Why we need STOs: The truth about ICO’s and non-dilutive financing

First off let me start by saying I get it. ICOs are all the rage and with good reason. Projects have been able to raise lots and lots of money and coin buyers are able to buy tokens at a discount and (in some cases) immediately flip them for a profit. What’s not to like?

If the current model was sustainable then I would be very hard-pressed to find an opposing argument. I am a big fan of win/win scenarios and on the surface it appears to exist here. A closer look however, reveals some major flaws that need to be addressed to continue to grow the token economy.

The token economy

Much of the money flowing into ICOs is a direct result of the meteoric rise in price of Bitcoin — which resulted in an overall rise in the crypto market, often regardless of the quality of the project or actual utility of the corresponding token. When a lot of wealth materializes out of nowhere, its natural for that money to look for a new home — this is basically what the token economy is right now.

As natural as it is for early crypto investors to seek new investments for their newly created wealth, its just as natural for founders to take notice when they see billions of dollars flowing into projects with little more than a website and a whitepaper. So you have money looking for a home and projects that need funding — a perfect match right? Well yes and no.

Its an age-old problem. Someone has an idea for a product or business — it takes money to turn an idea into a real business. Enter the angel investor, Venture Capitalist, or anyone else willing to take a bet on the founder and business. In exchange for putting up the dough (and taking considerable risk) to get the company started, the investor typically gets some percentage ownership in the business. Sure this is a very simple way to put things and deals can end up being very complicated. At a high level though, this is basically how it works. It’s simple and it’s fair.

Now let’s look at ICOs. Same problem: projects need funding to get started and investors need somewhere to grow their money. Only instead of actual ownership in the business, the investor gets some tokens. Those tokens are tied to…nothing. No equity. No voting rights. No dividends. No revenue. The tokens are supposedly tied to some utility and their value is driven strictly by the secondary market for the token. The ICO investor is betting that this token will go up in value because other people are willing to pay more for it than you did. Meanwhile the company gets to keep all the raised funds and do with them what they please.

Now why would any sane person agree to this? Well, because token prices largely went up in 2017. When things are going well for the investor, who’s gonna ask questions? The projects get the cash, the investor gets to make a quick buck, and everyone is happy.

Well if it ain’t broke don’t fix it…right?

Right. Except it is broken. A few things are happening:

1. Everyone and their mom all of a sudden has a cool new blockchain project that all of a sudden needs $20 million dollars to get started.
2. Nobody seems to care about the laws and SEC rules that are already in place to regulate the raising of money and selling and trading of securities. Yes these tokens are securities. Get comfortable with that idea.
3. Not surprisingly, many of these projects pull in these funds and then nothing happens. No live product. No revenues. Code commits stop happening.
4. Mainstream people are entering the fray. Its one thing to steal money from newly created Bitcoin millionaires. Its another to steal money from Joe the Plumber who’s moving money from his 401k to buy some alt-coin. THAT’S WHY WE HAVE LAWS AND REGULATIONS.
5. The term “non-dilutive financing” is getting tossed around like its an awesome thing. Well it is awesome — for those collecting the funds. Its just a fancy way of saying, you give me money, and I give you nothing in return. I keep all of my company and here’s a token that may or may not have any real function and may or may not go up in value. Thanks and good luck. I wonder who ends up losing in that scenario?

So how do we fix this?

I’ve said it before. Just because there are flaws in the current version of the token economy doesn’t mean I don’t believe it won’t have a future. It will and I want it to. Tokenization makes sense for a lot of reasons. We just need to balance the equation.

That’s where Security Tokens and STOs come in. I want to be able to invest in startups at their earliest stages. The types of investments previously reserved only for the very wealthy and Venture Capitalists. When I invest, I want something in return. A token that represents equity or debt is the perfect solution. They can help democratize access to early stage startup investing and much more. They can lower costs and improve transaction speed. Smart Contracts can be written to fit just about any scenario. ICOs 1.0 have successfully demonstrated a couple things:

1. Tokens can be used as a vehicle to raise money
2. There can be a large, liquid secondary market for them

STOs will force some efficiencies into the market that don’t currently exist:

1. They will force companies to place a valuation on themselves. No more asking for some super large, random amount of money
2. It will be harder for scam artists to enter the space and successfully pull off large heists.
3. The secondary market will become more efficient. Making it harder for companies to trade at unrealistic valuations
4. Investors have real long term upside and protection. Its not a bad thing to reward those that were first to believe in you. They took the risk. They fueled the fire. They should share in the reward.

The good news is the STO push is on its way. I think there will be a large wave of them this year including the Equity Token Offering of Documo. Official announcement of this offering coming soon. To learn more about it, feel free to contact me directly.