What’s an ICO and what does it mean for investors in 2017?
Towards the end of 2016 I started noticing crypto and blockchain making a resurgence in the mindshare of VCs and developers. I felt pretty disoriented around the concepts in my initial conversations on the topic so I spent part of the holidays reading “The Business Blockchain” and as well as BTC blogs like Coindesk and others in an effort to put together a broader picture and better understanding of what’s going on.
When I mentioned the topic to other people I generally got two types of responses (both excited): one version of the excitement imbued in confidence, and the other followed by the phrase “I wish I knew more about blockchain.”
As I saw bitcoin creep past $1,000 today, it felt like an opportune time to start sharing some of what I’ve been learning. One of the topics I found most approachable was ICOs.
ICOs, a cure for the hype-cycle?
One of the issues plaguing crypto for the last few years has been the hype-cycle and what it means for funding in the sector. As shown below, crypto funding has been chunky at best with many viewing the funding swings caused by singular events and scandals that are outside of any one startup’s control.
Enter the ICO, a potential solution to the volatility that comes with the VC market.
What is an ICO?
ICOs (“Initial Coin Offerings” or “Token Crowdsales”) is a fundraising mechanism for crypto projects. More specifically, they are events where cryptocurrency projects sell their tokens to early adopters in exchange for money.
Unlike many crowdfunding platforms, ICOs give you a form of ownership over the success of the projects you back. Unlike IPOs, they’re generally used to invest at the earlier stages of a crypto project’s life.
One of the first ICOs was by Mastercoin when it raised $600,000 in August, 2013. Etherium later surpassed that with a whopping $18 million in June 2014.
2016 saw an even greater increase in ICO activity, including The Dao, which raised $160 million. 2016 saw around $200 million invested in ICOs, largely driven by The DAO.
As of Jan 1, 2017 there are 35 upcoming listings on ICOList.com.
What Do ICOs mean for startups?
Put simply, ICOs are a complimentary source of funds for early stage startups in the crypto space. Many view ICOs as a cure for the problems that come with reliance on traditional sources of venture financing (e.g., groupthink, market timing hesitations).
But, ICOs come with risks, including security. This depends on how your project is designed of course, but notable cases of token theft have already occurred.
ICOs also come with strings. While not necessarily as binding as the terms agreed to over a traditional VC financing, many ICOs have promises attached around a future product or milestone. Not making good on these could tarnish a company’s reputation with their customers, partners and potential investors. For that reason, many are cautioning against raising as much as possible via the ICO market, advocating a more measured approach instead.
What ICOs mean for VCs
If you believe that the more funding in an ecosystem, the better off everyone is, then ICOs should be a good thing for VCs.
But, ICOs can also overvalue companies, since there are more buyers at the table. They can also limit VCs visibility into exciting crypto opportunities, since companies can avoid the VC ecosystem altogether via an ICO.
As for investing in ICOs, the general consensus is to proceed with caution.
Foremost in concerns for VCs is the variability around what terms, if any, are binding between the seller and buyer of tokens. This not only has implications for VCs in the long term, but in the immediate term as they are likely bound by duties to their LPs around requiring certain investor protections in their new investments.
If VCs can proceed, the paradigms and formulas for actually evaluating the value of tokens are still small in number. Many industry players are proposing grades and other rubrics to measure the risk, rewards and commensurate value of tokens issued in new projects.
Some institutions have shown an interest in working towards agreements that resemble traditional VC docs, but include tokens as financing instruments. This could be the middle-ground that makes ICOs accessible to VCs at large.
Despite their current associated risks, funding for ICOs is projected to surpass 2016 levels this year, with many believing that the market will “iron out the kinks.”
My thoughts?
A few things are true, ICOs are a real and they’re here to stay. ICOs provide a more risk seeking source of capital than traditional VCs, which many crypto startups will likely benefit from.
With that said, the risks around ICOs are significant and extend beyond those in this post. Contemplating solutions to these risks will determine whether ICOs become a source of funding that companies aspire to (like IPOs) or a last resort.
