ICOs Got You Rekt? Check Out Tokenized Business Offerings
Bitcoin, blockchain, and cryptocurrency assets were all the rage in 2016 and 2017. However, 2018 was pretty much a never-ending house of pain for retail investors. Though the easy money has most likely been made in this industry, that does not mean that there are not significant alpha-generating investment opportunities littering the landscape. In fact, now may still be a great time to commit fresh capital to the cryptosphere due to the evolving nature of token-based capital raises. The blockchain asset industry is moving from funding the dreams of “two geeks and a whitepaper” via initial coin offerings (ICOs) to a dilution-free extension of the runway for successful entrepreneurs via tokenized business offerings (TBOs).
Those who invested in the ICOs of AntShares (NEO), Verge (XVG), Icon (ICX), Tron (TRX), and other freshly minted tokens turned a pittance into prosperity back in 2016 and 2017. Today, most ICOs, if not down savagely upon listing, quickly proceed to the bottom of the barrel. Losses of fifty, sixty, seventy, ninety, and even ninety-nine percent are not unheard of.
Yet, money continued to pour into ICO investments. Despite a market slump that lasted all of 2018, the crypto market continued to soak up around $1 billion per month of venture capital, or VC, according to icodata.io. Though this trend definitely slowed down during the dog days of summer — July and August — we can now fairly say that ICOs are no longer a passing fad and could likely remain a fixture of the VC and private equity, or PE, universe for years to come. ICOs are just a far easier and faster way to raise capital than those traditional methods.
In fact, with more than $20 billion raised since J.R. Willett invented the term in 2012, it’s high time we started differentiating between these types of offerings. Painting all token-based capital raises with the same broad ICO brush is like calling all the different cuts of beef in the world just meat. You have your filet mignon, prime rib, New York strip, your tenderloin, sirloin, short loin, and then all your different varieties of beef — Kobe, Angus, grain-fed, and on and on. There are close to 500 kinds of beef cuts. By the end of 2018, there were close to 2,000 cryptoassets (recognized by Coinmarketcap) trading on exchanges all over the world.
ICO is Now a Bad Word
We need a better vocabulary term to distinguish the grass-fed organic natural Wagyu beef from the leftover fatty trimmings that will end up in the 80/20 ground beef you buy for the second round of hamburger patties at your summer cookout. You know, the stuff that you give to the uninvited overflow guests and your sun-drunk buddies going for seconds and thirds.
Not every token-based capital raise was created equal. The traditional ICO, of which Ethereum is by far the most successful, is for more traditional startups. Two guys and a whitepaper in a garage working in their skivvies after hours because there’s no air conditioning. In a traditional ICO, investors fund the nascent dreams of fresh-faced entrepreneurs. Thus, it is not unreasonable to expect a 100x or even 1000x return. That is, at least, as long as you are comfortable with by far the most likely result: a 100% loss.
Ninety-plus percent of startups fail. We are now seeing that statistic start to play out with the horde of ICOs that raised funds in 2017. Aside from the seemingly never-ending list of scams that have stolen investor funds, the industry is now faced with the very real fragility of startup dreams. Sometimes your idea just does not work out. Sometimes your startup team abandons you for greener pastures. Sometimes the pressure of doing a startup wreaks havoc on the closely knit ties between the original founding members that are necessary for a successful startup. These are all legit reasons for VC investments to not work out. Why do I mention venture capital?
In 2017, traditional ICO investors were told they were financing a decentralized revolution. In 2018, they came to find out that, in reality, they were playing at being novice VC’s. There’s a good reason why only wealthy people have been drawn to VC investment over the years. In order to be successful, investors must be willing to invest in 100 opportunities. Anything less risks you getting completely “rekt” (a term cryptocurrency enthusiasts use to describe a substantial, if not total, loss of principal in an investment). Thus, most retail investors should not invest directly in any traditional ICO. Most individuals do not have the bandwidth to engage in the due diligence required to vet such an investment, nor do they have sufficient capital to endure the potential losses that most of these investments will likely realize, regardless of their merit.
