With the recent increase in the number of Initial Coin Offering (ICO) launches, it is no surprise that there has been growing interest in ICOs as an investment avenue, apart from the more commonly-known Initial Public Offerings (IPOs).
This article explores the differences between ICOs and IPOs, focusing on the:
- Procedures for launching ICOs and IPOs;
- Advantages and disadvantages of ICOs against IPOs; and
- Regulatory issues concerning ICOs.
What is an Initial Coin Offering?
In brief, an ICO allows an entity (the issuer) to raise funds without having to sell its shares or to take on loans. Essentially, the issuer offers virtual currency that it has created, otherwise known as “tokens” or “coins”, in exchange for cash or established virtual currencies (such as Bitcoin or Ether) from investors.
In return for investing in the issuer, investors may then have access to certain of the issuer’s physical and/or virtual assets (for asset-backed tokens), and/or goods and services (for utility tokens).
Procedure for launching an ICO
The procedure for launching an ICO is as follows:
- Pre-announcement: The issuer first writes a white paper explaining the proposed project. The white paper could discuss the issuer’s business model, development roadmap, currency integration within the project, or the project’s benefits. The white paper is then published on community platforms such as BitcoinTalk or Reddit. Based on the community’s views on the project, the issuer may then modify the project to meet prospective investors’ needs.
- Offering: The issuer offers a contract that states the terms and conditions of the sale, project life cycle and timeline, investors’ rights, as well as the amount of funding it is seeking.
- Marketing: The issuer markets its coins to investors directly and/or through third-party agencies so it can obtain sufficient funds for its project.
- Launch: The issuer then issues coins to investors in exchange for virtual currency or cash (depending on the terms of the ICO). The investors will also obtain a private key which they can use to prove their ownership of the coins.
Many start-ups have leveraged on ICOs as a means of crowdfunding to raise capital, when doing so through conventional means such as launching an IPO would be more difficult.
What is an Initial Public Offering?
An IPO is an entity’s first offering of its shares to the public in return for cash. Commonly known as “going public”, IPOs are done with the assistance of an underwriter which recommends the type of security to issue, the appropriate offering price, the number of shares to be issued, and the appropriate time to bring the issue to market.
In exchange for investing in the issuer, investors will own a stake in the issuer (along with accompanying rights).
While launching an IPO allows an entity to reach a sizeable pool of investors and so generate capital quickly, it is a costly method of fundraising given its regulated and complex process.
Procedure for launching an IPO in Singapore
The procedure for launching an IPO in Singapore is as follows:
- Underwriting: The issuer engages investment banks to advise on and assist with launching the IPO.
- Due diligence: Bankers, lawyers and accountants conduct due diligence on the issuer to ensure that its prospectus or offer document is in line with Singapore’s regulatory requirements for IPOs. They will also ensure that the prospectus or offer document has disclosed all material information required for investors to assess whether they should invest in the issuer.
- Regulatory filing: The issue manager, i.e. the investment bank leading the underwriting arrangement, files the prospectus or offer document with the Singapore Exchange (SGX) to obtain SGX’s approval for the issuer to be listed on the stock market.
- Pricing: Upon SGX’s approval, the investment banks carry out roadshows to market the IPO to potential buyers. They then hold a pricing meeting with the issuer to agree on the offer price of the shares and the number of shares to be offered.
- Allocation: The underwriters allocate shares to investors.
- Listing: The issue is brought to market, and the issuer is listed on either the SGX Mainboard or SGX Catalist boards. The public will then be able to purchase the issuer’s shares with cash.
How Can Issuers and Investors Benefit from Initial Coin Offerings?
For issuers, ICOs offer several advantages over IPOs:
- ICOs are currently less regulated worldwide. They therefore can be brought to market more quickly.
- The transaction costs incurred are likely to be lower. Issuer do not have to hire investment bankers to underwrite the transaction. Also, the confirming of contributions and distribution of coins merely involve the overseeing and updating of digital ledgers.
- The marketing of ICOs can be primarily done online. ICOs therefore have potential to reach large audiences within a short span of time.
Similarly, investors also stand to benefit from ICOs:
- Investors can gain access to valuable assets and services. For example, blockchain data storage company Filecoin offers investors cloud storage space in return for investing in its coins.
- Investors can participate in projects undertaken by the issuer. For instance, the Decentralized Autonomous Fund is a decentralised venture fund established on the Ethereum cryptocurrency that allows investors to vote on how its funds should be disbursed. The resulting profits from investments are then channeled back to these investors.
- Investors may enjoy significant gains if their coins increase in value.
What are the Risks that Come with Initial Coin Offerings?
Notwithstanding these advantages, ICOs are often accompanied by risks, especially for investors:
- It is difficult for investors to conduct due diligence on the issuers. This is given the general absence of transparency arising from the current lack of disclosure requirements. Many investors also have limited understanding of the mechanics of cryptocurrencies, blockchain technology and ICOs. As a result, they are exposed to the risks that the projects undertaken by the issuers might fail, and/or that the assets owned and services provided by the issuer might be lacking.
- The prices of coins are particularly volatile. This is unlike share prices which are subject to less drastic fluctuations.
- Given the less rigorous regulation surrounding ICOs, there are risks that an ICO may turn out to be a fraudulent investment scheme. For example, investors in REcoin Group Foundation were told that proceeds from the company’s ICO would be invested in property, when in actual fact the company did not have any real operations.
Additionally, as the transactions surrounding ICOs and the storing of coins are done online, issuers and/or investors may be victims of hackers who attempt to steal the coins.
Regulation of Initial Coin Offerings in Singapore
ICOs are currently not regulated in Singapore.
However, given increasing interest in them and the resulting concerns (especially regarding investor protection), the Monetary Authority of Singapore has stated that digital coins may be considered as either an offer of shares or units in a collective investment scheme, or debts owed to an issuer.
If so, the coins would then be subject to regulation under the Securities and Futures Act (SFA). For example, issuers would then have to provide a prospectus when offering coins to Singapore investors.
Whether further requirements would be imposed on ICO issuers remains to be seen. However, you can be certain that ICOs will increasingly take on greater prominence in the months to come.