The Origins of ICOs and Tokens

Assessing the key factors supporting the rise of digital currencies

I know most of us in #cryptoland are probably a bit tired of talking about digital currencies, tokens, and ICOs. Lou Kerner hosts a great monthly webcast with Geektime and wanted to do one on tokens and ICOs, so I knew it would be a good catalyst to force me to sit down and organize my thoughts. You can see his notes from our discussion with Bancor, Tezos, Olaf Carlson-Wee (Polychain) here.

As I started thinking about my experiences in bitcoin and before that, B2B and B2c startups, I saw some similar themes in the way changes in the external environment could open up new avenues for experimentation. I would be remiss if I didn’t point out that the most critical ingredient to fueling the rise of token mania has been timing, and luck. A number of the right things happened at the right time, which have created an environment that is exceptionally friendly to entrepreneurs and opportunists alike.

“Timing is everything. There is a tide in the affairs of men which when taken at the flood leads on to fortune.” — Shakespeare

Outside of the factor of luck and timing, I see four key factors that have shaped the digital currency landscape and enabled the token economy to become a ~$100 billion market. These are:

  • Robust Global Infrastructure to Support Token Markets
  • Reduced Technical Complexity and Cost of Launching Tokens
  • Growing Social Networks Dedicated to Tokens and ICOs
  • Rise of Crypto Millionaire Investors and Sector Specific Funds

Robust Global Infrastructure

In my opinion, both the volume and velocity of existing token sales and ICOs would not be possible without the billion dollars that has been deployed by VCs, investors, and entrepreneurs into building bitcoin infrastructure. There are hundreds of businesses that were built to support the bitcoin network that also support the Ethereum ecosystem, and now, the token ecosystem.

I don’t think many people new to digital currencies appreciate just how quickly growth happened in this industry. In January of 2017, just six months ago, the total market cap of all digital currencies was only $18 billion, and 87% of that market was bitcoin. Today, the digital currency market is a $100 billion market, and bitcoin comprises 40 to 50%. Platforms can’t scale from 1,000 users to 100,000 users overnight. Yet that’s what happening on many digital currency trading platforms around the world — customer volumes are exceeding both the capacity of these platforms. In addition, the wallets to enable users to custody and manage these new tokens haven’t even been creating yet, putting additional pressure on exchanges to act as temporary custodians. Security is tantamount in the world of digital currencies, and rapid growth puts the security of the entire ecosystem at risk.

While today’s bitcoin infrastructure is supporting the token ecosystem, I believe the market of products and services will grow and mature rapidly. The infrastructure supporting tokens is still very immature, and many entrepreneurs are debating if deploying capital to build new features and add resources to support tokens will be worth it. I believe the world has shifted from asked “if” digital currencies will succeed to “how and when” digital currencies will become mainstream. In the current environment, it’s very difficult to determine if this is a bubble and therefore a short-term opportunity, or if there is a long to medium term business case to be made for investing in changes to infrastructure. However, many entrepreneurs and companies have created amassed considerable wealth over the last three months, and are beginning to deploy some of it into infrastructure projects that will support the emerging token ecosystem.

Technical Complexity and Cost

Just as AWS and compute on demand services have drastically lowered the cost of starting a company, the emergence of bitcoin, ethereum, and other protocols have made it technically simpler and far cheaper to deploy your own token without having to do the really hard stuff. As early as 2013, there digital currencies like Litecoin, Namecoin, and others emerged by leveraging the codebase of bitcoin, but simple token creation has really flourished with the advent of the Ethereum ERC20 token standard.

There is an entire cottage industry of developers, auditors, token sale platforms, and marketing groups that can help teams launch a token in a few weeks, with a few thousand dollars, without ever writing a line of code. There’s even a service called ICObox that lets you launch your ICO for 50 bitcoins ($150K). They’ll write you a smart contract for your token, give you some legal paperwork, create a landing page, and even throw in $20k of marketing! All of a sudden, anyone, anywhere can create their own token.

Lowering the technical and financial barriers to entry has led to a proliferation of token sales trying to capture some of the investor craze around digital currencies.

