IPO vs. ICO vs. STO
All businesses start small, would it be in a rental office space, garage or a friend’s one-bedroom apartment. As they begin to scale, it becomes essential to raise more money in order to accommodate growing needs — expansion, research and development, overall profit maximization, etc.. Many companies tend to reach out to different entities, as they seek for financial support. Major money-raising schemes sit in the financial markets, and companies usually take advantage of fundraising options such as venture capital, corporate debt and initial public offering (IPO).
Successful companies oftentimes decide on the IPO financing scheme. This structure has proven to be one of the most often utilized and financially lucrative ones. The scheme revolves around the issuance of shares of the business to the general public.
However, with the emergence of cryptocurrencies — a new non-conventional asset class — the fundraising options have also diversified. The following blog will discuss the fundraising alternatives to the traditional markets and will draw differences between them.
ICO vs. IPO
As discussed, in a traditional market IPO is a universal form of financing from the public; however, it is not as useful or relevant in the crypto market.
The crypto folks have substituted the IPO with the ICO, which stands for Initial Coin Offering. The ICO is a business’s flotation on the crypto exchange and a way of becoming a publicly tradable entity. In 2017, ICOs raised $9 billion; By March 2018 it totaled $23 billion (Elementus). Well, let’s see the differences between the ICOs and the IPOs, shall we?
First and foremost, during the ICOs companies raise funds by offering digital coins/tokens to investors, unlike tangible stocks. In a traditional sense, listing on a major stock exchange platform and initial public offering takes place at the same time so that when the company goes public, its shares become available on the trading platform and the public gets an easy access to buying and selling the shares through a stockbroker. On the flip side, when you purchase a coin or a cryptocurrency during the initial coin offering you gain an ownership of a utility on the blockchain — this is called tokenization. Unlike shares, the purchased token does not give an investor rights to the company because the coin does not provide you with an equity stake in the company. Rather, a coin promises a purchaser the right to use a good or a service that will eventually be developed by the project. In addition to this, there is also a speculation that if the value of a digital token appreciates than the investor can trade the coin and generate additional profits in this manner.
Along with the structure, the investor expectations also vary from the IPO to the ICO. In terms of the short-term outlook, both of the investors focus on capital gains. When it comes to the long-term, if a traditional investor’s return is a share in all future earnings of a company, as well as the consistent and growing dividends, the crypto investor only expects a utility gain from the investment that will be limited to the platform on which the token is built.
Let’s shift to the financing process and find out who and how can gain access to it. Interestingly, unlike the IPO, where only investors with a broker and sufficient funds can participate, the ICO allows anyone to take part in the scheme. Additionally, one can only purchase a coin using a crypto payment system. So an investor who is interested in buying a coin has to convert fiat currency to crypto in order to gain access to the ICO. In the traditional model, investors can purchase the share using cash.
Another difference that comes up while comparing ICO with IPO is the growth stage of the company that can initiate the funding process. For the traditional companies, it is required to have some type of revenue already generated prior to the IPO. On the other hand, the ICO can be done with a company that has recently been launched without holding any relevant track record. A crypto business can simply issue a white paper that goes over all the relevant information about the company, the issued coin and the way the value of the token can be redeemed. On the flip side, the traditional model requires companies to present a legal document, prospectus, with a detailed analysis of what has been the company’s prior performance, business model, how the raised funds will be used and what will investors get in return. Thus, the traditional model requires more transparency and credibility. However, as the ICO market matures, it’s becoming impossible to just raise capital using a pure white paper and investors demand more evidence of the project.
Finally, the time frame of the funding campaign also varies between the ICO and IPO. For the ICO, the time to prepare varies a lot across different projects while for the traditional model it is between six and twelve months. Generally, the IPO takes longer, as there are many requirements and legal paperwork that a company has to fill out in order to move forward.
