The ICO Model is Broken

Much like how the crypto trading markets operate on an entirely different pace as compared to traditional markets, ICOs too seem to have a need to get everything done at a greater pace. Bank accounts around the world are gradually being traded for crypto-wallets, so it’s no surprise that there is a digital, crypto equivalent to company shares and fundraising as well. Initial Coin Offering (ICO for short) is a method of fundraising for a company or project through token generation and distribution.

What is the ICO Model?

Very similar to the tried-and-tested method of selling shares to investors who expect the value of the shares to increase in the future, the ICO model is a faster, more transparent equivalent, which uses digital currency rather than traditional money. Typically, in ICO, a company sells a new cryptocurrency or a “token” at a low price to investors. If the value of the cryptocurrency increases over time, the investor benefits from it. However, unlike the stock market, owning a token doesn’t mean that the investor owns any part of the company or will get any share of its profits. It’s a huge risk to invest through the ICO model, even more so than traditional stock market investment, but its increasing popularity can be attributed to the phenomenal appreciation in the value of Bitcoin in just a few years.

How popular is the ICO model?

Like everything else related to cryptocurrency, the ICO model has gained a great deal of popularity in a very short time. In the past year alone, over $2 billion have been made in token sales through close to 150 ICOs. This reflects the investors’ faith in digital currency, in addition to the sheer volume of companies taking the digital route in the recent past.

It’s a great, albeit risky way for companies to raise a decent amount of money in a single sale. It is, however, hyped to look much more valuable than it really is, masking the risks involved. The hype around it also hides the fact that it’s only a good way to fundraise if there’s a dedicated team working in this direction or if a blockchain is an integral part of the company’s working.

(Source: ITOSG)

So what is the problem?

• The fact that buying a token from a company doesn’t give the investor any share in the company’s ownership is at the heart of the problem with the ICO model.
• Traditional fundraising methods are both regulated and buying stocks through them give the investor some amount of ownership of the company, and hence some security. The companies are therefore obliged to come up with new products and keep improving on them because if they don’t perform, the share price and hence the company itself will suffer.
• However, since the ICO model is not regulated and tokens have been sold for cryptocoins directly, not all companies are incentivized to build a product at all. In fact, some of ones have begun to rely purely on marketing to raise insane amounts of money.
• The ICO market also attracts a lot of beginner (or noob) investors who are unaware of the risks involved, and do not perform research and diligence as well as the seasoned traditional investors do.
• A related issue is that of overvaluation. With no previous investor experience to rely on, many of these investors tend to overvalue many projects, while in reality, a more comprehensive review would yield lower numbers.
• As a result, it’s become relatively easy for ICOs to set up a nice white paper, put up slick graphics on their website, and run Facebook and YouTube ads to succeed. These teams are not incentivised to create an actual working product, and this is now the primary problem the concept is struggling with.

Is there a solution?

The fact that the ICO model is unregulated seems like an open invitation for cheaters to run away with money without bothering to build a product. Some countries have taken the easy way out to prevent cheating: ban the token system itself. However, the risk of theft shouldn’t mask the positives of the model: it’s a fast way to raise funds, and if the company actually wishes to innovate, it’s much better than the red tape and restrictions in the share market. It is upon the investors — the individuals — to:

• Demand a more structured timeline of delivery from ICOs
• Expect a product (or updates on product) before an ICO and not ages after one.
• Call out and shame the ones riding the marketing wave and not offering a timeline on delivery.
• Pay close attention to the whitepaper, and the team behind an ICO. Look up their credentials. Perhaps we need reputation metrics?

Regulation on ICOs isn’t the solution. In fact, ICOs are the best example of free market forces at work. Together, the shady ICOs can be relegated to obscurity and the well intentioned ones can thrive!

Originally published at peerbuds.