ICOs are broken and we should fix them

Last Monday I had the pleasure to give a talk about Ethereum at the Full Stack Fest in Barcelona. After the talk we had a 10 minutes-long Q&A session. All the questions were very good, but the last one was particularly tricky.

This is a very broad question and also a very delicate one. That’s why I decided to dribble it by promising this article, instead of trying to answer in 30 seconds.

First, let’s get some context.

What is an ICO

ICO stands for « Initial Coin Offering », which sounds like « Initial Public Offering » (the process firms go through to sell their shares on the stock market).
ICOs an IPOs are both ways for investors to bet on a company and get a certain amount of a commodity (shares, in the case of IPOs) they can trade, whose value is tied to the value of the company (the value of the company being somehow tied to the market-value of the commodity, which makes the game pretty exciting).

In IPOs, companies sell shares, meaning that investors end up owning a little bit of the company. Big investments give investors a certain weight in the decision process of the company.
IPOs are also heavily regulated in order to prevent scams and other abuses both on investor-side and company-side.

ICOs have become a common startup-funding practice in the blockchain ecosystem and are similar to IPOs in practice, but with some relevant differences that make them controversial.
Startups seeking to fund their project, issue a crypto-coin (like Bitcoin or Ether) via an Ethereum smart-contract. This operation is relatively simple for an average-skilled developer, that’s why it can be performed before funding.

The company promises that this new crypto-token will be the official and unique payment method for the services once it will achieve production-stage.

So, what’s wrong here?

Yeah, what’s wrong, really? ICOs look like a smart way of allowing ordinary people to take part of the blockchain revolution. What justifies the term « controversial » I used above? What pushed China to forbid them? What made the United States strongly regulate them?

If, in theory, ICOs look great, in practice the lack of regulation makes things a little bit more complicated. Especially when we look at the amounts of money raised since 2014 via ICOs. It counts in billions of dollars. Quite more than the volume raised by Kickstarter.
When investors buy ICO tokens, they give cash money to the company. Cash. Directly to the company. With no intermediary, no way to get the money back and, above all, no way to commit the company to its original mission. Sometimes, tokens are issued months after the funding campaign. I’ve seen people on Slack yelling desperately for tokens, being told « you’re impatient ».

Parts of the image are blurred to avoid revealing the source
Parts of the image are blurred to avoid revealing the source

Even Kickstarter avoids this.

Kickstarter holds the money until the cap is reached and gives backers a (fairly low) guarantee that the project will be completed. And we’re talking about fairly small amounts of money.

It’s pretty funny how blockchains, systems where every node can verify what other nodes do (in a fully trustless fashion), where nothing can go against consensus, are now the platforms for blind-trust « take-my-money », scam-friendly fund-raising campaigns.

China has banned ICOs right while I was humming the Money-song from the Wolf of Wall Street at the end of my talk. And that’s probably because of the huge percentage of « take the money and run » scams among the numerous ICOs that happened in 2017.

People are dishonest? Probably some of them are. But if blockchains create game-theoretical situations in order to make cheating less profitable than playing by the rules, why are we funding companies with no mechanism to force them to respect their commitments?

What can we expect from a small group of humans passing (in a matter of hours) from being ordinary people to being the owners of a multi-million wallet with no other locking mechanism than three out of five signatures?

It depends on their integrity and mental state and I wouldn’t be surprised if some weird situations would occur.

So who do you blame?

Things can be seen from different points of view.

Investors are responsible for placing their money without knowing what they’re actually doing, out of greed and ignorance. I mean, no-one is forcing nobody to invest their money.

If you lost money in an ICO, I’m not even sorry for you. You may have learned a lesson. You just let your money go and it’s gone.

This is really like the gold rush of the .net in the nineties, those who invested on the good companies got rich. True. But the nineties were full of bullshit and the bubble eventually exploded.

Many people haven’t learned the lesson.

Startups are responsible for badly-designed ICOs. The typical post-mortem is « we didn’t expect to raise so much money ». Ok, now you know people are not rational when talking about the blockchain. You have the choice to educate them or to exploit their mix of greed and ignorance.

So what can we do?

If you choose to invest, choose wisely.

Talk to the company before giving your money away, they use to have a Slack channel. Ask precise information about the token sale. If you are a developer, ask for the source-code of the smart-contract that issues the token (you will be able to verify its byte code by compiling the source and comparing it to the deployed byte-code).

Ask when the tokens will be distributed. Avoid late token distributions.

Keep in mind that owning tokens will give you no weight in the decision process of the company. You will be nothing more than a customer.

You probably won’t get any service from the tokens in the short term. You don’t even control the relationship between the tokens and the services of the company in the long term.

The only thing you’ll be able to do with the tokens is trade them (which is probably what you want to do).

If you are fund-raising, take your responsibility.

You probably want to earn a decent living by helping humanity out, that’s good. So keep in mind the credibility of the whole ecosystem. ICOs, in their actual form, are broken. And banning is a good temporary measure to avoid mayhem. But ICOs are not bad as themselves. The way they are carried out is bad.

Smart contracts behind ICOs should be designed in a way that money does not go directly in the pockets of the company.

Backers should be able to democratically decide whether to unlock or not part of the funds based on the progress made on the project. Venture capital fund-raising processes are made like that.

Your company may need two hundred millions for the whole run, but it probably won’t get them all at once from a serious A-series VC.

If investors ask for better ICOs, companies will follow.

If companies start raising funds in a way that guarantees their commitment while discouraging scam, there will be no point in banning the ICOs anymore.

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