Initial Coin Offerings: Cutting Through the Bullshit

Are you getting the feeling that most ICO’s are a load of BS? Are you struggling to see how these companies will ever make any money? Considering the recent flurry of news surrounding ICO’s, and the fact that $2.4 billion has been raised to date, I wanted to look pragmatically at the status of ICO’s in their current form and how they could/should evolve in the near future.

For those who need a refresher on the economics and implications of ICO’s, please see here.

PROS

To avoid repeating other experts that covered the benefits of ICO’s, here is a brief summary of the four major pros of ICO’s. Each of these Pros has counter arguments that we will explore in detail in the Cons section.

1) Democratization of capital markets — Anyone, regardless of geographical location, race, religion, or wealth can raise capital and invest in startups.

2) Liquidity — investors can trade tokens in secondary markets rather than have their value locked up in equity.

3) Crowd backing — ICO’s leverage a community of investors that is in theory incentivized to encourage growth.

4) Speed & convenience — ICO’s make it significantly easier to set up and manage a funding process. All it takes is a whitepaper, a website, and some marketing.

CONS

1. Scammers

There are a TON of scammers in this space, because capital is easy to get. When you have such easy access to capital, the scammers come out of the woodwork to suck up the money. If all you need is a whitepaper, a nice website, and some PR, can you blame them? Often times ICO’s are led by entrepreneurial hustlers who would never go to a VC because a) they don’t want to be managed and b) they want to keep their astronomical, indefensible valuations. If they can’t raise money under THEIR terms, they would rather not raise at all. Any time you see an early stage startup with multiple advisory boards featuring individuals with fancy names from around the world, second-guess this company. Why would the company need that many advisory boards at such an early stage of development? An open source team works when you have revenue, clients, and momentum — not from the get-go. Unfortunately, the biggest consequence of these scams is the decreased faith of the public in blockchain technology.

2) Liquidity

The degree of liquidity in ICO’s is frightening. I fully understand why early pre-ICO investors and founders want liquidity after issuance, but tokens are traded on exchanges that are effectively dark pools with no transparency. This means that the people you are backing in an ICO can easily exit directly after the ICO before creating any real value, or gradually dump their holdings over time before the market does if they feel unsure in their business. There is currently no way to mitigate this risk — you just have to trust that they won’t.

3) Speculators

When investing in an ICO, you are speculating on an idea — a conceptual idea of something that the developers want to create in the FUTURE. You read the whitepaper, do some digging, and if you think the team is credible and the project has promise, you invest. 90% of startups fail, and blockchain is certainly not immune to that. ICO’s are prone to hacks, attacks, developers not finishing what they started, and price manipulations by whales. Not to mention, it is troublesome that companies are raising tens of millions on ideas with no validity. At the very least, a working prototype that demonstrates product-market fit should be required.

4) Whales

Whales are people that have a lot of money and resources to manipulate the space and rig the ICO game in their favor. They do this by paying extremely high mining fees to “cut the line” and get first preference during the ICO. In the case of the BAT ICO, for example, that raised $35 million in just 24 seconds, whales paid as much as $6,600 in transaction fees to make sure that they take the first bite of the pie. Afterwards, these individuals sell their tokens at a premium to turn in a profit. Just a handful of people control speculation, manipulate the price, and essentially make or break the value of your token. This volatility might be troublesome to an entrepreneur looking to build a sustainable company.

5) Pressure of going public

Many successful companies choose never to IPO because of heavy reporting requirements and because it can force companies to become short-termist and reactionary, which is often seen as a killer of innovation. Many startups that ICO are naive to the fact that crowdfunding demands having a permanent investor relations team to constantly communicate with the investors and manage community sentiment. Unlike normal equity crowdfunding, however, ICO’s are full of speculators who can/will short you as soon as they can make a profit. Furthermore, investing in startups before they have achieved product-market fit means that pivots will undoubtedly happen, which requires supportive and experienced investors. Going public pre-market fit is troublesome, and where I see a big role for early stage VC’s to come in and ready these startups for ICO’s.

6) Government intervention

This is where ICO’s can really come to a grinding halt. Due to the increasing number of scams and massive amount of unregulated money, governments may simply decide to start regulating ICO’s, just as they did with equity crowdfunding in the JOBS Act. Non-accredited investors may still be allowed to participate and marketing of the token offering to the general public may still be permitted. However, the whole point of cryptocurrency decentralization and being outside of government control — will be moot. It is the responsibility of those that genuinely want to see this nascent industry grow to help it self-regulate so it isn’t just turned off.

CONCLUSION

The reality is, 99% of today’s ICO’s will fail. There are far too many people out there rushing in with blinders on and a group of yes man’s around them. Human tendency is to exploit any loopholes for their selfish benefits and ICO’s seem to be the tool of choice for most.

One central issue that we have to overcome is that of professional due diligence. There is a real need for professional investors and analysts to perform due diligence and act as pre-ICO backers to ensure there are standards and quality control. This is where early stage VC’s can play a critical role in this new paradigm.

All that said, you cannot stop technology. ICO’s, in one form or another, will continue to be a critical part of the crypto ecosystem. It would be so wrong to overlook the immense good that ICO’s have done, like giving birth to technologies like Ethereum and Golem. Pandora’s box has been opened. Buyer beware.

This story is published in The Startup, Medium’s largest entrepreneurship publication followed by 275,365+ people.

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