Why ICOs were doomed to fail from the start
Arkadia was once optimistic about ICOs and even started to pursue one in September 2017, back then there was huge optimism and frenzy in the crypto space. Ambitious ideas that would change the world were being reported across different news media and the cryptocurrency market was rebounding from it’s lows after the China ban. The ICO was seen as a new corporate finance model to democratise venture capital and angel investment which deny retail or unsophisticated investors the chance to invest in the next Google.
As more and more ICOs launched it became clear that marketing budgets and compliance costs were spiralling out of control for start-ups. Logistical issues such as these were merely the beginning though, as time went on the worst of the financial world came to feed on the unregulated market.
At the time we brushed off suggestions that this was the Wild West but now looking back we find it hard to disagree. Ultimately, the reason we stopped the ICO wasn’t that of logistics or scams, it was because we found the model didn’t work. If we had of continued with the ICO it would have hurt our investors and community as well as potentially killing the dream we have for this company.
So why didn’t the model work? Well, there was a combination of different things, but it really came down to the fact that tokens or coins are an investment. Anybody telling you any different is lying, people bought tokens or coins because they wanted to make money.
Do you really think VCs and funds would get involved just to use your product?
Now, this is an issue because ultimately both from a risk perspective and from when looking directly at the token mechanics itself, tokens were expensive and designed to drop in value as the project scaled.
ICOs turned the startup model on its head, projects would raise huge amounts of money and then build a grand vision.
In reality, this isn’t how product development works. Products go through rapid testing and are built from proof of concepts to minimum viable products until after many trials and variations they become a full-fledged product.
Imagine going straight to a product, which was built from a whitepaper, written in an academic format and with a community demanding it looks exactly like you described in your whitepaper. Furthermore, with much of this community, not even an end user!
Now imagine having millions or even hundreds of millions of dollars to do that!
Startups hone their products and efficiency by having tight budgets and constantly adapting their products by building from the ground up. This leads to reduced waste and ultimately a product which your users/customers want to buy. This reduces the risk to any investors because they can attach defined milestones to the project and release capital injections in tranches as opposed to making an idea into a billion dollar company overnight.
I have even seen ICOs building ecosystems and markets for their products because they raised so much cash and the market wasn’t ready for what they were doing!
Essentially ICOs are/were overvalued and this led to the investments not reflecting the risk accurately.
Now aside from the issue that you are adding a layer of complication onto your business at a time when you should be keeping things as simple as possible to remain flexible, utility tokens were designed to drop in value.
Utility tokens need an extremely high velocity in order to function because if you can’t get hold of a utility token you can’t access the function it gives you access to.
Velocity = Total Transaction Volume / Average Network Value
Average Network Value = Total Transaction Volume / Velocity
Ultimately the higher the velocity the lower the network value, the lower the value of the utility token.
Sharks — Insult to injury
The reason you saw most ICO prices tank when they hit exchanges was that large early investors bought in with huge discounts essentially just to flip the discounted tokens at ridiculous margins like 4x their buy-in. Projects that preached about democracy and equality basically stole from the vulnerable.
Some successful ICOs even then replicated the process investing into other ICOs multiplying the size of the theft.
Imagine trying to work with integrity in this space?
Fake communities, fake team members, fake credentials, fake money and fake projects — the sharks smelt blood. The ordinary investors were easy pickings, a lot had ideological sympathies with libertarian concepts and were deeply sceptical of regulation. I am very disillusioned with the entire industry as you can probably tell. This started out as something so pure and it was tainted by greed.
The regulation that exists isn’t fit for purpose and ultimately it has failed ordinary investors. We would pay lawyers to look over our whitepaper and they would either engage in wordplay or break the product by changing the token mechanics.
Right now, you will fall under existing regulation which is designed for traditional finance, it isn’t suited for ICO models which turn most of the traditional aspects on their head. I don’t think this space can survive without specific regulation and even then, because of the customisable nature of most token models, it will be difficult not to fall into the same trap as before.
Many ICOs have turned into Security Token Offerings (STOs) or even Token Generation Events (TGEs). STOs are essentially like listing on a smaller exchange with all the compliance aspects of traditional securities. I think people who go down this route have missed the point of an ICO (not because of compliance) and are instead trying to capitalise on the inflated values in this space.
Whatever ICOs evolve into be that STOs or TGEs it is essential that it remains simple and that the economic benefits outweigh the complication. The added complexity increases the risk and if there is no proportionate economic benefit it is not worth doing! There is a lot of value in considering the traditional startup model when doing this too, one mistake we made was trying to grow too quickly purely for the ICO.
For investors it is important to try and maintain a sense of rationality and risk aversion, your money is at risk especially in unregulated areas of finance. Maybe regulators around the world are partially right protecting retail and unsophisticated investors — whether their classification should be based on the size of their wallets is another matter. Perhaps even the current degree of protection spawned the ICO space and the exploration of unregulated and under-regulated spaces. Regulators should be pragmatic and try not to be too paternalistic.
It is clear however that not running an ICO was the best decision Arkadia made.
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Written by Ellis Hudson Co-Founder and CEO for Arkadia Lending (www.arkadialending.com)