What is the difference between an ICO and an IPO?

8 April, 2019

The immense popularity of cryptocurrencies as investments has led to the adoption of the term 'initial coin offering' (ICO). Due to its similarity to the stock market's initial public offering (IPO) there is some confusion among investors between the two. They are similar in many ways, but they are also remarkably different in others.

It has been said that ICOs are for younger, more adventurous investors while IPOs are still the domain of older, more risk-averse investors. Whether or not that is true, there are some functional differences between the two that really should be understood before investing. Note that you can make or lose lots of money with either one.

The BIG difference

Let us start with the biggest difference between the ICO and IPO given that it is also the most important. An IPO is always facilitated by a well-established company with a good track record behind it. The company has verifiable sales, verifiable revenue, a solid business plan, and a vision for the future.

Take Facebook as an example. Facebook was a privately-held company for years before its IPO. It had established revenue in its ad sales and a proven track record of solid annual sales. The company also had the vision for the future and how it planned to continue monetizing its social media platform.

An ICO is something completely different. An ICO doesn't start with anything. It doesn't begin with the creation of a company that goes on to establish a track record of sales, revenues, and future vision. There may be a business plan in place, but that's about it.

As such, an ICO is offered based solely on speculation. The typical ICO is proposed on the premise that the offering will establish a value for the new coin and thus get it off the ground. In theory, this would encourage people to actually begin trading coins, mining them, and using them to buy things. It works well when everything goes as planned. But when it doesn't, investors can lose quite a bit.

Requirements to launch an IPO

Securities are regulated throughout the world. It doesn't matter whether you are talking the U.S., the UK, or even China or Russia. Regulators are very wary of investors getting ripped off, so they have established very stringent rules outlining who can file an IPO. There are some basic requirements that IPOs in just about every country must meet.

These are:

  • Minimum Earnings - IPOs are almost always subject to the threshold of minimum earnings. In other words, the company must make so much money per year to be eligible for an IPO. This is to guarantee that there is some financial backing to protect investors.
  • A Prospectus - Next, companies looking to issue an IPO must have a prospectus in place. A prospectus is a legal document that declares the company's intention to offer stocks and shares. It is designed to inform investors of the details of the IPO before they invest.
  • Verifiable History - Finally, companies must have a verifiable history in order to issue an IPO. That history has to be significant enough for investors to look back and see what they are getting into.

Companies also have to have a bit of vision and a lot of patience. Why? Because you cannot decide to offer an IPO and then have it ready for market the following day. Establishing and IPO takes a long time. Companies have to work with experienced attorneys to make sure their IPOs are structured correctly. They have to work with regulators to file paperwork.

Everything about an IPO is purposely complex to ensure companies are up to the task. If IPOs were easy to come by, they would also be subject to easy fraud. So the regulations mitigate fraud by making it difficult to establish an IPO.

Requirements to launch an ICO

Though some countries are currently working on requirements for offering an ICO, any such requirements are hit and miss at this point. It is generally accepted that ICOs can be offered without minimum earnings, a prospectus, or a verifiable history. So how do investors decide whether to invest or not?

The general rule of thumb right now is to precede an ICO with the white paper. In a general sense, a white paper is a document that lays out a problem, explains what the problem is, and then offers a solution. A white paper can be adapted to the cryptocurrency environment by making a few minor adjustments.

In the cryptocurrency environment, a white paper is an official document that lays out your project with as much detail as necessary to satisfy investors. A typical ICO white paper is made up of the following six components:

  • Introduction - The introduction lays out the current circumstances that make the case for a new ICO. It doesn't necessarily lay out a problem or challenge the ICO is expected to address, but it does provide a reason for the ICOs existence.
  • Definitions - The next part lays out the basic concepts of the blockchain including the key algorithms on which it will operate.
  • Technical Details - A third section lays out the technical details of how the entire platform will work. It not only includes algorithm details, but also details about available coins, mining, security, etc.
  • Potential Problems - Next is a section explaining any potential problems that currently exist outside of the ICO as well as an explanation of how the ICO addresses them.
  • Examples - The fifth section lists examples of how the technologies tapped for this particular ICO have been put to use in other places for purposes of demonstrating they are, in fact, effective.
  • Conclusion - Finally is the conclusion of the white paper. It wraps everything up, connects any remaining doubts, and summarizes the purpose and position of the ICO in question.

The purpose of a white paper, in general, is to convince readers that the problem outlined therein is very real and that the solution offered is more than adequate for addressing it. While it's true that an ICO white paper is not necessarily intended to offer a solution to a particular problem (the world wouldn't end without yet another ICO), the underlying principles are the same.

Developers write white papers as their main piece of evidence supporting the idea that their ICO deserves funding. So it is their job to convince investors that another ICO is necessary. They must also convince investors that they stand to make money through their investment. If there is no money to be made, there is no point investing in a new cryptocurrency. The world already has enough payment systems.

Requirements for investors

Next, we need to discuss the different requirements for investors. There aren't that many, so that's good. To invest in an IPO in your own country, you only need access to that IPO through a broker. Anyone with a broker and sufficient financial resources to fork out for an IPO is more than welcome to buy.

International IPOs are another matter. Investing in a foreign company is wrought with legal ramifications, especially if the foreign country is not well favored by your own country. You will definitely need a broker to invest in a foreign company. You may need an attorney as well.

Investing in an ICO is pretty straightforward. Your only requirements are access to the internet and sufficient financial resources. The other thing to remember is that ICOs do not require nearly as much capital as IPOs. Developers are typically happy to receive investments of any size and from any location. With access to the internet and just $100 to invest, you could still get in on most ICOs.

Investment utility

Last but not least are the differences in utility between IPOs and ICOs. Because 'utility' means different things to different people, we will define it for the purposes of this post as being a measure of value. In other words, what does a person's investment represent?

When you buy into an IPO, you are buying a share of ownership in that company. Let's do some simple math. If an IPO offers 100 shares of stock and you buy 10 of those shares, you are essentially buying a 10% interest in that company. The utility of stocks and shares is ownership.

The utility of an ICO rests almost entirely in future investment. For example, let's say you invest in bitcoins so that you can play Mega Moolah online. The value of those coins is derived by the daily price of Bitcoin on the open market. This does not affect your ability to play Mega Moolah, but it does affect the value of your bets and winnings.

The end result is that investing in ICO means investing in something that is not tangible. Furthermore, it is only liquid as long as you have access to an exchange willing to convert your coins into fiat. Conversely, the stocks you purchase through an IPO can be made liquid as long as the company stays in business. The value may go up or down based on performance, but liquidity is rarely a concern.

Now you know the differences between IPOs and ICOs. Is one a better investment than the other? No, not really. There is a measure of risk in every kind of investment. Anyone considering an ICO instead of an IPO would have to measure the same risk factors and make a decision from there.