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ICO vs IPO: so alike and yet so different

20 November 2017 00:00, UTC
ICO vs IPO: so alike and yet so different
By Stanislav Sokolovskiy, senior lawyer at GMT Legal
Over the recent months, there has been more and more talks about the difference between ICO and IPO. It is largely due to the fact that these two procedures look quite similar for a layman. However, they differ in a variety of parameters, and this comparison is largely inaccurate. First you need to understand what are ICO and IPO.

IPO (Initial Public Offering) - is a type of public offering in which issuer's securities are first available to the general public. It should be noted that the placement of securities can be realized not only within the framework of an IPO. Companies that go public already have finished product, and their activities comply with all legal requirements (companies also get special licenses for this type of activity, the founders of the company and its management are given responsibility for non-compliance with the law). In this case, before IPO process begins investor has a chance to learn about the company's products, its activity, and also can determine its growth potential based on real economic and other indicators.

ICO (Initial Coin Offering) - a way to raise funds for the project's development by selling software products of the company - tokens. In this context tokens are considered a software product sold to an unlimited number of persons. ICO shouldn't be considered as a form of crowdfunding, because, unlike crowdfunding, where individuals donate their funds for the development of a project, participants of ICO receive tokens that have a certain value. They can be sold on exchange or bring various kinds of advantages and even income to their holders.

Those ICO models, where token grants the right to pay dividends (passive income) shouldn't be considered as ICO in its classic form. In this case, it serves as a mechanism for the sale of securities, which, by its structure, doesn't differ much from IPO.

Most often the founders do not offer a finished product for ICO, but rather raise funds for its development and further promotion.

There are no uniform rules for regulating such investments, which potentially makes it possible for organizers not to fulfill their promises and avoid liability (in fact, there is liability for non-fulfillment of obligations, but it is not considered in this article).

Thus, ICO and IPO are very different in their purpose because they are created for different goals and implemented through different mechanisms.

Model of functioning is another difference between ICO and IPO. IPO means that the founders create an organization whose shares are bought by investors who receive a certain amount of dividends from this, depending on how profitable is its economic activity. In ICO investors are in fact not connected in any way with founders of a project that issues tokens. 

All the advantages and disadvantages of the project will be reflected in the value and functional component of the project's tokens, and this is particularly the case with regard to fundraising at the stage when project is developed from scratch.

  • Investors transfer funds in exchange for stocks that give the right to own a share in the company
  • A company planning IPO functions for a long time before going public, meets all the requirements of the legislation and needs significant investments to organize the sale of shares
  • ICO participants invest cryptocurrency in exchange for tokens, that give certain functions or income opportunities within the system developed by the founders
  • A company-issuer does not actually issue tokens. Tokens are issued by the founders on behalf of the issuing company. A company-issuer most often exists only on paper
  • Most projects do not even establish an issuing company, which is supposed to operate in the future. In most cases еhe activity of the founders does not meet any standards, and tokens are issued when there is no finished product

Scheme 1. Comparison of IPO and ICO mechanisms

Thus, IPO investors put their money in a real and functioning business, while ICO participants invest in a certain idea.

From the legal point of view, the organizational structure of IPO and ICO differs as well. Speaking generally during IPO a person buys shares of a certain company associated with its founders, who also have a stake in it. All of the parties deal at the level of this company. When it comes to ICO, at the moment, unfortunately, the founders often even do not care about registration of the company that is used for fundraising. However, there is a legal pattern that can be applied to ICO. In this regard relations between the participants of ICO and the founders are implemented at the level of the company in foreign jurisdictions that has a positive attitude to cryptocurrency. These relations are fixed by accepting conditions of a public offer published on the project's website that considers tokens as software products which, under certain conditions, may bring profit in the future.

However, in view of the current restrictions on the law and the rules of banking activity, it is most often impossible for company to open a bank account. It makes organization to create an additional company that will operate in fiat. As a result, the activity is implemented at the level of one company, the relationship is settled at the level of another company, and the responsibility of organizers is narrowed down to the public offer and civil legislation (if it is not a criminal violation).

Scheme 2: Comparison of organizational structure of ICO and IPO

Now, as long as there is no regulation of cryptocurrency and ICO, the comparison with a well-settled IPO procedure seems inaccurate and does not reflect the whole essence of the process and the goals pursued by the founders and participants of ICO.

But is the very existence of ICO so bad? The answer is no. At the moment we are seeing formation of a new mechanism that is much cheaper than an IPO and makes an easy entrance to the market not only for large players but also for ordinary citizens who can invest their money in an idea and receive a tool that can be much more functional than share in IPO.

At the same time it is unreasonable to expect that there will be no ICO regulation. The time has come for projects to think about the potential risks and liabilities for failure to fulfill their obligations. If ICO is viewed from IPO perspective, the project should collect information about ICO participants, make relations on a contract basis, comply with existing requirements for the token functionality. Founders in their turn should be responsible for failure to fulfill their obligations. All these factors indicate that ICO is supposed to play a role of a new tool, previously unknown from a financial and legal point of view, which will be considered as an alternative to IPO, rather than being compared with it.

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