If you’re at all interested in investing in cryptocurrency and blockchain you’ll have heard of the term Initial Coin Offering or ICO. Use of ICOs to raise capital has truly exploded over the last year. But not all ICOs are created equal.
Along with the potential rewards of investing in an ICO there are many risks. In this article we’ll be touching briefly on how ICOs work, who’s been using them and for what purposes as well as some interesting recent developments that will shape the ICO market going forward.
So What Exactly is an ICO?
Instead of startups travelling around hat in hand to private investors, they create a splashy website, an obligatory whitepaper and a social media marketing campaign to crowdfund directly from the public through a token sale. There are several blockchain platforms that help enable token sales for ICOs, the most notable being Ethereum and EOS (read our comparison of the two here).
Because of the similarity between the names and purposes of ICOs and IPOs it’s common to think they are the same thing, but there are some important distinctions.
ICO vs IPO – Not Potato, Potahto
Risk/Reward of Tokens Compared to Shares
The primary difference between an ICO and an IPO (Initial Public Offering) is instead of offering shares or stock in the organization, an ICO offers its investors digital currency in the form of tokens. What those tokens represent, and their inherent value depends on the ICO in question.
In many cases they’re a currency that can used on the platform/blockchain under development and so their value will appreciate if the platform/application is successful. This is part of the allure of investing in ICOs. It’s the equivalent of allowing average investors to participate in the early seed type fundraising for high potential startups. Find the right startup/project and the payback could be huge.
Just ask early investors of Bitcoin what getting in on the ground floor of a potentially useful digital asset can do to the type of car in your driveway.
— Lambo Newport Beach (@Lamborghini_NB) December 22, 2017
But along with the potential rewards of investing in an ICO, there comes an inherent risk. When investing in IPOs or early stage ventures that risk is typically mitigated by private equity and venture capitalists having done the due diligence to validate and value the company before the stock becomes public.
But in an ICO the burden of the due diligence rests solely on the individual investor. Instead of institutional investors and private equity vetting the business model, the team and the strategy, ICO investors need to use the typically limited information available on the internet to determine the quality of the investment.
Furthermore, in traditional fundraising a company and its founders need to give up at least some control in the form of shares to investors in return for cash, whereas in an ICO there typically isn’t a lot of influence the token holders can have over the direction of the company. This can be a double-edged sword as the company and founders are allowed to more freely execute their vision, but there isn’t anyone there to check them when they go astray.
What is certain is that by using an ICO, a company is changing the dynamic of risk and transferring some of the risk from the founders and companies to the individual investors.
Murky Regulations Fueling the ICO Bonanza
A secondary, but still important distinction between ICOs and IPOs is that regulations surrounding ICOs are considerably murkier. Many have been using ICOs to outright evade the trials and tribulations of raising money through more traditional channels like venture capital or public stock offerings. Although, finding ways around regulations of raising capital are not new.
Some in the blockchain space have also been pursuing arrangements such as Reverse Takeovers (RTOs) or Special Purpose Acquisition Corporations (SPACs) to go public, however, ICOs at least for the time being are an even shorter path to very high value capital raises.
Regulation of ICOs is an ongoing issue that will continue to dominate the conversation until more governments put into practice modernized definitions of how and when to consider ICO tokens as securities. Some governments such as China have opted on the side of protectionism and placed outright bans on ICOs. Others, such as the Swiss, have aimed to craft a more formal definition of how and when existing securities laws should be applied to ICO tokens.
But most governments have remained mired in debate and discussion about the topic. International bodies such as the IMF could help bring clarity and guidance to governments unwilling to chart their own path, but they too are just starting to get in on the discussion. Until clarity is brought to the regulatory burden that ICO issuers must face in all major jurisdictions, there will be a significant risk to investing in any ICO.
EVERYONE gets an ICO!!
There have been over 575 ICOs since May 2017 with the total raised exceeding $13 billion (Source: Cryptocurrency ICO Stats). It truly has become the wild west of fundraising and in most cases the hype has far outweighed the tangible value that this instrument has brought to the market with a good number being outright fraud (paywall).
So you’re a contender and want to compete against highly capitalized web/digital platforms to build out the platform of the future. YOU GET AN ICO!
Maybe you’re a pretender company with limited upside potential, losing money and need a quick capital injection so you can go on to lose even more money due to mismanagement. YOU GET AN ICO!
Or perhaps you’re a huckster, a quick talking slick marketer, who wants to jump on the bandwagon, raise a fuckton of money and then screw over all your investors. YOU GET AN ICO!
That’s right, EVERYONE GETS AN ICO!
Judges, Juries and Executioners
What’s clear from the examples above is that investors who wish to participate in the high risk/high reward world of ICOs need to be careful in choosing where and how to place their bets. As with any investment, it’s important to research the asset, the team behind the asset, and the business model. This applies just as much to investing in an ICO — because of the huge returns that have been seen in the past many are trying to ‘get in on the action’.
However, as with any industry, as it matures the ICO ecosystem is beginning to attract more secondary parties and platforms to help investors and users in deciding the winners and losers.
Similar to the popular service Shapeshift that lets users exchange one crypto asset for another, a new crypto portfolio and trading platform built exclusively for diversifying crypto investments called faast has focused on the ICO market with its ERC-20 based platform. It’s an interesting new tool that will surely make investing in ICOs easier and help them judge the performance of their ICO asset portfolio in one place.
To help users decide which ICO investments are legitimate or scams there are also new startups looking to become the deciding jury on the matter. Recently funded, TruStory will be a platform to research ICOs and to verify the claims that they use in promotional materials. Platforms like these will help to prevent the large scams that have happened in the past and will be critical to improving the reputation of ICOs in the public mind.
But for ICOs to move beyond the niche Nerd Money market and get the breadth of mainstream investment they will need a large and trusted platform through which the investment can be made. This is why recent news that Coinbase (one of the most recognizable and largest crypto exchanges in the US) bought a small decentralized exchange called Paradex as well as a securities dealer with important licenses, Keystone Capital, is so interesting.
The Paradex move is clearly a path for Coinbase to integrate the smaller exchange’s technology with its own and will likely allow for the listing of Ethereum ERC20 tokens (a popular mechanism used to ICO) on Coinbase. While the Keystone acquisition will allow Coinbase to potentially operate under the Keystone licenses and open up its services to institutional investors as well as offer “blockchain based securities, under the oversight of the [SEC]“. This will give Coinbase the ability to act as the de facto executioner for ICOs by deciding which tokens it wants to list on the exchange and expose to its 13 million users and which it wants to snuff out of existence.