ICOs: The New IPOs - How Initial Coin Offerings Are Disrupting The Traditional Investment Landscape

What Are ICOs?

Though there is no one official and widely accepted definition for ICO (sometimes called "token sale" or "token generating event" (TGE) it is basically a new form of fundraising wherein blockchain related ventures raise public capital (in the form of either fiat currencies or cryptocurrencies) in exchange for newly issued digital tokens.

After the initial offering, the tokens can generally be either exchanged among investors or converted into other cryptocurrencies (or fiat currencies) on the secondary market, in cryptocurrency exchanges.

The idea of ICO was first applied by J.R. Willet to launch the Mastercoin in 2013. Four years later, in 2017, over $10 billion was raised by over one thousand firms, 99 and by October 2018, over $21 billion was raised by over three thousand firms.

Against that background, this subpart discusses the benefits associated with ICOs-both from investors' perspectives and from firms' perspectives-which may partially explain this rapid growth.

Key considerations for successful ICOs

What The Benefits of ICOs?

From firms' perspectives, there are four major benefits associated with ICOs. First, when an issuer issues a utility token (e.g., a token that grants the right to access a future service), it can create a user base during the ICO itself.

In such cases, token holders become not only investors who help to fund the service but also future users of this very service, and hence they are likely to be more engaged in the project.

Second, and related to the previous point, issuers conducting an ICO potentially can benefit from a network effect. Lin William Cong et al. developed a theoretical model with respect to this matter, according. to which when a platform has a native token (coin), investors (users) join the platform not only to enjoy its utility, but also to benefit from the rising token price as a result of the growing network size. Since the value of the issued tokens is determined (at least partially) by the network size of its users, issuers have an incentive to attract as many users as possible, and investors have an incentive to prejoin the ICO-to benefit from the value appreciation.

Last, the ICO mechanism provides firms with benefits in terms of global outreach and transaction costs. The process of creating a new token can be very simple and cheap using the ERC20 standard. Potential issuers can download the code for the token from Ethereum's website and then easily adjust the code to set parameters like the total amount of tokens that they want to create."' Similarly, the launch of the ICO itself is very simple and cheap compared to IPOs.

The issuer simply creates an address to which investors' funds will be sent, and after investors send their funds to the address, they receive tokens in accordance with a predefined exchange ratio (e.g., 1 Ether = 500 Tokens). On top of that, ICO operates as a "worldwide crowdfunding event, which means that issuers may easily obtain a global outreach.

ICOs can be leveraged by coporates to alternatively finance and “spin off” business ideas of the incubator / accelerator programs that are not strategically relevant

From investors' perspectives, the ICO mechanism offers a twofold benefit. First, investors may enjoy liquidity in early stages of the company. Most ICO projects are launched at the idea stage, and their tokens become tradeable on average between 18.5-93 days after the ICO ends.This means that investors can easily sell their holdings in the early stages of the firm.

Second, investing in ICOs is easy and cheap. In order to invest in a foreign company through an IPO, a potential investor will probably need to use the services of a broker. In ICOs, on the other hand, potential investors need only to have access to the internet. This means that, from an investor's perspective, investing in ICOs is often easier and less costly compared to IPOs.?

How is an ICO Different from an IPO?

In an ICO, like in an IPO, a company issues a share (a token) in order to raise public capital, and this share (token) is then traded on the secondary market. Nevertheless, there are major differences between the two methods.

“Both ICOs and IPOs therefore differ greatly from the purpose of crowdfunding, where supporters want to realize a specific idea based on minor rewards or early access to a certain product or service.”?

First, the rights conferred to investors of an ICO are considerably different from those of an IPO. In an IPO, shareholders get ownership rights in the company, dividend rights, and voting rights depending on the type of the shares issued.

In an ICO, by contrast, the issued tokens can represent a variety of rights and obligations and can be defined to embody utility-like rights only. This difference implies that issuers of an ICO can raise public capital without diluting their ownership over the. company, thus overcoming a major impediment associated with an IPO.

Second, and related to the previous point, documentation requirements are different. While a company that launches an IPO faces disclosure and registration requirements imposed by the securities regulator, ICOs' disclosure requirements are unclear and depend on their function as well as on the governing jurisdiction.

Most ICOs generally publish a white paper that outlines the business model of the project, a technical white paper that features the technological aspects of the project, and the source code of the project.

However, unlike IPOs' documentation, ICOs' documentation format is not standard and the documents disclosed tend to be poor and often misleading. This absence of standard disclosure requirements exacerbates the information asymmetries between token issuers and investors.

Third, ICOs are launched at a lower level of maturity compared to IPOs.

In order to initiate an IPO, a potential issuer will have to "demonstrate a proper (and stable) amount of revenues, which can only be achieved after a company has reached a certain level of maturity.

This is partially due to the listing requirements of exchanges and the tendency of investment banks (which act as underwriters) to select IPOs that have the potential to perform well after.

ICOs, on the other hand, allow firms to raise public capital outside of the traditional capital market-without the involvement of underwriters and traditional exchanges-and thus they can be launched at a very early stage. Indeed, empirical evidence suggests that the majority of ICOs are launched at the idea stage.1 65 This difference between ICOs' and IPOs' levels of maturity is important because it translates into different degrees of risk and information asymmetries.

Fourth, ICOs' marketing process is significantly different from IPOs' marketing process. While in an IPO an underwriter conducts a book-building process, ICOs' marketing is done primarily through social media channels.

In contrast with IPOs, which generally use social media to raise awareness for the project, ICOs use social media to publish vital information like launch announcements and to communicate directly with potential investors.1 68 This difference in the way firms market their launches and communicate with their investors translates into different investor-investee relationships, and is important since it affects the way by which firms can reduce uncertainty about their projects.

Similarities and differences between ICOs vs. IPOs vs. crowdfunding.

As the names already imply, ICOs and IPOs share the same logic: in both scenarios, the initiators are trying to raise funds and find investors in exchange for a stake in the company. Investors are attracted by potential profits on their investment. Nevertheless, the most important difference is that ICOs are currently not regulated and are therefore neither controlled nor supervised by regulatory bodies.

This lack of regulation on ICOs poses potential risks to initiators and investors alike, but ensures seamless funding that is easy to initiate for exponential ideas or white papers.