Growing Social Networks

Today’s startups heavily leverage social networks to grow and scale. With over 2 billion people around the planet connected to the internet, massive platforms such as Facebook and Twitter are uniquely positioned to provide startups with access to tens of millions of potential customers, drastically lowering the cost of user acquisition. In addition, the emergence of APIs enables startup marketing organizations to be very lean — typically one person in a growth hacking role can reach millions of users with a few key strokes, and engage in programmatic marketing. (Here’s a great blog post about it).

In the world of digital currencies, the social network around open source projects has become a critical test bed for ideas, products, services, and early users. The social network around bitcoin began to grow in 2011 on sites like Reddit and new, dedicated community sites like More importantly, all new projects in the digital currency ecosystem have their own Slack or Telegram groups with multiple channels where users, fans, and devs can collaborate, discuss project ideas, and even build new companies together. Many of these new tokens are heavily dependent on investor networks and developer networks to market their wares and provide the early capital. The majority of communication in the token ecosystem happens on crypto twitter, Reddit, and in Slack groups. I expect these platforms will continue to play a critical role in educating and advocating for digital currencies and tokens, and new platforms will emerge for the new tokens coming to market.

Capital Formation

In the 2000s, the rise of operator-led micro VC’s fueled a new wave of startup funding and micro VC models. As a result of the changes happening in open source, cloud enabled software development, entrepreneurs could start new software companies very cheaply. The VC market wasn’t necessarily looking to put $50 to $100k into these firms, and many operators saw opportunities to generate meaningful returns by investing small amounts of capital into these very early concepts. At the time, many of these sole GP funds were getting investment capital from high-net worth individuals. According to Preqin, the proportion of micro VC funds in market reached its highest point in 2009, when 74% of venture capital funds closed on $100mn or less.

Over time, micro VC has grown into a large portion of the VC landscape, and these smaller firms have grown into industry behemoths. (samir kaji has done a lot of excellent writing on the topic here). More importantly, the operators launching these crazy funds have become some of the best known investors in Silicon Valley and beyond, and now command millions, if not billions, of dollars in capital. The total number of micro VC funds closed per year has continued on an upward trend, as more and more firms emerge to invest in niche areas. DCG is one such example — we invest exclusively in digital currency and blockchain companies, as well as digital currencies and tokens themselves.

Similarly, a wave of early bitcoin and ethereum investors who have benefited financially and professionally from the growth of digital currency markets are now seeing opportunities to invest small amounts of money, primarily sourced from high net worth individuals, into the emerging token ecosystem. We are seeing dozens, if not hundreds, of new fund vehicles being launched to invest in tokens, projects, and companies in new ways. It may take one or two cycles for these funds to the generate the returns needed to grow assets under management in a meaningful way, but I would not be surprised to see more operators and early adopters become digital currency fund managers. Over time, these funds will attract institutional capital as the digital currency market grows and investors begin to look for exposure to new projects and new tokens. Eventually, those with vast social networks, industry connections, and an intimate understanding of the technology and the industry will be uniquely positioned to capitalize on the information flow they have through various fund structures.

Where Do We Go Next?

So what happens from this point forward? I think it’s time to buckle our seat belts and get ready for a wild ride! I’m excited about the emergence of tokens, and while I’m skeptical of many of the early projects being launched, I do believe we are seeing the emergence of an entirely new asset class that will foster the growth of a new investment community, a new set of social networks, and most importantly, a new class of technologies. There are still many unanswered questions, and it will likely take years, not months, before the infrastructure in the sector matures sufficiently to warrant institutional capital.

In the short term, I’d caution everyone to remember that luck and skill are two distinct tides that can both lift, and sink, boats. Conflating one for the other is a dangerous game.

Over time, I am certain the industry will begin to bifurcate into two sectors — one comprised of tokens and projects that are seen as legitimate and credible, with long term potential for growth and value creation, and a second comprised of tokens that are viewed purely as investment vehicles to leverage information arbitrage by industry insiders and friends of these new projects. That isn’t intended to be a value judgment, but rather an observation. Perhaps this is something akin to startups who raise VC and those who crowdfund or bootstrap — not all projects will be able to raise large volumes of capital from a high quality network of investors, but all have the potential to be successful over time. Even the best investors miss from time to time, and I expect this will be no different.

If you are interesting in getting involved, join me over on crypto-twitter (all the cool kids are doing it), attend some meet ups, and check out some of the great blogs from various industry leaders to form your own perspective.