“Reverse ICO” is an Even Worse Word
Fed up with these odds, the VC tides are now turning towards another type of token-based capital raise. Part of the industry is referring to these new investment vehicles as “reverse ICOs.” Though the term has kicked around the industry since last summer, the high-profile $100 million tokenized raise held by existing Canadian messaging app Kik in September 2017 comes to mind, the trend has become quite popular in South Korea and China.
The first time I heard this term was at the 2018 Asia Blockchain Summit in Taipei from the Korean partner at crypto hedge fund Global Blockchain Innovative Capital (GBIC), Sinhae Lee. Her presentation provided a variety of examples including Cosmochain, TTC Protocol, Carry Protocol, Contents Protocol, and ContentBox. All of these token raises involve existing companies with existing users and revenue streams that integrate blockchain elements to increase trust and transparency. They also happen to provide access to new capital markets via Willett’s profound fund-raising innovation — the ICO. I guess because these companies are using that framework, they all refer to themselves as engaging in a “reverse ICO.”
But oh how quickly market participants forget! This same impetus toward novel access to capital markets drove Chinese fraudsters in the shadow of the Great Recession to scam nearly $50 billion from American investors using a Wall Street tactic known as a reverse takeover, a.k.a. RTO, or “reverse merger.” Using this practice, shady Chinese companies merged with the shell of an extant listed company in the US in order to give their enterprise the veneer of respectability and, essentially, a barely scrutinized backdoor initial public offering or IPO. This phenomenon has now been immortalized in the 2018 film, The China Hustle.
The crew of criminal hype artists, both Chinese businessmen and their American advisors, not only duped hopeful mom-and-pop investors looking to fast-track the recovery of their Great Recession-depleted nest eggs, but also deceived seasoned investors like John Paulson. His firm, Paulson & Co. Inc., made over $15 billion in a single year shorting the US housing bubble. But an investment in a single Chinese reverse merger stock, Sino-Forest, cost it more than $720 million in 2011.
In total, Chinese reverse mergers caused investor losses in the tens of billions of dollars. That figure dwarfs the amount of ICO losses due to fraud. Yet, the crypto industry, a substantial part of which is located in China, continues to use the term “reverse ICO” to describe a token-based capital raise for an existing platform business.
It doesn’t make any sense. To old China hands, “reverse anything” when it comes to financial assets with significant Chinese involvement is simply marketing suicide. Couple that with the growing list of exit scams in the ICO space, and a “reverse ICO” starts to sound like a dreaded double whammy that investors should avoid at all costs. However, there is a better, more appropriate term for legitimate capital raises for existing platform businesses using tokens.
Introducing Tokenized Business Offerings
Tokenized Business Offering (TBO) is an elegant solution to this rhetorical misnomer. When you create a tokenized ecosystem based around an existing platform solution, there is nothing “reverse” or “initial” about it. In fact, blockchain purists would argue that there is not even a “coin” involved, just an easily verifiable utility token that unlocks features of the platform. Thus, TBO is an evolution in the nomenclature of a nascent industry, a more accurate term to help separate the wheat from the chaff in the growing list of cryptoassets listed on Coinmarketcap.
Moreover, TBO’s do not really share the same characteristics as an RTO. These companies are not buying listed shell tokens and then adapting them for use on their platform. They have real reasons for incorporating blockchain technology into their existing platform business.
For Sang Lee, CEO of both DarcMatter, an alternative investments platform, and Konstellation, a pioneering technical solutions provider committed to expanding the blockchain ecosystem for the massive global financial services industry, “blockchain not only represents the next phase of growth, but the maturation and acceptance of a technology that truly allows us to step one step closer to the ultimate vision of disintermediating asset management.
“Payments and store of value are just an initial step. By having the participants on our platform engage concurrently in wealth generation while simultaneously contributing to the underlying security and health of the ecosystem, blockchain will completely transform asset management.”
