currency rather than a more traditional business.

How does an ICO work?

In order to raise capital for the new crypto currency venture, the people behind it should release details explaining how the money raised will be spent, the aims of the new currency and even how much of the money raised by the ICO they expect to keep themselves. At this stage, the money that investors put into the ICO in order to purchase the new crypto coins that have been made available will also be virtual – they’re known as ‘tokens’ and in a sense are like the shares that you can buy in any other publicly-floated company. In simple terms, in return for their investment, people taking part in the ICO will get electronic tokens that confirm that they will receive a share in any future profits.

What are the advantages of ICOs?

Well, they can, sometimes, generate big profits for investors – a recent example was a smart contracts platform called Ethereum which raised $18 million in Bitcoins from its ICO and generated a market capitalisation of over $1 billion. Also, because they’re essentially blockchain entries, ICOs tokens or coins are as anonymous as any other crypto currency, if that’s an important consideration for you. And, they can also be bought and traded at special exchanges, just like any other crypto currency.

What are the disadvantages?

While the benefits of investing in an ICO can be huge, so can the pitfalls. One big difference between ICOs and IPOs is that the ventures that are looking to raise capital via an ICO are usually at a pretty early stage of their development – most companies who want to raise funds via an IPO will probably already have a product or service that is giving them some kind of proven return. That makes them considerably more attractive to investors than an unproven crypto currency – when General Motors had their IPO in 2010 for example, they still raised an incredible $15.774 billion despite having been declared bankrupt the year before.

Another disadvantage of ICOs is a lack of regulation. IPOs are very heavily monitored by the relevant financial regulators but ICOs in contrast are not. (It’s worth noting however that this doesn’t necessarily mean that all IPOs are necessarily sound either – just because they’re regulated doesn’t always mean that they are safer for investors or more likely to deliver big returns). However recent moves to impose greater controls on ICOs suggest that more regulation is on the way – the Chinese government recently banned them because they see them as disruptive to the financial markets, and it’s unlikely that they will return without more regulation.

Finally, ICO organisers are often very good at thinking about raising money, but not necessarily about how they will distribute any future profits. The way an ICO works means that it is focused heavily on the fundraising aspects of the offering, but they often fail to have an effective mechanism in place to distribute dividends easily, as in a traditional IPO.

So what’s next for ICOs?

2017 has been a huge year for ICOs – it’s estimated that over the last 12 months they’ve raised $3.25 billion. But the signs are that the current unregulated nature of the ICO may be on the way out – the Chinese ban and a growing call for increased regulation in the US is likely to make the ICO a very different proposition in the future. And in October this year, there were signs that the market is also cooling on them – only 69 of 169 ICOs that month managed to reach the fundraising goals they’d set, according to one report.

So, approach ICOs with care – perform the same due diligence that you would as a smart investor in any traditional venture, and watch out for scams in a unregulated market.

 – Robert Weider 

 

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