This article is written by Isonex Capital, in an attempt to offer a few balanced thoughts on the ICO market. ICOs, or Initial Coin Offerings, are a crowdfunding type investment model conceived with the idea of raising capital exclusively on the blockchain. ICOs have created tremendous opportunities for start-ups to secure capital to develop concept to reality, as well as providing easy access for retail investors to enter the cryptocurrency investment market. Getting in on the early stages of any company’s potential growth curve is a risky business to begin with, and some projects will fail. But if you have invested in tomorrow’s market-disrupting technology, the long-term returns could be life changing, and that is the allure and the advantage that ICOs bring to investors.
Start-ups launching an ICO, write and publish a white paper on their website; this is a document detailing the business model and technical specifications of the project, details include the projects roadmap objectives as well as a target budget, detailing future fund expenditures and coin/token distribution. During the crowdfunding campaign run, where the project seeks to raise public awareness and a following via social media, investors can purchase tokens before they are launched on the open market via exchanges; this is the ICO stage. Most projects use a proportion of the raised funds to further develop the project, whereas very few are market-ready at the token-sale stage. Once the rounds of the token sale have commenced and the financial targets for a successful launch are met, the project team will distribute the coins/tokens as pre-scheduled and the tokens will launch on cryptocurrency exchanges where they can be traded on the open market. The investor, in purchasing the tokens, is not buying equity in the company; rather, they are funding the project to enable it to develop utility for said tokens with a view to selling them at a higher price as the demand for the services / products increase.
The ability to tap into a worldwide pool of investors without the need of financial intermediaries is perhaps the key to the initial success, as investors recognize that ICOs offer a viable alternative to the usual monopoly held by traditional financial funding institutions. ICOs offer a unique opportunity to scale and develop new concepts and products in specific fields of application, such as advanced research where raising capital traditionally can be extremely difficult. It has proved to be a powerful tool that has enabled creators to retain control and ownership of their innovations. This is not to say that ICOs are a better means of raising capital than venture capitalism, which can bring business and marketing expertise plus invaluable trade connections and additional resources to the table. But for many start-ups, ICOs do offer very real advantages compared to traditional funding.
Venture capital funding comes with a high cost in terms of equity shares surrendered, along with high share capital dilution. ICOs have the advantage of easy access to a global market of potential investors compared to small groups of elite investors. They offer the benefit of retaining full controlling rights of your company, product or concept; the importance of this alone cannot be overstated, as many start-ups are forced into surrendering a majority of company shares in order to secure investment. ICOs are democratizing entrepreneurship just as tokens are democratizing the investment market. From an investors perspective, one of the attractions that ICOs offer is that there are no financial constraints to entry. Most ICOs have no restrictions on investment entry such as minimum buy-ins that many traditional investment funds impose.
But in spite of the obvious benefits, ICOs have experienced a particularly tough time of late. So what is it about ICOs that has proved so polarizing? To better understand, let’s go back to the beginning. The first ICO token sale was held by Mastercoin in July 2013, with other projects launching intermittently over the following years. But in the second half of 2017 the ICO market really took off, resulting in over 50 ICO launches per month by year end. ICOs have proved to be an extremely effective way to raise capital for start-ups in the cryptocurrency space.
Unfortunately, largely due to a lack of regulatory oversight which many equated to a wild west, it wasn’t long before this groundbreaking fund raising model became a playground for scammers. Some of which through outright deception, unrealized promises or cash-flow strapped projects, put a dark stain on the ICO market which lead to Investor confidence understandably hitting a low point. It should be remembered that many early investors were first-timers in any investment market, lured in by stories of incredible gains while lacking in experience and knowledge. With a lack of any investor protection that regulatory oversight affords, there were always going to be casualties. But responsibility must be shared between regulators and the naivety of the ICO start-ups in enabling an environment where capital was able to flow without any form of escrow or oversight. Now that the dust has settled, investors themselves have become more analytical and savvy of a project’s background and history prior to investing. This is evidenced by capital figures raised by ICOs, which retained market share throughout 2018.