The lead investor for Mr. Lee’s companies is South Korean crypto fund #Hashed. Perhaps the Korean translation for “reverse ICO” does not carry the same baggage as it does in English, but Korea is bonkers for TBO’s. Not surprisingly, #Hashed’s most recent investment, XCHNG, is also a TBO.
XCHNG is a tokenized platform based on the stalwart Kochava advertising and analytics network. Seven years ago Kochava Inc. set out to better the ecosystem by providing best-in-class measurement and attribution tools to their clients. Fast forwarding to today, Kochava Labs SEZC CEO, Charles Manning says, “We’re still on the path to better the digital advertising ecosystem through the common blockchain framework XCHNG.”
DarcMatter and Kochava are existing businesses with established revenue streams that turned to blockchain-based capital raises to fund their substantial growth in order to compete with much larger established businesses in their respective industries. Blockchain provides both funding and product differentiation in industries that are in very sore need of disruption. As such, they should not be associated with the scams and “air coins” that typically characterize ICOs these days.
TBOs Evolve the Blockchain Fundraising Model
As the industry evolves, risk management becomes more important. Newly-minted crypto hedge funds naturally are moving from inherently more risky venture capital “seed stage” investments to tokens that exhibit a more PE-style profile of Series A and B round investments. Savvy retail crypto investors should also consider a greater allocation to TBO’s by virtue of their safer risk profiles. In fact, the industry has already voted with its pocketbook.
Investors just didn’t realize what they were voting on. Two of the top four most successful crypto capital raises in 2018 were TBO’s — Telegram (TON) and Huobi Token (HT). Similarly, in 2019, Bitfinex raised a billion dollars in a little over a week for its LEO utility token. All three companies have massive user bases and existing data and revenue streams.
In contrast to traditional VC-type ICO’s, later-stage companies that might benefit from a TBO have often already engaged in an equity round, or two or three. A token-based capital raise can provide these elder startups with enough additional runway to effectively pivot to the blockchain without diluting existing equity.
Investors themselves benefit as well. “TBO’s offer companies the liquidity they need to grow without locking investors into long-term commitments,” says William Parker, Chief Brand Officer of A7 Core, a blockchain port of an existing B2B point-of-sale infrastructure system.
As the cryptosphere evolves, funding mechanisms will have to evolve as well. While the blockchain industry grappled with a verifiable “crypto winter,” as industry insiders often refer to the market action that began in August 2018 and lasted into March 2019, prescient institutional investors looked to go bargain shopping.
Retail investors who had been on the sidelines in the blockchain revolution may want to consider establishing initial positions in companies that stoke their interest. However, these investments should in no way be based on social media metrics. Those can all be gamed. Telegram users, Twitter followers, even comments on Medium articles can all be too easily outsourced to “growth-hacking” companies. It is widely recognized throughout the industry that much of the volume on most cryptoasset exchanges is fake. When making decisions about whether or not to become a tokenholder of a cryptoasset in today’s environment, assess the quality and experience of the leadership team as well as the quality and sustainability of revenue opportunities. If you cannot determine these basic characteristics, you should by no means become a token holder of that particular project.
When the cryptoasset market inevitably recovers, and whether or not the face-melting action of spring 2019 constitutes a true recovery or not is still up for debate, the industry most certainly does not need to see a replay of the late 2017 bubble behavior that rewarded bare-bones projects for facile buzzword marketing with 10–20x returns in a matter of a few weeks. Though most of these projects have now crashed precipitously, most of them likely never to recover, their calamity in no way should discount the fund-raising revolution that token-based capital raises represent. By providing another arrow in the quiver for entrepreneurs to fund their ideas, TBOs provide an efficient liquidity system that will help the fintech and blockchain industries thrive far into the future.
TBOs are a fantastic alternative for businesses with a proven track record of both technological and business development that does not require the equity dilution of traditional financing. For long-term oriented token holders, the chance for fraud with a TBO is substantially lower than with a traditional ICO. TBOs offer a significant alpha-generating opportunity to enjoy better risk-adjusted returns via exposure to the utility tokens of pre-IPO businesses. In short, if you’ve been burned by ICOs before, make sure the next token you invest in is a TBO!
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