It wasn’t very long ago that Bitcoin and other similar crypto-currencies disrupted the financial ecosystem. It surpassed the US Dollar, other fiat currencies and even gold. Pretty soon it earned the title of “digital gold” and broad the fame, and infamy, that would inevitably come with such a moniker. Similarly, other crypto-currencies like Ethereum tripled in value and Ripple skyrocketed. The whole ecosystem of crypto-currencies exploded with their total market capitalization rocketing past $100 billion, as this blog was written. Large Investment Banks like Goldman Sachs and Fund Managers like Fidelity are taking these currencies seriously now. This rapid momentum has led to the birth of more than 900 crypto-currencies, all looking for a piece of the action.
This rapid growth also drew attention to a key technology that crypto-currencies rely on — blockchain. People soon realized that blockchain technology could be used for an incredible variety of use cases with companies like IBM, financial institutions and other big players placing big bets on the technology, which we do not agree with, by the way, as decentralisation is lost when institutions use blockchain for running their eco-systems.
In 2013, this all let to the creation of the most exciting funding innovation in recent history — the Initial Coin Offering (ICO). Simply put, an ICO is the advance sale of a platform’s crypto-currencies or tokens, to be used within their platforms or outside, in advance, to fund the development of their platforms. These tokens can be easily sold and traded at anytime, on all crypto-currency exchanges depending on their demand. So, an ICO is when a company raises money in bitcoin or other crypto-currencies for the technical development of their projects. These tokens are essentially the incentives, for several market participants to use and grow the platform in a decentralised manner. Such incentives are paramount in making a decentralised eco-system operate sustainably.
Much like the crypto-currencies that fund them, ICOs have experienced exponential growth in 2017 and in the past few months have raised more money than early stage VC funding has, a cool $1.2billion. Companies like Filecoin, Bancor, Tezos, EOS.io have each raised more than $150 million in a matter of hours. ICOs so far has proved to be an incredibly successful instrument to raise funds for the development of a new application / platform.
These are the key reasons, why ICOs have enjoyed so much success:
- There is a willingness among the community to decentralize control, away from large corporations, large internet firms and financial regulations.
- Investors are investing very early in the process, hoping to repeat the success of early stage Bitcoin investors who saw it’s value rise from a few cents to $4,900+ within 7 years, creating generational wealth for some investors.
- The surplus money people generated from early investments into crypto-currencies, is being re-invested into new crypto-currencies.
- A genuine desire to fund some interesting causes / projects that are closer to the crypto-investors’ hearts.
- Limited liquidity (supply) of tokens means that as the use of token and platform grows, the value of tokens shall grow as well, hence fetching decent returns for the early-stage crypto-investors.
ICOs also carry a key benefit for the little guy that in that early stage crypto-investments are not limited to private investors or VCs. Anyone from any part of the world can take part or invest in any company that is offering their tokens for sale. Very much like the concept of Kickstarter, where people fund or support different projects which they feel would be successful and effective so the potential of the project plays an important role in raising funds during an ICO. These projects are usually technology driven and somehow relate to crypto-currencies, blockchain and decentralization.
In order to achieve mass appeal, the whole ICO process generally remains quite transparent and open all the way to the completion of the fundraising. ICOs are also comparatively easier and faster than traditional VC and angel fundraising, which usually takes at least 6 months for a Series A raise.
What are the general challenges with ICOs?
Like any new industry or innovation, ICOs have many challenges as well. Several projects have been, and may continue to be funded on random ideas including: an average team, unqualified project plans with a weak whitepaper, and a website. And importantly, no product / MVP to show. How is an investor to know if the concept works and whether the team can actually build it if there is no demo?
Here’s what you can do as a potential ICO investor to help avoid these pitfalls:
- Spend some time doing proper due diligence for each ICO plan.
- Do a lot of research on the team behind the ICO, they are the ones that are going to deliver the success or failure.
- Read reviews done by third party investors, authors and critics of the ICO plan and then make up your own mind.
You need to answer these question in your own mind: “Do I think this team can successfully build and grow this concept?”
- Are they creating the project to raise funds through ICO or are they running the project and exploring ICO as one of the fund raising alternates?
- Do they have an MVP (minimum viable product), and team, and clients / users? This should help one differentiate from idea stage investing versus business scale up investing?
- How will the company use the funds in building / scaling their business / project?
- Test to see if they fully understand their token structure.
- Are they getting enough tokens for the investment?
- Have any other investors been offered more discounts on the same tokens in recent past?
- Are the tokens integral to platform’s success?
- Consider getting a third party crowd sourced technical reviews (github for example) on token structures as well as token privacy / security
The considerations mentioned above are mostly the same steps an angel investor or VC would take when assessing an investment, just adapted for the ICO environment. If ICO investors start pursuing the same diligent approach to their investments they will be able to find much more ‘investable’ ICOs and it would also help the maturing of the industry.
ICO boom vs Dot Com boom
The ICO hype is comparable to the Dot Com boom in 1990s. Most business plans with a website idea were getting funded. The bubble eventually burst, and thousands of companies with flawed business models were instantly purged but those that were credible survived, creating incredible value eg Google, Amazon, eBay etc. All ICO investors should challenge themselves to find the next Bitcoin or the next Google amongst the upcoming flurry of ICOs by identifying sustainable and scalable businesses.
There is a lot of debate as to whether ICOs are any different to VC or angel funding. At the end of the day, ICOs are a new way of raising funds for good business ideas just like any other form of investment. VCs arguably bring more value with their team’s experience and network contacts, as well as the money they invest. Either ways, there will be space for Angel investors, VCs, Crowdfunding platforms, and ICOs. We believe all these eco-systems can co-exist.
Legal challenges of doing ICO
There has been significant negative media coverage in August 2017 around jurisdictional backlash against ICOs. In my humble opinion, the negative news, especially their titles (like can you be hanged in china for doing an ICO) had been exaggerated and misrepresented the crux of the jurisdictional stances.