Scammy Waters: The Differences Between an IPO and an ICO

The industry for Initial Coin Offerings (ICOs) has exploded recently. Startups are able to raise money directly from the public, without going through the rigorous process required of venture capitalists and banks. While there are legitimate ICOs, the industry has also attracted many scammers.

Also read: ICO Fever: How Crowdsales Are Taking Over Cryptocurrency

ICO, Not a Crypto IPO

An ICO is often compared to an Initial Public Offering (IPO) for stocks. However, there is a world of difference. While the former uses a technical whitepaper to market to investors, the latter needs a comprehensive prospectus and register with regulators. In the U.S., companies seeking to IPO must file a registration statement with the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), as well as file in the states in which it intends to offer the securities.

With the SEC involved, the overall process can take up to six months for the filing to be effective. During that time, the company’s activities are restricted and they usually have to work with the SEC back and forth to ensure compliance. The burdensome IPO process weeds out most scammers and incompetent actors.

Some are Outright Scams

Without filing requirements and professional oversight of an ICO, the project founders can write anything in their whitepaper. They often omit, whether intentionally or otherwise, information that is important for investors to judge the project’s legitimacy. Individual investors are left to do their own due diligence and some do not have enough knowledge to make informed decisions.

“Often the investment community has little understanding of the uniqueness of the underlying technology of the cryptocurrency itself,” Tim Lea, CEO of Veredictum.io, noted about ICOs. Individuals “[invest] blindly in the expectation that the coins will have a subsequent, profitable tradeable market on the cryptocurrency exchanges,” he added.

Since some investors do not have enough knowledge to make informed decisions, they invest in good faith but some project founders take advantage of the situation. Defining an ICO as a “cryptocurrency crowdsale,” Lea, said:

A number of crowdsales for cryptocurrencies have turned out to be outright scams, where people promised the launch of a new cryptocurrency but never made good on the promise, absconding with the funds collected during the process.

The scams have made the community as a whole “become increasingly cautious and wary of new coins,” he continued, adding that this could result in the ICO of genuinely good ideas being rejected by the community.

Possible ICO Regulations

Currently, there are no laws governing ICOs. However, it might change. A report by Outlier Ventures Research explains the possibility of the SEC regulating the ICO market.

The worse case scenario is that, “Tokens are regulated as securities after a bad actor achieves widespread media coverage and uses a token presale to scam participants out of a lot of money,” the firm wrote. In this case, the SEC would regulate tokens as securities, therefore ending the ICO market as we know it today.

However, Outlier Ventures Research believes it is more likely that ICOs will “continue to operate in a legal grey area.” Eventually, the industry should improve and produce better whitepapers, presale documentation and communication. Once the standards and expectations are raised, the possibility of success for bad actors would be limited, the firm believes.

What do you think of the ICO market? Let us know in the comments section below.

Images courtesy of Shutterstock, SEC, Youtube, Outlier Ventures

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