Initial public offerings of stock raise money for companies that are becoming public and result in the distribution of shares of the company’s stock to investors. For ICOs, crypto companies raise funds through the sales of coins or tokens. In both cases, investors are bullish, whether about the company or the cryptocurrency, and invest based on some belief that the asset’s value will increase over time.
The primary difference between an ICO and an initial public offering of stock is that investing in an ICO doesn’t secure you an ownership stake in the crypto project or company. ICO participants are gambling that a currently worthless currency will later increase in value above its original purchase price.
IPOs are highly regulated by government organisations such as the Securities and Exchange Commission, while ICOs are largely unregulated. This lack of regulation coupled with the often decentralised nature of crypto projects means that an ICO’s structure can vary significantly. By contrast, the structure of most IPOs is largely similar.
Though IPOs are funded by generally more conservative investors anticipating a financial return, ICOs may receive funding from risk-tolerant supporters who are keen to invest in a new, exciting project. An ICO differs from a crowdfunding event because it offers the possibility of financial gain over time, whereas crowdfunding initiatives essentially just receive donations. ICOs are also referred to as “crowdsales” because of the possibility of financial gain.
Advantages and Disadvantages of Initial Coin Offerings
Online services can facilitate the generation of cryptocurrency tokens, making it exceptionally easy for a company to consider launching an ICO. ICO managers generate tokens according to the terms of the ICO, receive them, and then distribute the tokens by transferring the coins to individual investors. But because ICOs are not regulated by financial authorities like the SEC, funds that are lost due to fraud or incompetence may never be recovered.
Early investors in an ICO are usually motivated by the expectation that the tokens will gain value after the cryptocurrency launches. This is the primary benefit of an ICO: the potential for very high returns.
But the legality of cryptocurrency or digital assets is not guaranteed to persist. In 2017, the People’s Bank of China officially banned ICOs, slamming them as counterproductive to economic and financial stability.7 The Chinese government in 2021 went on to ban cryptocurrency mining and declared all cryptocurrency transactions illegal.8
SEC Introduces the HoweyCoin
The SEC in 2018 introduced a fake coin called the HoweyCoin to display the dangers of ICOs. The SEC’s HoweyCoin is named after the agency’s Howey’s Test, which is used to determine whether an investment qualifies as a security.9 The SEC then used the Howey Test to charge Kik, a messaging service that raised $100 million in an unregistered ICO, with unlawful sales of a security.
The first instance of the SEC cracking down on an ICO occurred on Dec. 11, 2017, when the agency halted an ICO by Munchee, a California company with a food review app. Munchee was attempting to raise money to create a cryptocurrency that would work within the app to order food. The SEC issued a cease-and-desist letter, treating the ICO as an offering of unregistered securities.
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