To date, the Venture Capital community has invested close to $1.2bn in the Blockchain space. They have been inspired by its raw potential, its power to disrupt and the lure of exceptional returns as the land-grab becomes progressively aggressive. Whilst this level of traditional funding shows no signs of abating, the VC community itself is being disrupted by a style of funding that is not that well known outside of the cryptocurrency community, but which is gaining increased traction – the ICO or Initial Coin Offering.
What is an Initial Coin Offering (ICO)?
An ICO is a cryptocurrency crowdsale. Typically, a technology team comes up with a great, new idea – usually a new technology platform based around Blockchain technology. In order to be able to use the newly created platform, cryptocurrency tokens are required. These are issued at the ICO (or purchased as we will see in the subsequent secondary market). The tokens represent the cost of transacting on the new platform. This was how Ethereum was funded to enable them to create their smart contract platform, where users are charged “Ethers”as a transaction fee, or parts thereof – called “Gas”.
These cryptocurrency tokens are made available for sale as part of the ICO and have value in the future for those that wish to work with the platform or develop ideas for it. More often than not, these will be technical developers, who will benefit directly from using the new platform by being able to develop their own applications on top of the newly created platform. The reason why this is easy to do is that in the majority of cases, the platform code that is being developed by those behind the ICO is open source and therefore freely available for the community to review and update to their own specific requirements.
Rather than issuing a formal prospectus or Information Memorandum, most ICO’s are represented by a technical white paper. These are very similar, in structure and format, to traditional academic whitepapers. These papers show developers how the platform will work, how it can benefit them, and how it will be developed technically using the proceeds of the ICO. If the tech community buys into the ideas, they will contribute to the project – usually in the form of bitcoin (the preferred currency of choice for ICO’s). If sufficient finds are raised from the sale of the ICO cryptocurrency, the project goes ahead.
So why use ICO’s ?
The ICO provides a great way to bootstrap a project by a team that has a good idea, usually involving the blockchain. It provides the initial capital required to attract talented people to work on the project, and can can provide as much funding as a regular seed round by Silicon Valley venture capital funds. There is, however, one major difference – there is no need to give up equity for the funds raised.
In addition to getting some equity-free money to kick-start the project, ICO’s can provide a way of gauging interest in the project from the wider community – in a very similar way pre-sales work well for the traditional crowdfunding on Kickstarter, for example.
Equally, given the usual open source nature of the ICO projects, they are very easy to ‘fork’ i.e. to create a clone, that differs from the parent in minimal ways. In order to judge whether there is a market for the new ideas, an ICO can be an ideal test fro market viability, as people are voting with their digital wallets.
Finally, in addition to the money required to kick off the project at launch, crowdsales help the team maintain the cryptocurrency for the longer term. Innovation in the cryptocurrency space happens at a rapid rate primarily because of the open source nature of most of the produced code, so if a feature is developed by one team and found to be useful to the users, it is often adopted by the other cryptocurrencies quickly.
In summary, ICO’s help projects maintain the value of the cryptocurrencies for the long term if the raised funds are used wisely and enables the project owners to position themselves well to raise future rounds of equity for any commercial capability they wish to fund.
The downsides to ICO’s
As great as ICO’s can be to attract initial funds from the community, there are several downsides to going this route.
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 community as a whole, therefore, has become increasingly cautious and wary of new coins. This means even if you have a genuinely good idea, it is possible that the community could reject your ICO.
In addition, for larger and more promising projects, one of the major risks is regulatory uncertainty. Because regulation by its very nature will always lag behind technology, it is very hard to know when and where the regulators will get involved. Whilst ICO’s are always very careful about distancing their crowdsale offering from “equities” and their associated regulation, as we will see below ICO’s do have some features that are usually associated with equities. This could explain why many of the not for profit foundations behind ICO’s are headquartered in Switzerland. Undoubtedly, over time, the regulators will get involved especially if bad experiences are seen, but in the interim, ICO’s are on the increase.
Why ICO’s could be viewed as “Shadow Equities”
The whole funding structure of ICO’s has at its core something which will, with time, place regulators in a quandry. ICO’s implicitly leverage the speculative investment interest from the cryptocurrency community as a whole. Once the ICO has finished the cryptocurrency coins are typically made available in the secondary market for trading. This usually happens on cyrptocurrency exchanges, for example Poloniex.
The cryptocurrency investment community buys into Initial Coin Offerings in expectation of a healthy return when the coins are available for exchange in the markets – in a very similar way that traditional IPO’s are viewed. Often the investment community has little understanding of the uniqueness of the underlying technology of the crytpocurrency itself, and invests blindly in the expectation that the coins will have a subsequent, profitable trade-able market on the crytptocurrency exchanges. Some very high returns have been seen historically, but be warned so have high losses.
As a result of the above, not only do token holders get access to the future benefits of using the new platform, but the tokens are viewed, rightly or wrongly, as an investment for a number, leveraging the power to trade within the exchanges.
Recent examples of successful cryptocurrency crowdsales:
The following are recent examples of successful ICO’s, and you can understand more about their original offerings from their respective whitepapers available in their websites. Please note these are just examples of successful ICO’s and do not represent any recommendation or investment advice
- The DAO HUB: Has raised $120 million and counting.
- Ethereum: Raised $18 million.
- Maidsafecoin: Raised $7 million.
- Lisk: Raised $6 million
The Blockchain space is evolving very quickly, and is beginning to implement some very sophisticated agents of change. The Venture Capital Community has seen this power and has invested heavily. But the Blockchain & Cryptocurrency communities themselves are backing projects they believe in, in an almost peer-to-peer structure that by-passes the VC community altogether. Equally, with the open source nature of so many projects, the technical community can undertake their own due diligence to see how best to work with the new technologies, and to see where new opportunities can be created. They are directly in touch with the core fundamentals of the project and can leverage them.
With the increasing size of funds that are being raised via ICO’s, the Venture Capital community as agents of disruption, are themselves being disrupted.
It will, however, only be a matter of time before the regulators get involved and instigate appropriate measures to ensure the man or woman in the street does not get compromised. Cryptocurrencies are new and interesting, but they are also highly risky – with many cases of people being burned. It is Caveat Emptor – and should be approached very cautiously.
In the meantime, the cryptocommunity is making hay when the sun shines, with new platforms being regularly developed. I suspect, however, that class action lawyers are gently rubbing their hands with glee, just waiting to pounce as the financial arbiters of shadow regulation.
As they say in the music business – get a hit; get a writ. Successful coins beware…
Disclosure: The author of this article owns DAO Hub tokens, and amongst other coins, Etheruem & Maidsafe coins.
If you are interested in understanding more about the Blockchain, its power and its challenges, on December 8, 2016 I am releasing my new book Down The Rabbit Hole, a book for business & non-technical people, like you, to truly understand the Blockchain & to capitalize on its power.