Three Facts Why ICO Will Become A Multi-trillion Dollar Market
Five years ago the software engineer J.R. Willett launched the very first Initial Coin Offering for Mastercoin (now called Omni) and raised around USD 500k worth in Bitcoins. With his ground-breaking idea, a new funding opportunity based on blockchain technology emerged out of the blue. A technology which allows investors around the world to contribute to projects with decentralized currencies such as Bitcoin or Ether encouraged entrepreneurs to raise money for their companies.
Since then, Initial Coin Offerings have turned into a multi-billion dollar industry.
Total ICO Size and Number of ICOs as of April 2018
New stakeholders showed up in this game: Crypto investment firms, specialised law firms, crypto marketing agencies, custodians, or Know Your Customer and Anti-Money Laundering service firms. When measuring the total ICO market size, we usually refer to the total market capitalisation on Coinmarketcap, which is currently at around 250bn USD (End of June 2018). Due to the recent downturn in the crypto market, pessimists already see a collapse of the “so-called” ICO hype. But is that true?
Here are my three reasons on why I believe that ICO will mature as the next fundraising tool. We have just seen a fraction of the total market capitalisation in crypto compared to what we can expect over the next five years.
Venture Capital firms will turn into ICO powerhouses
With the recent announcement of Andreessen Horowitz launching a USD 300m fund the cryptocurrency market has gained one more prominent world class investor putting skin in the crypto game. According to Crunchbase, Andreessen Horowitz manages USD 2.7bn. This implies a 10–11% stake for not only equity type investments but also token investments. What seems like a tiny stake in the crypto sector, this is just the beginning and that the Venture Capital market will put a considerable amount of capital into this industry.
I believe, pre-seed and seed investments in blockchain technology companies are becoming more and more essential to Venture Capital firms giving investors an early footstep in the company they invest in. With an equity investment in place, Venture Capitals can exit earlier through an Initial Coin Offering instead of waiting for a big shot through an Initial Public Offering (IPO) on conventional capital markets.
The last strategy paper by Daniel Diemers from PwC Strategy& testifies my predicition of a hybrid funding model in Venture Capital which tries to combine seed capital investments with ICO.
Archetypes of Fundraising for Venture Capital
If ICOs give Venture Capitalists the opportunity to shorten exit cycles from 5–7 years to about 1–2 years, the appetite for Venture Capital helping their portfolio companies to go public via ICOs/ITOs will rise exponentially. Blockchain Valley Ventures has already pioneered this model.
Security Token Offerings are the ICO 2.0
Lots of money has been raised in 2017 and 2018 with tokens which were officially classified as utility tokens. According to the Swiss regulator FINMA, utility tokens are tokens which are intended to provide digital access to an application or service. This might be an attractive investment opportunity in case tokens are offered at a significant discount before these tokens are listed on exchanges or offered as product at a higher price in the future.
Utility tokens or even cryptocurrencies have value because people believe that they will be able to exchange this token for applications and services in the future (by paying with the tokens for them). This belief will persist so long as people do not fear future inflation or the failure of the company. However, there is a fundamental flaw in this belief. Technology companies can go bust any time and currently there is no obligation for technology companies to report on their current status. In most cases, utility tokens are not backed by any assets and thus the only security for the investor is the belief to sell before something bad might happen.
I believe security tokens offer a way more attractive opportunity for investors to improve risk reward ratio in the cryptocurrency space. As an example, security tokens can be constructed as financial derivatives which give investors the right to convert tokens into real shares with dividend and/ or voting rights. The ICO of Securosys, a leading enterprise grade security solution provider for crypto assets and blockchain systems, is a very good example for a security token which allows the investor to trade tokens on a secondary market while having the option to convert tokens into equity. Also, Lykke was one of the very first security coins, which gives investors the right to convert Lykke coins LKK into real shares. Lykke Coins LKK, constructed as a financial derivative called “Forward at the run”, can also be perceived as a breakthrough concept in the token world. New financial instruments are being created to tackle current limitations in the regulatory environment. In the future, we will even see equity entirely tokenized, however, the regulatory environment is too immature for this big step yet.
Furthermore, the market itself does not seem ready yet; big crowd investors have not yet switched their attention to ITOs. Uncertain regulatory environments also hold back investors, mainly from the US, to invest in such funding rounds. However, once markets mature we will see the next wave of professional capital to be invested into tokenized securities offerings.
Regulated exchanges will bring a new ICO boom
Over the last years crypto exchanges allowed to exchange cryptocurrencies such as Bitcoin, Ether or Litecoin between buyers and sellers on secondary markets. In the next step of the crypto evolution utility tokens were listed on exchanges. This gave investors and traders the opportunity to buy and sell these tokens next to cryptocurrencies. However, According to former BlackRock Executive, banks, institutions and professional investors have not entered the crypto market yet (or on a very small scale), as regulatory uncertainty over tokens, volatility and lack of education are still prevalent.
Next will be exchanges that are allowed to list security tokens. I am strongly convinced that the cryptocurrency and token market will experience a new boom once regulated exchanges will provide sufficient regulatory structure, technical security and ease of use. Stable and reliable infrastructure is a top priority in capital markets in order for institutional money with a risk averse mindset to enter the crypto market. Once these conditions are set, a new wave of money will flow in, potentially boosting total market cap to a multi-trillion dollar size.
Summing up, ICOs are here to stay and will shake up conventional capital markets at its core. Venture Capital firms will potentially reinvent their business model and turn into ICO/ITO issuing houses to capitalise on the opportunity to shorten investment cycles through Initial Coin and Token Offerings. Security tokens will become more prevalent in the market as the investment proposition to retail and institutional investors is outweighing the promise of a future value of utility tokens. Last but not least, the main boost will come from regulated exchanges, that will give conventional capital markets the security and regulatory certainty to allocate capital into riskier assets. This will be the breakthrough for a new multi-trillion dollar market in the next three to five years.
