ICO trends and evolution | FY2017

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VINPrimeCapital

8 min readJun 2, 2018

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A historical snapshot and assessment of ICO performance, trends, investors, success rates, segmentation, and regulations in 2017

Investor interest for Initial Coin Offerings

The nature of ICOs enable retail investors to contribute to a project prior to material development of a concept (may be established on a “whitepaper” outlining its intentions), and achieve rapid liquidity and returns based on its perceived success. Outsized returns from early ICOs such as Ethereum and IOTA reveal returns that are not seen in many other asset classes, which attracted the interest of venture capital, institutional, and retail investors globally.

ICO returns have evolved and varied since 2016 due to increased volume, scams, and perception of a bubble. However, there remains a great deal of value embedded in the noise. Successful ICOs have patterns, and access is shifting towards pre-sale investors such as Funds through existing networks, creating a barrier of entry for promising ICOs.

In order to evaluate the potential success of future ICO investments, a historical view of performance must be examined to identify patterns. Although not always indicative of future performances, themes tend to be directional in predicting the success of upcoming prospects.

ICO Performance and Trends

Over $6B USD in cumulative funding has been invested in ICOs. Notable raises include EOS, Bancor, Tezos, Filecoin, and Polkadot, indicating clear investor appetite despite uncertain valuations.

Funding saw steady progression in 2017, with ICO funding exceeding VC funding for blockchain projects in Q3 2017.

An examination by Smith & Crown into capital raises of ICOs reveals a bias towards the $5–25M range.

Furthermore, we see volume decrease after $25M, however ICOs beyond that threshold constitute >50% of the capital raised within ICOs.

An industry segmentation of ICO investment reveals a transition from currency and infrastructure projects in early years, to a more diversified industries. Investment is not reflective of ROI, however, it is leading indicator on appetite of technology application and potential.

A time-bound distribution of 2017 ICO investments by industry shows bias in volume and size towards finance and information, revealing a focus on the building blocks of technology application.

Another view on industry investments reveals a bias towards infrastructure projects, or “protocols”, followed by finance.

More complex use cases such as consumer applications see funding interest, however the infrastructure (scaling, transaction capacity, functionality) is not ready to handle sophisticated use cases yet. Therefore, projects pursuing infrastructure improvement yield greater promise and focus.

The graphic below represents a focus on expanding the infrastructure capabilities so that diverse applications can be built on its resulting protocol.

Investment is dominated by geographies such as North America, and Western Europe.

Furthermore, a deeper dive into Europe reveals investment from UK and Switzerland.

Institutional capital from venture capitalists like Digital Currency Group and Blockchain Capital lead the way, and this pool of participants continues to grow.

Institutional investors also invest by proxy, and are slowly engaging in more direct investments as blockchain approaches the main stage.

Prominent VC investors such as Andreessen Horowitz are increasing exposure into the blockchain ecosystem, with a recent investment in Dfinity as part of a $61M raise.

ICO Insights

The ICO market experienced a decline in capital raised through the early months of 2018 compared to December 2017.

Co-incidentally, the cryptocurrency market experienced in decline during this period (January — February 2018). A study revealed strong correlation with bitcoin price, strongly viewed as a proxy to the health of the cryptocurrency market, and ICO raises. Therefore, the Fund maintains a focused view on monitoring macroeconomic and fundamental factors that move bitcoin movement, which are imperative to anticipating the success of the ICO market.

A different set of dynamics govern the ICO market, leading to abnormally high capital raises in brief amounts of time. These trends defy the traditional perspectives of valuation maintained by VCs.

ICOs such as Brave and BitClave sold out in seconds due to their capped structure and hype surrounding the ICO market at the time of raise. Traditional measures of valuation such as multiples, Discounted Cash Flow (“DCF”), and means of payment are replaced with an evaluation of token economics, hype factors, raise amount relative to benchmarks, and team strength.

As a result, the lack of fundamental valuation leads to a volatile spread of returns when liquidity avenues open through token release and exchange trading.

Numerous ICO rating communities have formed in order to identify, evaluate, and rank upcoming opportunities. Below is a sample of a review aggregation by WalrusCap.

There is a clear sentiment among cryptocurrency investors that greater value exists in the protocol layer before application opportunities.

ICO success and failure rates

As ICO raise volumes increase due to the perceived ease of a capital raise, quality decreases over time, resulting in a higher failure rate. As evidenced by the visual below in 2017, 93% of ICOs achieved their fundraising goals, compared to a 60% decline four months later. This trend does not undermine the good ICOs — rather, it places the responsibility on investors to improve their selection criteria and access points to identify and invest in promising ICOs, whose returns continue to deliver multiples.

Comparatively speaking, failure rates are still higher than traditional VC companies. Data on traditional fundraising by startups collected by Kickstarter, Mattermark, and CB Insights reveals 40–68% failure rates. ICO success rates do not differ materially from traditionally fundraised firms, however, more time is needed to determine operational success rates (18% of ICOs experienced operational failure in 2017).

In 2017, Mangrove Capital Partners evaluated ICO investments, and discovered that a blind investment in all ICOs would have yielded a return of 13.2x on initial investment, per the exhibit below.

Evolution of ICOs

As systemic factors (regulatory) and market considerations (varying appetite) challenge the existing ICO model, thought leadership has offered alternatives. Vitalik Buterin, founder of the Ethereum network, introduced the concept of the “DAICO”, which incorporates elements of distributed autonomous organizations (“DAO”) with the current ICO model to incorporate accountability, trust, and time into the fundraising process.

Other models propose incorporation of securities frameworks to appease regulators. One proposed model includes categorizing ICOs into existing U.S. structures such as the JOBS Act, which outlines the following:

Regulation D 506(c), where accredited investors can invest with no limits. Investors need to be verified and pass the Bank Secrecy and USA Patriot Acts test also called AML/KYC/CIP (love those acronyms).
Regulation Crowdfunding, where anyone can invest and the company can raise up to $1.07M per year.
Regulation A+, where anyone can invest and the company raise up to $50M per year after the SEC has qualified the offering. While more expensive, it is the future of ICOs.

Furthermore, they could be offered through one of the following avenues:

Simple Agreement for Future Token (“SAFT”) is a derivative securities instrument. It is simple to put in place and offers investors the ability to invest before the token is ready.
Real Agreement for Tokens and Equity (“RATE”) is a two token offering. One of them is equity in the company and the other the delivery of another token as a perk.
Simple Agreement for Future Equity (“SAFE”) is an equity-only offering. The token can be a preferred or common equity investment. If it is a preferred offering, it can offer a non-convertible security with a dividend similar to a revenue share.
Straight equity offering by issuing a token. This is simple because the company offers a new class of equity, be it common with or without voting rights. The token can also be preferred and offer dividends.

Since, the classification of securities is unclear, the medium for exchange is yet to be determined. Meanwhile, the SEC has authorized broker dealers to use Alternative Trading Systems (“ATS”) to sell securities that are not offered on national marketplaces. In 2018, we may see a shift of securitized tokens offered on ATS to maintain compliance.

References:

ICO trends and evolution | FY2017

Investor interest for Initial Coin Offerings

ICO Performance and Trends

ICO Insights

Evolution of ICOs

Written by Nik Jacob