IPO vs ICO: what’s the difference?
ICOs and IPOs may seem very similar, but their investment potential can be very different
How do IPO and ICO differ? The distinction between initial public offerings (IPO) and initial coin offerings (ICO) can be like night and day. Not only can the businesses that embark on such fundraising drives do so at dramatically different points in their lifecycle, but the protections offered to investors can vary widely too. Here, we’re going to explore five things that separate the two, enabling you to make an informed decision next time you’re looking for a big opportunity.
1. Business maturity
Many of the businesses that pursue an initial public offering are already established brands who need financing in order to embark on an aggressive expansion. A quick glance at some of the companies that have successfully completed an IPO in 2021 include Squarespace, ZipRecruiter and Coinbase. Each of these businesses enjoy a degree of public profile – indeed, you may already be using their products. Most IPO debutants already have goods and services available to buy and they’ve likely been around for a good number of years. ZipRecruiter was founded in 2010, while Squarespace was born way back in 2004.
The start-ups behind initial coin offerings often don’t have this track record to fall back on. In many circumstances, they are seeking fundraising for an idea, a product or a service that they wish to build with an investor’s help. Their vision is normally set out through a sleek website punctuated with illustrations of prototypes, along with a white paper that spells out the project’s market research, future milestones, financial projections and budget. Many ICOs have been successful in raising tens of millions of dollars – sometimes even hundreds of millions of dollars. Some, such as NEO and Ethereum, have gone on to become stalwarts of the crypto and blockchain industries, with token prices leaping in value substantially from where they began. Other ICOs have ended in disarray, either because they were an exit scam or because the token price collapsed.
There are rarely many investor protections offered with ICOs, primarily because they aren’t regulated in many territories, meaning that there’s a lot of risk with getting in on the ground floor of one of these projects. IPOs are a different beast altogether because of how they are regulated by the US Securities and Exchange Commission. Prior to an IPO taking place, a prospectus document must be released that provides thorough information on the company’s current financial standing and how any monies raised through the flotation will be used.
2. Tokens versus shares
Once an initial coin offering is complete, investors in a crypto start-up will normally be awarded tokens. These tokens can have a multitude of purposes. In some cases, they will entitle the holder to access a service on a subscription basis, while in others, they serve as a purely speculative asset – meaning that the investor will seek to hold on to the token until it rises in value.
Shares released through initial public offerings are similar in a way. Usually, investors will hope that the security increases in value from what they initially paid for it, meaning they’ll turn a profit. However, a crucial difference with IPOs is how these shares reflect an ownership stake in a company. Those who hold shares in a publicly listed organisation could receive dividends (cash that is returned from the profits generated over a given period) or they could be given voting rights that help them decide the future direction of the company. There is no guarantee that investing in an ICO will result in an entitlement to a share of future profit, meaning that it’s crucial to read the small print before making an investment decision.
3. The target market
Although ICOs may set a minimum amount on how much a curious investor can contribute to their project, these fundraising initiatives are often open to all. Investors usually need to go through few checks in order to be eligible. This is a far cry from IPOs, where such opportunities are often only available to individuals with a high net worth, experienced traders or financial institutions.
4. How they are traded
ICOs are popular in the crypto industry, meaning that tokens are often purchased using popular digital currencies such as bitcoin and ethereum. A crypto start-up will often seek to list their project on a crypto exchange, enabling tokens to be bought, sold and converted into other cryptocurrencies, 24 hours a day.
Following on from an IPO, shares in a publicly traded company are listed on stock exchanges, such as those found in New York, London, Hong Kong and Paris. Payments are handled in fiat currencies, with clearing and settlement systems enabling trades to be executed in a matter of seconds.
Erratic price movements in an asset are normally linked to levels of liquidity. That is, how quickly they can be bought or sold on the open market. Given their profile and the established nature of international stock exchanges, it can be relatively easy to transact shares following an IPO at will. As a result, the frequent number of buy and sell orders can help absorb sudden fluctuations.
Cryptocurrencies and ICO tokens tend to be prone to higher levels of volatility because there are fewer people willing to buy or sell them at any given time – meaning that they are part of something known as a “thin market”. The lack of a stock exchange, with regimented rules and greater levels of transparency, also means such tokens can be susceptible to so-called “pump and dumps”, where prices are artificially increased before suddenly crashing.
There are good attributes and bad attributes to both ICOs and IPOs. Initial coin offerings allow promising businesses without a track record to access much-needed funding. They can unlock these funds quickly and investors face fewer hurdles if they wish to get involved. On the other hand, IPOs do offer the safety net of regulatory certainty for businesses and investors alike – and, mostly, they are less susceptible to price volatility and fraud.