Most people have heard about cryptocurrencies. Some have heard about ICOs. Few actually understand them. This post will tell you why ICOs are important news for startup founders. It will tell you how it all began and why the crowd is the best investor. In the process, you will learn about a prodigy of our time and see what communist regimes did wrong. In the end, founders have gotten a new tool for fund raising. Use it.
In 1997, a new era began.
For the first time ever, a rock band asked their fans to fund their upcoming tour. The fans went online and pledged $60,000. The press called it crowdfunding.
A decade later, crowdfunding would fund everything from paintings to high tech gadgets. In 2012, a dock for iPhones became the first project to raise more than $1 million on Kickstarter. However, the biggest breakthrough was yet to come.
Crowdfunding mainly benefitted physical products. This makes sense because physical products have tangible value. In comparison, software hadn’t benefitted much. It was simply too hard to define what backers were pre-paying for. But that was about to change.
In 2013, a Russian prodigy named Vitalik Buterin made history. He designed a completely new Blockchain named Ethereum. It would prove to become a breakthrough in crowdfunding. Vitalik was 19 years old.
Ethereum made it easy for developers to create new cryptocoins. And that is immensely important because cryptocoins solves the biggest problem about crowdfunding software.
Cryptocoins allows software projects to provide a tangible asset to backers. The projects can mint digital coins that represent a specific value. A simple example would be a coin that can buy a song in a music app. Anyone wanting a song could buy the coin. If enough people buy the coins, the founders have enough money to build the app. That’s called crowdfunding.
But that’s not all. If the backer no longer wants the coin, he can sell the coin someone else with a click of a button.
Already ICOs have outpaced VC funding. And it is just getting started. I am about to tell you why.
The key to successful investing
Investing is fundamentally about information. The information investors need is this: How big will the demand be?
If you can assess how many people will use a new product, you also know how much to invest in the project.
How accurate you can assess the demand depends on how close the investor is to the demand. In other words, to the users.
The communist experiments of the 1950s show the consequences of making investment decisions too far from the demand. At the time, Moscow and Beijing decided how much food farmers should grow. But the communist elite had little feel for the true need. Economists call it: misallocation of resources. The consequences were catastrophic.
VCs exist because they have better feel for the demand of tech products than big pension funds. In theory, VCs have superior information, and can make better investment decisions.
However, there is a group with an even better feel for the demand. And that’s the users. They are the ultimate source of information because they are the demand side.
Why ICOs are great news for founders
Crowdfunding allows users to vote for products they want with their money. In aggregate, users are the ultimate investor and allocator of resources. If 100 backers need a product, the project receives exactly the right amount of funding to fulfill the demand.
For many software startups, the invention of cryptocoins is heaven sent. Most founders spent an enormous amount of time and effort to convince VCs that they have a market. Sometimes they succeed, but the investor takes a risk premium. The risk premium is unfair terms. Like milestones, liquidity preferences and downside protection.
But thanks to a young Russian prodigy, software startups can do what artists and gadget-makers have been doing for the past five years. To raise funding directly from users. And because users don’t have to guess the demand, they also don’t require risk premiums. The money comes without a nasty set of legal documents and a rigid due diligence.
Luckily, many have already taken advantage. As of this writing, software projects have raised more than $1 billion through ICOs. And many more will follow.
Many critics will point to fraudulent and overhyped projects. All that is true. But that always happens in the early days of great innovations.
In time, ICOs will mature and software founders will finally have an alternative to the exhausting VC pitches.
At Accelerace, we will do our best to help founders take advantage.
Check out Accelerace. We invest in tech startups.