In January — September, the market of Initial Coin Offerings (ICO) was growing at a blinding speed. But in October its growth suddenly halted. In September tech startups raised in ICOs about $825 million, according to data website Coinschedule.com. In October the result was $600 million, and in November even more modest — about $120 million (Source: Coinschedule. “Cryptocurrency ICO Stats 2017”).
Yes, I know that the ICO market is proverbially volatile. In 2016 there was a big drop in ICO activity in June and July and then in December (Source: CoinSchedule. “Cryptocurrency ICO Stats 2016"). This year the market decided to take a holiday in August.
But maybe the October decrease was not so sudden? Over the last year we saw crazy returns in the ICO market. A blind investment in every ICO, including the significant number of ICOs that failed, would have delivered an average return of 1,320%, according to venture capital firm Mangrove Capital Partners (Source: Mangrove Capital Partners. “Tokenization. Implication for venture capital industry”).
A Japanese Village, Paris Hilton and Venture Capital
Yes, the ICO market is very hot. Apart from traditional players, tech startups, some exotic players also appeared on it. In November a Japanese village said that it considers a municipal ICO to revitalize its economy (Source: CoinTelegraph. “Japanese Village Plans to Conduct ICO to Revive Its Economy”). But if so, why did the market drop in October?
Surely, there should be a lot of retail investors on this market who snap up tokens indiscriminately. That is why TV star Paris Hilton, boxer Floyd Mayweather and rap artist The Game advertise crypto companies in social media (Source: Fortune. “Why Celebrities Like Mayweather Could Face Legal Trouble Over ICOs”). Retail investors are their target audience.
That is why US, European and Japanese financial regulators have been warning about risks involved in ICOs for many months. “The price of the coin or token is typically extremely volatile and investors may not be able to redeem them for a prolonged period”, recently said the European Securities and Markets Authority said (Source: ESMA. “ESMA highlights ICO risks for investors and firms”).
Maybe, retail investors do not want to hear warnings, but smart money, professional investors, including venture capital, can’t ignore them. I think that it is only logical that they began to stay on sidelines several months ago and the result is that the ICO volume dropped.
Venture capital dollars may be locked up for at least three years in startups after the ICO. In some startups the lock up period can last for almost a decade. But the failure rate of startups is so high that investors can’t be sure that their money will not be burned during this period.
“The Biggest Scam Ever”
Between 1990 and 2010 the percentage of venture-backed startups that fail was 60 percent, says Cambridge Associates, a global investment firm based in Boston, that tracked the performance of venture investments in 27,259 startups. In 2000, during the dotcom bust the failure rate was even bigger — 79 percent (Source: Wall Street Journal. “Startup Values Set Records”).
“The UET ICO transparently offers investors no value, so there will be no expectation of gains,” its creator, who only goes by UET CEO, writes on its website. “Remember — this is a completely honest ICO, which means I don’t want anyone to mistakenly expect the value of the tokens to go up, either. They’re called Useless Ethereum Tokens for a reason.”
It looks that the ICO boom will also result in the growth of failure rate. About 50 percent of startups fail in the in first two years, and about 30 percent — in their first year. Curiously enough, many startups that fail went through thorough due diligence conducted by venture funds.
Startups fail because there is no need on the market for their product, or they run out of cash, or they have a bad team, or get outcompeted, or lack good business model, or pricing of their product is wrong — you name it.
ICOs also fail because some of startups are a complete scam without a product. According to Jordan Belfort, known as Wolf of Wall Street, five to ten ICOs are scams. Jordan Belfort is someone to be trusted: he went to prison for 22 months for securities fraud. After release from prison in 2005 he works as a motivational speaker. He says that ICOs are the biggest scam ever and far worse than anything he was ever doing (Source: Financial Times. “‘Wolf of Wall Street’ warns of impending cryptocurrencies ‘scam’”).
And his words seem to be true. In the middle of November investors of Confido startup that raised $375 000 from ICO learned that the founders of the company vanished and so did their money (Source: CNBC. “Cryptocurrency start-up Confido disappears with $375,000 from an ICO, and nobody can find the founders”).
ICO market is so dangerously loosely regulated that some scam startups even do not try to develop a product to offer to investors.
In July 2017 investors sunk thousands of dollars into joke tokens called Useless Ethereum Token (UET). In three days it raised about $40 000. “I realized that people didn’t really care about the product. They cared about spending a little bit of money, watching a chart and then withdrawing a little bit more money. So why not have an ICO without a product, and do so completely transparently just to see what happened?”, — said anonymous UET CEO to the New York Observer. (Source: Observer. “Cryptocurrency Has Its Potato Salad Moment With the Useless Ethereum Token”)
And you know what? The market capitalization of UET is still $45 000. It boasts the proud 942nd place on the cryptocurrency market (Source: CoinMarketCap. Useless Ethereum Token).
How to Protect Investors
To protect quality investors, fundraising platform Headstart said that in December it will hold its ICO for the so-called Mother of All Tokens (Source: Digital Journey. “ICO HeadStart, the fundraising platform for ICOs” ). It wants to choose the most credible ICO and recommend them to investor.
Some people think that only sophisticated investors with net assets above $1 million should be allowed to invest in ICO. Wow! The UET creator should be proud: they have just been compared to respectable hedge funds!
Surely, there should be some way to protect investors’ money. It may be some sort of insurance that will help to keep at least some money intact for a period of time. Why not to make ICO financing gradually? For example, 30 percent is invested in ICO, another 30 percent — a year later on condition that the startup demonstrates promising results and the rest — two years later (or after the startup earns its first profit)?
If not, then what?
Well, maybe, something different. About 40 years ago the futures and options market was in its childhood and resembled the current ICO market very much. It was volatile and risky. And its first regulator was itself. It was self-regulated. Among those who developed the first requirements for the futures and options market was Patrick Arbor. Later he became CBOT chairman and established the National Futures Association (Source: CNBC. “It’s hard to mourn the loss of open-outcry trading”).
Arbor is old and very rich now. Recently he divorced and to avoid a big divorce payout fled the US and moved his assets.
My bet is that sooner or later the ICO market will be properly regulated as well. And the person who creates such regulation will make a fortune.