While the ICO sounds simpler and more convenient than the IPO, there exist some risks associated with the event due to a lack of regulatory oversight. Uncertainty, fraud, scams, undisclosed information and lack of security pose an array of threats to the entity that is going public as well as the investors who are getting involved during the ICOs. Interestingly, the legal landscape of the ICOs is pretty fragmented worldwide. Some countries such as China and South Korea declared ICOs to be illegal and banned any activities related to raising capital through digital currencies. In the United States currently there are no official regulatory policies but some coins might be classified as securities and fall under SEC regulations, which prompts the company issuing the coin to register with the SEC. Even though there have not been any specific regulatory frameworks issued with regard to the ICOs, SEC has proclaimed that the financial event is not secure and has encouraged people to take caution while dealing with such endeavors. Finally, in Europe, the European Securities and Markets Authority (ESMA) released the ICO related guidelines last year. Similarly to SEC, ESMA also noted that if the coin is classed as a financial instrument it will have to act in accordance with relevant laws. Other countries have also been invested in creating specific guidance for the ICOs. However, prevailing uncertainties and lack of regulations have resulted in lower investor interest in the ICOs.
Other than the regulatory framework, there are other risks associated with this financial event. Putting money into something that does not exist yet is definitely risky business. Many projects have already failed and broadly speaking there are many more that are doomed to not materialize in the future. The fraudulent projects, security breaches, little consumer protections make ICOs a hazardous business to partake in.
Due to the potential risks associated with the ICOs, an additional financing vehicle has emerged in crypto space, that allows for more secure, reliable and regulated funding processes.
The STO stands for Security Token Offerings and sometimes it is also referred to as a Blockchain equivalent of IPOs. The scheme allows companies to raise funds on the blockchain platform, while strictly classifying the offered assets as securities. The STO puts a bigger emphasis on security and regulatory side of the coin issuance. It makes sure that the companies selling coins provide prospective investors with as much knowledge as possible, and encourages investors to become fully informed of the product before they make any investing decisions. Additionally, the STO ensures that the companies initiating this type of fundraising are more compliant with appropriate regulations and legal frameworks.
The significance of the STO is that the purchased token is a security and it grants a purchaser the ownership of the company. With the ownership, the security token receiver can have a say in the way business operates, benefit from the company’s future gains, dividends and other rights to the company. Additionally, as the STOs trade securities, the businesses are required to be compliant with the securities laws and regulations of appropriate jurisdiction, depending on which part of the world the STO takes place in. Thus, the STOs are far more secure and reliable than the ICOs.
It is important to note that security tokens do not represent the exact replica of regular securities. The major difference is that these tokens reside on the blockchain platform rather than on a piece of a certificate. This feature gives security tokens wider properties such as the ability to incorporate the customer rules and different shareholder policies inside the token itself. The security tokens hold smart attributes that have the ability to revolutionize the way stock issuance takes place.
Even though the STO embraces higher levels of security and reliability, the blockchain and cryptocurrency devotees are not very enthusiastic about the security tokens, as they believe that the token securitization undermines the fundamental ideas of decentralization and anonymity that are central in cryptocurrencies. However, the other half of the crypto population believes that the STO is a great way to shift from the wild west structure of the ICOs to more stable and secure financing composition of the crypto market.
Cryptocurrency and blockchain technology are still in their infancy stages. Even though these innovations definitely have a long-term potential and very bright future ahead, currently, whether we like it or not, it contains a lot of fuzz, uncertainty, and risk. Likewise, the crypto fundraising events are also surrounded by obscurity and ambiguity.
The truth is that there are many crypto projects that represent great investment opportunities, somehow due to lack of regulatory oversight the possibility of scamming and fraud is very high. Investors who decide to invest should be very cautious and make informed decisions as well as conduct due diligence before moving forward with an investment.
The crypto market is maturing and the efforts to make it more reliable are underway. Down the road, as the appropriate legislation is drafted, regulatory oversight is in action and the infrastructure is fully set up the crypto investing will become highly secure, and there is no doubt, it will become a primary investment vehicle for both institutional and retail investors.
*Edited based on a Medium article from Panda Analytics.