What in the world are ICOs?
An Initial Coin Offering (ICO) refers to different processes of digitising (tokenising) a currency (asset) via the internet. These processes have dubious legal status. In many cases, an ICO is a new crowdfunding option for start-ups. In such cases, a better name would be Initial Token Offering (ITO).
Initially, the term ICO referred to the launch of new cryptocurrencies. Today, many ICOs sell tokens as some kind of shares in a business and should be called ITOs. In fact, they raise money via crowdfunding campaigns that use blockchain-based tokens.
An ICO offers a chance to make big money by buying a piece of the next Uber or TransferWise, particularly of the blockchain type. It sounds like an Initial Public Offering (IPO). Although it has similarities with an IPO, it differs quite a bit.
Some differences between IPOs and ICOs
IPOs take place at a stage when companies have products or services generating revenues, are profitable or close to profitable. ICOs take place at an earlier stage, when companies have unproven products or services, and limited or no revenues.
IPOs are regulated events. Most ICOs are not regulated. In the US, the SEC stated that ICOs may be securities offerings, and fall under SEC’s securities laws. Tokens can be called different names, but merely calling them “utility tokens” does not prevent them from being a security.
IPOs communicate the problem their companies solve and how with a prospectus, a mandatory, rich document. ICOs communicate the problem their companies will solve and how with a whitepaper, a non-mandatory, lighter document.
Typically, tokens do not provide equity or voting rights in the company offering them. They provide some utility. In some cases, this utility has dubious value. There is no guarantee that the product or service their company planned to develop will ever launch.
Nevertheless, ICOs exploded in 2017. They raised US$ 4 to 6 bn, reports show. In the US, Filecoin, a blockchain-based data storage project, raised US$ 200 m or so. In Europe, Sirin Labs, a Swiss company developing a blockchain-based smartphone, raised US$ 150+ m.
The popularity of ICOs is due to many factors. For example: Bitcoin investors who got wealthy quick found them a way to diversify, without using traditional assets (regulated and taxed); some ICOs offer to make the economy greener, such as Solarcoin and Climatecoin.
Just for the reasons above, ICOs carry higher risks than IPOs. In addition, some give cybersecurity a low priority, are scams or have badly written code. Around US$ 500 m of ICO funds disappeared in 2017 due to hacks, scams or bugs, according to Coindesk.
In the UK, the FCA highlighted the following risks:
- Most ICOs are not regulated by the FCA and many are based overseas
- You are extremely unlikely to have access to UK regulatory protections
- The value of a token may be extremely volatile
- Some issuers might not use the funds raised in the way set out when the project was marketed
- Whitepapers might be unbalanced, incomplete or misleading
- Projects are in a very early stage and their business models are experimental
Meanwhile, countries like South Korea and China banned ICOs, at least for now. Considering all the risks, ICO investors should demand higher returns than IPO investors.
Many people do not think much of ICOs, including some executives in Fintech. Stefan Thomas, CTO of Ripple, a cryptocurrency, predicted their death in 2018!
We think ICOs will evolve and comply with dedicated regulation, possibly increasing their appeal to more investors. They will be called differently.
We expect that tokens with clear utility will do better than others.