What exactly is an ICO and why do they make all this noise? | Part 1
A short guide to grasp the fundamentals of a the most controversial and discussed fundraising method
A token sale or generally referred to as ICO is a form of early seed fundraising alternative to Venture Capitals (VC). Through token sales, start-ups can issue crypto tokens on a blockchain, most commonly that of Ethereum (ERC-20 Tokens), and sell them to investors or contributors. An official report from a cryptocurrency data provider refers that worldwide in 2017 were raised 5.6Bn USD worth in tokens. This represents an increase of 2233% vs. 2016 and around 5.5 times the amount raised by VCs during 2017. The average token sale raised 12.7M USD and collectively the 10 most successful token sales raised 25% of the total annual figure. One of the most successful in 2017 was OmiseGo with an ROI above 4300% while in token sales short history one of the most profitable is Ethereum with ROI above 200,000%. On average tokens have returned 12.8x the initial investment in dollar terms. Many industry observers believe that mainstream companies will one day issue shares through token sales, either in place of or in addition to traditional public offerings.
In many cases the projects never see the light
Given the premises, in 2017 only 435 projects were successful, the 52% of all token sales failed within the year while VC industry reported failure rate from National VC Association ranges from 25 to 30%. It is actually very tricky to tell a good ICO from a bad or, even worse, a fraudulent one. In some cases the projects collapse because of technical unfeasibility, fraudulent attempts, hacks, frozen bank account due to inability to justify the source of the proceeds or are severely delayed because of conflicts within the management of the projects. In most of the cases what should be borne in mind is that investors are not dealing with working companies with a finished product, but just well (not always) detailed concepts. Only few projects are able to show the level of completion of their codes, MVPs (Minimum Viable Product), partneships in place and pilot results. Whenever these conditions are not met, funding can be considered a mere act of faith.
Recovering the funds from an unsuccessful token sale it’s not an easy task. A structured approach is to set up a class action against the issuers of the tokens through a law firm as in Tezos’ case. This solution is expensive for the participants and it takes long time to get to a satisfactory conclusion but all in all, the compensation is uncertain in form and value.
Token Sale vs Venture Capital
A 2015 study published by the Stanford Business School refers that among all public companies founded from 1979 to 2013 in the U.S., 43% were VC-backed. These companies represent 57% of market cap and 38% of employees of all the public companies founded in that timeframe. Moreover, their R&D expenditure represents the 82% of the total R&D of new public companies.
Potentially a more democratic way to participate into groundbreaking projects (with a claim on the returns)
Token sales represent the modern approach to funding a project in its initial stage and it might potentially spur economic growth to an unprecedented pace. It represents a relatively easy and economical way to raise money for a startup. Within this funding solution there are much less restrictions and obligations as in VCs investments and the system is not bottlenecked by the number of financial institutions. Basically the pool of investors is gathered among whoever owns a laptop and is attracted by the business plan. Non-institutional investors however are not as strict on revenue production capabilities and adherence to risk standards as VCs are, and this represents an advantage for the issuer of the token and a risk(/opportunity) for the contributor. The size of the risk is inversely proportional to the level of awareness of the investor, constrained however by the amount of information available.
Information circulates across the web at high speed, but sources are highly fragmented and reliability is left to personal bias or notoriousness. Few sources can boast significant reliability and establishment in this sector is a concept extremely intangible. As a consequence, it is very difficult to have a clear picture when it comes to investments and the opinion is provided by actors that have more the traits of influencers than advisors. In a scenario then in which the most detailed of information is released by the issuers of the tokens themselves, common practices must be put in place to present opportunities in an unbiased and transparent way.
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