Financial regulators and media outlets have since cracked down on the ICO market with severity. This is an odd reaction in light of the fact that we’re almost two years in and still awaiting some form of regulatory clarity that would allow capital to flow again into a market that has so much untapped potential. I think regulators have shown irresponsibility in leaving investors and a great number of innovative entrepreneurs in a state of limbo, much to the detriment of the global economy. It would not be too difficult to imagine a concerted effort to kill the ICO. Except the outcome has actually been quite the opposite, in spite of regulatory obstacles and the intense campaign of negativity shown by mainstream media — who incidentally are the most vocal and perhaps the least educated critics in the digital currency space — the ICO investment market had actually doubled in investor capital in 2018 when compared to 2017.
While figures for the first two quarters of 2019 have shown a drop in market share, it should be remembered that we are STILL waiting for lawmakers to provide regulatory clarity and with the advent of the IEO (initial exchange offering) where exchanges themselves are acting as guarantors to provide assurances to investors while enabling entrepreneurs to attain funding. Although not purely altruistic, this morphing of ICOs into IEOs has obviously impacted the ICO funding statistics, but it’s encouraging to see this people’s fundraising method is alive and well as we move towards 2020. It should be said that IEOs are also experiencing their share of pump and dump schemes, but this comes as no surprise as they are also existing in the same regulatory limbo as the ICO.
Part of the reason for the stratospheric rise of ICOs is down to the power of social-media marketing. This has proved to be a powerful tool that has enabled entrepreneurs with a concept to gather a following and build market share. Media marketing is so critical that it can be the determining factor in whether a project will fail or succeed even before launch. But in another hurdle to the space, the very platform that enables innovation to gain market awareness has pulled the ground out from under the entire ICO market. In January 2018, Facebook banned all ICO and cryptocurrency advertising until such time that they could identify scam ICOs, which although in the minority, were increasingly difficult to spot. Twitter and Linkedin soon followed suit with MailChimp not far behind and Google also announcing a ban. With the major social-media ad channels no longer accessible, more traditional forms of marketing had to be deployed such as SEO and specialized crypto channels such as Reddit, although it proved difficult to attain the reach previously gained with the big social-media channels.
Interestingly, since I first penned this article, Facebook has lifted the cryptocurrency ban, prior to the proposed launch of their own stable coin, but it has kept it stance on ICOs. In doing so, Facebook just demonstrated the worst of self interest that centralized power represents, but that’s the subject of another story and makes a case for why we are working toward a decentralized internet.
The Securities and Exchange Commission remains ever concerned that blockchain based investments introduce great risks to investors, together with the Financial Industry Regulatory Authority — Wall Street’s industry-funded watchdog that is partly responsible for issuing licenses — is scrutinizing how start-ups serve as gatekeepers, a role traditionally provided by licensed brokers. Blockchain is turning the entire financial world on its head and regulators are quite obviously scrambling to catch up with the pace of innovation developing in this thriving space. The thing is that the internet structure that blockchain operates on was already established, so the pace at which the technological revolution is occurring has caught lawmakers off guard. Applications are languishing for months beyond the standard six-month decision-making time frame.
Without clarification on the definition of a security for this new asset class, where there are so many variations in token use cases, brokerage licenses are being withheld for major companies launching trading platforms to bring digital assets to demanding and well-heeled investors, leading to a series of postponements. Washington’s regulatory limbo is clearly preventing innovative technology from enabling financial markets to operate more efficiently. It could be countered with a degree of validity that this interim period of silence on rulings has given the market time to get their house in order. The critical issue of custodianship, which is the safe-keeping of digital currencies, which has so far prevented many from investing in digital currencies, is now in place. But the SEC’s silence has undercut the development of digital securities in the US. Hestor Peirce, an SEC commissioner has recently stated, “The SEC has yet to provide guidance to the public or FINRA on any of the core questions. The result is that many would be brokers and trading platforms are stuck in a frustrating waiting mode.”
