Simple about ICO
Why is everyone out there doing ICOs?
It seems like an easy way of making money, without getting into long discussions with investors. On top of this, there are no legal consequences for a start-up if it fails.
Why are people investing in ICOs?
I’ve been able to clearly identify four reasons, in descending order: 1) a desire to make earnings while the wave is on; 2) the effect of the crowd — “other people are investing and me too”; 3) a desire to feel like an investor; and 4) a belief in start-ups. The whole thing works beautifully in a rumour-mill, that tokens will ‘pump it up’ after ICO, or with observation of the expectations of other investors. A significant percentage of those in the market — or who are eager market observers — remain certain that the old-style model of venture investment (with its negotiations, tractions requirements, and due diligence) is dying out. In fact it’s not uncommon that investors with no strong feelings about putting their money into a startup will then leap at the chance to participate in its ICO. I feel this can only be satisfactorily explained by them really believing in the existence of significant numbers of people who’ll buy at a higher price.
What an ICO is?
ICO is a start-up pre-selling its own currency (tokens). Their value is directly linked to the number of future users (and their level of activity), and can rise exponentially in response to limitations on issue, and growing demand.
Is it possible to sell shares via ICO?
Yes, it is possible. You can do it mostly legally in both Singapore, and in Switzerland. Investors will still have to go through the identification process (KYC) whether selling or buying, but as far as I know, regulators are still closing their eyes when it comes to the secondary market.
But is it worth doing so?
Now that’s a tough question. On one hand, people are now buying tokens in any strongly-promoted ICO. Yet on the other, price growth in the shares can’t work out as dynamically as growth in the value of the tokens — because tokens are usually required to trigger ANY kind of action on the platform. All this tarnishes the attraction of ICOs for speculators.
What’s innovative about ICOs?
In the future, most business will be financed through ICO-like mechanisms. There are several reasons for this, among which are:
- the simultaneous involvement of numerous investors makes it possible to make effective price discovery
- access to a liquid secondary market at the time the sale is completed
- cutting down the demands made on investors (today in the United States only accredited investors can participate as investors)
- cutting the legal set-up costs by making use of standardization
- lowered infrastructure costs for holding, trading and registering securities (Ethereum, in fact, does all of this for free).
What risks do ICOs entail for investors?
The main risk is losing the funds, if the start-up goes down. And indeed, statistics show that this happens to 99% of start-ups. I don’t get the feeling that the new way of investing is likely to cause any positive uptick on these stats. Regrettably, the majority of startups regard setting-up ICO funds as free cash that comes with no responsibilities. The second most-significant risk is losing the keys (just as with Bitcoin). For example, if you keep the tokens on a exchange, and the exchange then gets hacked, you won’t get your money back. Another risk is for businesses who are not entirely virtual (and this is really most of them) — that there is no effective way to guarantee distribution of profits to the owners of the tokens.
What would an ideal situation look like?
You could imagine any online game for multiple players — for example, Warcraft. The game developer could release a decentralised version, in which each player holds their own full copy, and which all come together in a network. The game has its own internal currency (gold), as well as numerous objects (such as swords and shields) that can be traded — as well as an exchange which accepts fiat money. Accounting for the gold and game objects can be handled through a blockchain which is established among all the players. The game developer also holds an account in gold. The game developer is able to set an initial rule, that all transactions between players (in gold, or in objects) is subject to a small fee — which accumulates in favour of the developer. In fact, this will be the profit of this virtual company. And now we come to the main point. The developer can issue tokens, which function as the ‘shares’ in the game — and program the profit distribution proportionally to ownership of these tokens. These ‘shares’ can be traded even before the game is fully developed. There are some important factors here:
- The company has no servers at all
- The company can be entirely virtual, and not registered in any jurisdiction at all
- The company profits are generated completely transparently for all the players and investors
- Investors in the project are guaranteed to receive profits — because their distribution is no longer controlled by the developer
It’s this kind of ICO in which a majority of funds will be invested. Each project of this kind effectively creates its own closed economy. In general, any other business we might take can’t make use of such a set-up, because they work in open economies.
What is a token?
Tokens can play either one, or several functions:
- A share (stake) in a specific start-up
- An accounting system (number of API calls, or the volume of torrent uploads)
- A digital asset (digital rights to land ownership, tomatoes in the warehouse, etc)
- A way of rewarding the miners (Bitcoin is a good example)
- A way of preventing attacks (commission with Bitcoin, or the deposit in proof of stake blockchains)
- A currency — a way of making payments between the participants
- Payment for using the system.
How can I tether a token to my own business?
The most difficult problem in setting up a blockchain system with tokens, is to set up a viable economy with balanced supply and demand for each stage of the project’s development. The difficulty for most projects turns out to be that with user growth, the cost of tokens — and commission on transaction fees for them — will rise sharply (a problem we all recognize, don’t we?). Setting up an effective system needs specialists in the economics and game theory, who are not just blockchain developers alone. In 95% of blockchain projects, internal tokens aren’t needed at all.
What’s the future for the ICO industry?
Despite all the innovations in the mechanisms for ICOs, the market will go through inevitable stages of euphoria, disappointment, regulation, and then stable growth. The most significant consequence will be that regulators will slacken the requirements for investors and legal procedures, which make the entire investment process a lot cheaper. On the topic of mega-profits — the current situation is that the number of potential investors for such projects exceeds the actual numbers of projects available for investment. Sooner or later some kind of balance will be established, and everything will fall into place. Investors will once more be carrying out due diligence, and startups will be required to explain exactly how the money will be earned, and whether they really have any kind of expertise in what it is that they’re doing.