Cryptocurrencies become a new threat on the evolving Wall Street marketplace. Latest reports from the Q2 in 2018 show that the entire 45% of the IPOS were ICOs.
Although relatively new on the investment scene, with modest three years of existence, cryptocurrency capital market is leading in the raised capital against the traditional means of trading on the Wall Street. Cryptocurrency capital markets gained notably more customers compared to the incumbent investment banks and venture capital markets, which are neglecting the inceptive cryptocurrency trading.
The initial coin offering (ICO) is best described as raising a capital on the selling of the new cryptocurrencies, while the initial public offering (IPO) relates to selling the publicly offered shares of a company to investors. According to Coindesk, a leading news site focusing on cryptocurrencies, the ICO capital raised during the Q2 2018 was roughly $7.2 billion. For the same period of time, in reports by CB Insights and PwC, we learn that IPO and venture capital markets in the US raised $16 and $23 billions respectively.
Issuers Get Advantage
The ICO capital market provides several interesting benefits to the issuers—all of which translates to the issuers in the ICO market being able to raise capital more affordable than in the traditional IPO markets.
One of the advantages is that the ICO market doesn’t demand any covenants or inclinations from issuers. The ICO market is international and retail—which additionally attracts a wider group of investors.
The ICO can be described as selling a new digital currency at a discount and making a profit when it raises in price. The ICO is very similar to what is called a “secured financing” or “securitization” in the traditional capital markets. Generally speaking, there are many similarities between the ICO processes, securitization, and secured financing. They all provide investors with ways to trade a claim for money in other markets or redeem a claim for an underlying asset (with a slight distinction in secured financing, where investors typically only receive the underlying asset).
The relieving part of the ICO capital market is that around-the-clock access to trading, the transparency and the liquidity of the money, no covenants, etc. The ICO market offers a sense of freedom in this sense, there are much fewer limitations in terms of time, rules, and preferences.
This may just sound too idealistic to some.
The main reasons of the accessibility of the ICO market lie in the low maintenance costs, as there are no trustees, transfer agents, underwriters, custodians or central securities depositories, allowing the preference- and covenant-free approaches. The cryptocurrencies offered through the ICO are based on a standard protocol, meaning they can be listed on multiple blockchain exchange platforms without additional costs. In addition, this means that ICO issuers have the option to repurchase tokens much more efficiently than what would be the case with the traditional trading and securities. It’s important to note that buying and retaining a cryptocurrency trading account costs very little and happens at a glimpse of an eye while funding an established broker account requires a slow more expensive path.
You gain something and you lose something. Some may argue that the lack of covenants and preferences is the main weakness of the ICO, but it goes hand in hand with low friction costs, which are a great benefit over a longer time.
Cryptocurrencies became a real thing, and here are the examples of the renowned companies and their recent successful tradings.
Telegram chose ICO over IPO
Telegram, a leading communication app, counting more than 200 million active users, made two successful cryptocurrency sales in March, raising an impressive $1.7 billion. Telegram’s big win may be a textbook example of how much easier and more convenient it can be to choose a non-dilutive capital without much obstacles instead of traditional IPO offered by The Wall Street. The number of publicly-traded companies in the US is rapidly declining in the past 20 years, which partially may be reasoned by the high maintenance costs, pricey friction costs, and slow processes. On the contrary, the ICO market offers companies a new way of raising capital, while remaining private and going through far less hassle.
Eastman Kodak chose ICO over distressed financing
Eastman Kodak (NYSE: KODK) is a good example of how a public company can raise covenant-free and preference=free capital by immersing in the ICO trading. Kodak’s stock price grew around 20% simply by using the ICO, compared to $3.10 as it cost in January. This stock price was very low, and markets were implying that Kodak has lost access to traditional financing markets. When Kodak informed about their plans for the ICO partnership with WENN Digital, it already received $2 million in cash and stock from WENN Digital. From a total of $50 million offering, Kodak will soon receive approximately $3 million in KODAKCoin tokens which are covenant-free and are already underway. The initial steps taken towards ICO brought Kodak’s stock value to three times higher figures. Unfortunately, its value as dropped down substantially in the recent months (as the offering was delayed for regulatory and other reasons), Kodak’s closing price of $3.70 in August, 20% higher than in January, is still a notable success compared to the pre-announcement price.
