Why are ICOs so popular?
It seems that nowadays, every week there is a new batch of ICOs. And frankly, it’s all new, and cryptic. So let’s look a little bit more in details at what is this new trend and what it means.
First things first. An ICO (which means Initial Coin Offering) is an operation of crowdfunding. It’s basically a means by which some new company is going to try to raise money for their project by asking a bunch of people to chip in. It’s just a new way of doing this. Taking a sort of a quick historical shortcut look at funding for projects, we can see some of the major trends in this list:
- Bank loan. People go ask their favorite bank(s) for some money. Bank follows some predefined approval rules and if the answer is yes, they will make the funds available. At some point in the future, the funds will need to be reimbursed with a (usually) reasonably low interest rate. This is not too expensive, but often, banks have no real idea of what they are loaning money for.
- Venture Capital. These companies are capable of investing funds in a project after a close examination of the project (business plan, team, tracktion, current and forecasted business…). Usually VCs understand the projects they invest in. And ideally they provide smart money, i.e. not only the funds, but also contacts to help the project grow. This normally comes at a high cost. VCs are in this to make a lot of money, so they will either want to take a significant share in the project they fund… or expect to take a big cut when the investment exits.
- Crowdfunding. There are many platforms, these days, usually web based, where people can post their project, and ask individuals (or businesses, for that matter) to invest in their project in exchange for some (perceived) benefit. For example if somebody puts in a small amount of money, they get their product first. If they put more, they might get a T-shirt or some other goodie in addition to their product. And so on. These platforms come at a cost… impose rules as to what happens if funding amount isn’t reached and so on. They were a great change when they came up because they allowed individuals to basically try to fund any project they had, regardless of whether banks or VCs believed in them. But they come with rules…
- ICO. This is the latest buzz word when it comes to crowdfunding. The idea is to fund the creation of a new cryptocurrency (usually blockchain based) by enabling people (or companies) to purchase in advance tokens for the new currency. This will then be used to fund the creation of the currency and project attached. Interestingly enough this purchase of tokens gives absolutely no ownership in new company. It’s mostly a bet that the currency will grow and that when people sell their tokens, they will make a profit. This comes with no rules, no structure, no regulations… because it is fully based on a decentralized blockchain, it is fully independent of any controlling organization. As such it is very appealing to anybody who wants to raise a large amount of money without getting and key third party directly involved.
So why are people turning to ICOs? What makes it so popular?
There are several reasons that come from what has been described above.
- Banks… They don’t really know what you are doing. They don’t understand it. They only follow a set procedure. Your project may appear too risky for them, but not for you. They won’t invest. And they often won’t have an open door to discuss. And they are “dumb money”. (Albeit at a not too high cost).
- VCs… Anybody remember when your average VC was willing to take a risk with you because they believed in your project? Right… Me neither. In French, VCs are called “investisseur de capital risque”. They invest in risky projects (more risky than banks would be willing to). Because they understand the project. Because they know the market. Because they get involved in the team by providing entrepreneurs in residence who will act as CFO, CTO or whomever is needed to ensure the success of the project. The problem with VCs (appart from the fact that you have to sell your soul to the devil in exchange for their money) is that they aren’t willing to take risks anymore. They will ask for a strong demonstration that the project already has significant traction / revenue, and possibly a team with already a strong track record. To caricature somewhat, you could say that if you don’t need their money, they are willing to invest. There has to be a better way.
- Crowdfunding seems to be the exact way to get over the fact that corporate investors aren’t willing to take a risk (whether they understand it — VCs — or not — banks). Ask a large enough population to invest small amounts. And voilà, you get enough money for your project. Web-based crowdfunding platforms impose that if you don’t reach the preset amount that you initially targeted, the money goes back to the investors… But with an ICO, it’s open season. Any amount you get is for you to use. The only thing is that people might want to cash in on their coins in the future. But they have no control over your company. And no guarantee that they will get their money (or anything else) back.
And then there is the buzz factor. Everybody is doing ICOs. It sounds so much like IPOs that there is this “it’s the natural thing to do” factor.
Interestingly enough, both of the crowdfunding technologies operate on the same principle. A large group of people who, generally speaking, don’t understand the risks of investing in speculative projects are asked to put a small amount (comparatively) in it, with no promise of return… just a hope.
If you are going to create an ICO, think about it. Why are you doing it? What risk are you placing on others. Is this ethical for you?
And if you want to invest in an ICO… evaluate whether you actually understand exactly what is happening… and consider the risk that in the end, you might actually never, ever, get your funds back. Is this risk acceptable for you?
If you answer yes. Go for it. It’s the 21st century… new tools… new means. If the answer is no… It’s just as well a good choice. Managing risk is a tough business.