The hype around initial coin offerings

There’s a new hype in cryptocurrency land these days. They’re called initial coin offerings (ICO’s) and they’re basically a way for aspiring services to raise money by issuing new digital tokens on the blockchain. If the services are successfully built and widely used, these tokens appreciate in value, thereby rewarding early investors.

People much more knowledgeable than I am on the topic have written about ICO’s at length elsewhere. I’m not going to repeat what they’ve said, but will point out one flaw in the arguments that ICO advocates are making.

In particular, advocates of ICO’s state that ICO’s are a great way to solve the chicken and egg problem when attempting to attract users to a new service with network effects.

A service with network effects is one which becomes more valuable for users as more other users use the service. This makes it difficult to attract users at the beginning, when there are few other users using the service. As a result, centralized service providers resort to offering incentives (financial and non-financial) for users to participate in the network. The discounts that car-hailing companies offer passengers and the bonuses that they offer drivers are great examples of this.

Since ICO’s offer investors the potential for appreciation in the value of the service’s underlying token, the argument is that they help solve the chicken and egg problem. They do this by giving early investors tokens which, since they will increase in value if the service is widely used, the investors are incentivized to use.

The problem with this argument is that, while centralized service providers traditionally give money to their users to use the service, services that perform ICO’s are requesting money from their users. In other words, the direction of money transfer is reversed. You will get a lot more people to use a service by giving away money than by requesting it. As a result, services built upon ICO’s appeal to a much smaller pool of potential initial users than services built by centralized providers. The solution which ICO’s offer to the chicken and egg problem is therefore not nearly as big as ICO advocates make it out to be.

In addition, if we think of the people which a service gives money to as its users, and the people which a service takes money from as its investors, services built upon ICO’s are currently claiming to create a new class of investor users. The problem with this is that the level of diligence required to be a user of a service is different than the level of diligence required to be an investor in the service. In the former, you’re consuming, and consuming is easy. In the latter, you’re producing or at least understanding how something is being produced, and that’s hard.

ICO’s are currently making people believe that it’s easy to do what’s hard.

This is an attractive value proposition. It explains why there’s so much interest in ICO’s, to the point where services are raising millions of dollars in minutes for a service which they often have yet to build.

The problem is that, in reality, doing what’s hard isn’t easy. As the services built upon ICO’s are built, or are not built, and are used, or are not used, reality will emerge.


Originally published at Thoughts of a VC.