ICOs are specifically issuer-friendly for private companies and non-investment companies that would normally give up both preferences and covenants, in traditional markets, making them likely to join in on the ICO. The ICO is likely to affect the corporate capital structures, as it makes it possible for companies to raise billions by only using non-dilutive tokens without issuing debt and traditional equities. Therefore, it becomes simpler to reimburse the company’s employees with cryptocurrency tokens instead of traditional stock options.
Institutional Investors Join the ICO
Even the institutional investors start considering the cryptocurrency market as a serious new player, or even better, a playfield, regardless of its recent price fluctuations. Although they are not prevalent, the institutional-sized transactions are starting to raise hundreds of millions of dollars and even exceeding $1 billion sometimes. The first half of 2018 was a like an official recognition of the ICO market, with several institutional investors buy their first ICOs. For example, Bain and Lightspeed and the renowned investor Stanley Druckenmiller partook in the $133 million Basis ICO.
Liquidity of the ICO market also gains traction. The ICO market may be small by institutional standards, but according to coinmarketcap.com reports, its daily recorded liquidity varies between 8-10% of the total market size of around $300 billion. This is held true regardless of the market’s price changes after its bubble peak of more than $800 billion last year. Yet, this is not the true value of the overall liquidity, which is suspected much higher as the blockchain exchanges sometimes cross the clients’ transactions off-chain, resulting in the report shows the amount of the public blockchains.
Apart from venture capital firms, and traditional capital markets, slowly some hedge funds and family offices are starting to enter the cryptocurrency capital market, and even pension funds and mutual funds are starting to try out the new trend.
Cryptocurrency markets are like an alternative for all the trading strategies that fail in traditional markets, regardless of the small size. The things just work out there. Bid-offer spreads are lower, the inconsistencies in value are generally declining, and nascent derivatives markets are slowly growing in popularity.
The main obstacle for entering the pension funds and mutual funds is a lack of a qualified custodian, but considering the bright minds that cryptocurrency circle gathers, they will likely break out in these sectors in the near future.
Investment banks are not indifferent to the growing popularity of the cryptocurrency markets and will address this trend appropriately. Incumbents will not take the ICO lightly and will try different approaches to keep the issuers loyal to traditional capital markets. Their strengths are focused mostly on the established deep relationships, more security in the long-term engagements, the ability to offer credit facilities to issuers, and the competence of regulators to assure the status quo over advancing companies and startups. Whatever the case, most of the issuers choose to finance the most cost-efficient capital available—having a trustee obligation to their shareholders.
Curiously, the investment banking superstar Goldman Sachs (NYSE: GS) is actively participating in the game, as they’ve hired an experienced cryptocurrency trader last April. Goldman Sach has made an early investment in Circle, an early bitcoin player that just this year has made an important move by acquiring the Poloniex, one of the largest cryptocurrency exchanges which are registering for a US banking license. Goldman has promoted its CIO, Marty Chavez, to the position of CFO in December 2016. This move has indicated that Goldman Sach has a good understanding of the importance of software for the financial institutions and how they will become more intertwined in the coming years.
But the huge drawback for the investment banks, including Goldman Sachs, is that they don’t have the necessary technology capabilities to engage in the ICO market. Prior to raising capital in the blockchain market, the issuer needs to build a technology application, and since technology is an integral part of cryptocurrency capital raise—these two become inseparable. Traditional investment banks are not set up to assist with building technology applications for issuers, and their research analysts are not qualified to understand and analyze the technologies behind the ICO. Hence, there is a whole microcosm built around the cryptocurrency environment, that comes hand-in-hand with specialized exchanges, specific collateral managers, and even unique token research firms—all of which are better equipped with understanding the cryptocurrency markets thoroughly and making the processes run smoothly.
This post is a brief reflection on the raising demand for cryptos over the traditional stock market and the comparison between the imposing figures of 45% of total IPOs in the Q2 in 2018 being actually the ICOs. In the next articles will reflect on the rapidly increasing size and value of the cryptocurrencies and try to answer reappearing question of whether the incumbents will overtake the upcoming cryptocurrency market? There will be a word about the incumbents’ enterprise cryptocurrency projects and their efforts to attract both investors and issuers.
The main point: cryptocurrencies will directly affect traditional financial systems, pushing the incumbents to provide more stable and fairer system, or will outshine them and conquer the traditional market. Either way, regular investors won’t go wrong.