The ICO market offers an unrivaled way in which investors and entrepreneurs can be brought together to create truly innovative products, but everyone involved needs to take responsibility. This lies with regulators, entrepreneurs and marketing companies who in the early days of ICOs cranked out as much bullshit as possible to raise awareness to blockchain and crypto. But these are complex issues and in light of where it all went wrong, investors should be treated with respect instead of a promise to make everyone millionaires if they buy in today, etc, etc. A strategy designed to induce a sense of fear of missing out (FOMO). ICOs can no longer be a capital raising strategy built on unverified marketing claims. Marketers hired to sell a digital currency or ICO token have a responsibility to investors to call out fraudulent activity. I believe it to be counterproductive to engage in hysteria to move a product and sets that market up for eventual collapse.
Responsibility also rests on the project team, who need to have more than just an idea. Can you imagine walking into a venture capital meeting without a product or structured business plan and leaving with anything other than derision? The ICO market should not be a playground for scammers or dreamers but an investment platform for start-ups who can offer at the very least a proof of concept before any funds can be received. One way to implement this could be through the use of escrow accounts that would release capital in stages upon reaching roadmap objectives. There are some who would argue that this negates the whole decentralization issue but this could be performed through the use of smart contracts which gives complete transparency to all involved and does not rely on the actions of a third-party mediator. If these conditions were standardized then the ICO market could become an unrivalled platform for both entrepreneurs and investors.
This leaves the regulators who must take some responsibility for what happened during the ICO boom. I don’t envy their role in trying to regulate this emerging market, but that is the job they signed up for so they must take action. The digital currency market has no equal, in either complexity or technological advancement. I imagine it would extremely difficult to regulate under the 1946 Howey test as its impossible to rule that a single token has a single use case. Digital assets represent a fundamentally new class of financial instruments, which defy simple classification as security, commodity or currency. Many digital assets occupy several classifications at the same time depending on their context and use. For example, imagine a token created for a game. The initial sale could fund development of the game. Then the token may be distributed to users as a reward in the game (utility), traded on an exchange, (commodity), used to purchase virtual goods in an online story (currency) and used to confer voting rights in the project (security).
It could be possible that the regulation of digital currencies does not fall under the remit of the SEC at all. Although I have written about the lack of regulation which has impacted detrimentally. It could well be the over regulation that could have greater damage to the digital asset and ICO markets, it could have a negative effect on the funding of innovation and creativity that we see flourishing right now. Let’s not forget the infamous New York State BitLicense, a crippling 44 page document of legislative compliance drafted by Benjamin Lawsky that led to a hothouse of Bitcoin start-ups fleeing the state’s punitive measures. Reading through that document it is difficult to reach any other conclusion than it was drawn up to completely cripple the Bitcoin industry.
If we can get this right we could be looking at a boundless, decentralized, liquid market where you can trade any assets. Brokerage houses and intermediaries as they currently function, with their insider trading and bloated fees will be consigned to history, replaced by open source node software with all transactions made on mobile devices in a peer to peer structure that will settle within seconds and will not require the services of banks. A global decentralized blockchain based financial market where entire asset classes will be tokenized and traded openly, operating with complete transparency 365 days of the year round the clock. The potential here is limitless but worryingly depends on those in charge of the rules understanding what is at stake, and not letting this opportunity slip by through greed and ignorance.
I began this article with the statement that it was written by Isonex Capital. We are a digital asset fund management company, who for the past three years have been developing our vision to bring mature and transparent investment to the digital currency space. We have developed the world’s first tokenized equal-weighted digital currency index fund, IX15, which we plan to launch in the later part of 2019. The portfolio holds the top 15 digital currencies by equal weight. This is achieved through rebalancing the portfolio back to equilibrium every 30-days. Unlike most ICOs, participants in Isonex Capital’s token sale aren’t just investing in a concept, hoping that one day it may return a profit. Isonex Capital’s IX15 index fund holds value from day one because the underlying holdings equate to approx. 75% of the digital asset market. We are 100% self-funded and market-ready.