Who needs the Blockchain anyway?

A quick guide to Good ICOs.

Intro

Last week we discussed the bad, and the ugly of ICOs. This week we’ll be looking at the strengths and opportunities of the technology, and some of examples of good ICOs, and how their companies benefited from using the Blockchain.

Also last week, Crunchbase, one of the largest investor databases in the world, emailed their users with an article they wrote called “ICOs Race Ahead as Seed Capital Falters”. They believe that the golden era of Venture Capital is over.

“Two trends are combining to create an interesting market moment: As seed-stage capital in the United States slips, ICOs are forging ahead. The dynamic is notable as it shows that as some investors are pulling back from super early-stage investments, amateur investors are piling into new funding mechanisms for nascent projects.” — Alex Wilhelm, Crunchbase

Quick recap — Blockchain and ICOs

The best place to start, is by demystifying the Blockchain, Ethereum and Smart contracts, to explain: “Why is all of this happening right now?”

What is the Blockchain?

In short, the Blockchain is analogous to an accounting ledger which records anytime a transaction is made.

Every transaction is added to a previous set of transactions. The entire set of transactions that still need to be verified as valid form a single block. Each block is then added to the chain once it is verified as legitimate by the network.

What is the benefit of this?

Bitcoin and the Blockchain as described above, allows for one very important thing to be possible; eliminating a trusted third party (such as a bank) from a transaction between two people.

It means that any two people can transact with each other on the network without worrying about cross-country laws, exchange fees, bank fees, whether they can trust the sender etc. which greatly allows simplification of the global economy.

What is Ethereum?

Vitalik Buterin, the creator of Ethereum, thought that the power of the Blockchain could be expanded beyond just transactions and decided to create his own Blockchain based system called Ethereum.

Ethereum is a network of nodes, and a platform that verifies previous transactions that are added to a blockchain, however the distinguishing feature is that it also adds another layer of verification to a transaction called a smart contract. This smart contract acts like a real-world contract, and executes all the actions specified by it when adding the transaction to the Blockchain.

What is the benefit of this extra layer?

With Bitcoin, we remove the need for a trusted third party for pure transfer of funds. However with Ethereum we can go one step further and also remove the need for trust in transactions that don’t purely involve a transfer of money.

For example if someone were to enter into a financing program to buy a car, rather than set up a bank based credit transfer and pay all the associated fees, we could set up a smart contract to automatically deduct funds (ETH) from your account and be sure that this would happen without needing a bank to verify your credit etc.

What are ICOs?

ICOs are a new way to raise capital for companies. Companies raise funds by selling tokens, which can be Ethereum smart contracts. The tokens have some utility or value within the company that issues them.

Some examples of tokens include

• Used as a currency to buy or use services within the platform, like KIN
• Receive computing power or store files, like Filecoin
• Create a micro-economy where users can create and sell goods and services, like Bancor
• Give income to users who correctly predict future outcomes, like Augur
• Distribute the cost of utility bills by buying in bulk, like Grid+

The main aspect, is that the token has to be directly related to the product. If it isn’t, then there won’t be a strong incentive for the companies to keep using the token. This is dangerous because if the companies abandon the tokens, then the user will not receive a return on investment.

The Blockchain Test

Startups looking to ICO have to be able to demonstrate that their token will utilize the Blockchain. This is important for a number of reasons. The main one is that companies that need the Blockchain will inherit their properties such as:

• Transparency
• Security
• Integrity
• Large Network effects
• Reward Early adoption

A good example of this would be the Kik ICO, which launched Kin. Kik is a messaging platform that had 300 million users prior to releasing their ICOs and tested a point system called KIK points from 2014–2016. Kin was well tested before its actual rollout through the usage of Kik points in their ecosystem which showed that they had:

• A network that benefited from an internal currency
• An internal currency whose value grew with the decentralized network, not based on the price of other cryptocurrencies (like ETH or BTC)
• Early adopters could use the currency to benefit themselves while not devaluing the currency for others in the network (The best of example of how early adoption can be a benefit even if the currency is not a pump and dump scheme)
• A series of products that could already be purchased through their token system
• An ecosystem that enabled users to be rewarded for engaging with it and allowed them to support it by creating products that could also interact with KIN

The technology side is only half the story. It is also crucial for people to know why the founders make a great team to create this ICO. Even if the idea is great, why should prospective investors trust the company and founders?

The YC Test — Build Something People Want

Building a company requires a lot of knowledge and the ability to convince investors and clients alike. This means that founders have to be able to answer any question regarding their product, industry and execution plan, concisely and clearly.

YC calls this “The YC Test”. The idea is you have to be able to explain any of these questions in less than 10 seconds. If a startup cannot explain clearly how they are planning on executing, then it will also have problems with the actual execution.

Traction: What have you done?

Many ICOs have raised hundreds of millions of dollars without having tested their product fully. How can investors trust a company to deliver when there is little traction to use as evidence for competence, or inherent competitive advantages? Besides being the first to create the “ICO for X” why should we believe that your company will survive long term?

The ICO should be able to demonstrate that their idea has been somewhat proven and that the product is at least at an MVP stage. As we discussed in our last article, one of the largest factors during the dotcom bubble was a lack of testing the product in smaller samples and a lack of research for demand.

Comply with the authorities

Lastly, good ICOs should be lawful. ICOs have to make sure that they are operating within the legal limits of their geography. Tokens can be classified as securities or non securities, and this classification seems to vary from nation to nation and even on a state to state basis within some countries.

Selling security tokens as non-securities can carry strong penalties. In the same way that thousands of people can invest in you, they can also prepare a class action lawsuit if there is evidence that they have been lied to.

Tezos, for example, is currently facing a class action lawsuit that includes:

• Violations of the Securities Act selling unregistered securities
• Fraud in the offer and sale of securities
• False Advertising
• Unfair competition
• Alter Ego Liability

Companies looking to ICOs are highly recommended to talk to their local securities commissions and securities law firms.

The money and the valuation

The company should have a good understanding of how much money they need to complete their vision, and how much the company is currently worth. This means that the company has to demonstrate a realistic understanding of what it will take to make the vision a reality, and also a fair valuation to give their early users.

In many cases, ICOs ask for hundreds of millions of dollars and do not explain exactly how the money will be used, let alone why their token should be worth $1 or $100. Investors want to know that the company is treating them fairly, and that they are receiving value for their money.

Conclusion

The Blockchain creates an incredible opportunity for companies to take advantage of network effects and transparency in order to create a legitimate case for crowdfunding. These types of investment involves users that are typically not accredited investors.

It is critical for the ICO to demonstrate the value of their idea, technology and team to an audience that wants to invest in the company’s vision. Companies planning to use ICOs to build legitimate products should understand what they are getting into.

ICOs are here to stay. It is our responsibility as players in the space to create an investment ecosystem that people trust and that we do our best to provide value for our investors.

Afterall, cryptocurrencies will only be valuable if people want to invest in the ecosystem.

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