Blockchain projects stand accused and Initial Coin Offerings, also known as ICOs, are in the dock. After all, is there really any need for token-based networks? Aren’t tokens just share-like securities designed to raise capital for companies?
These arguments have spread across the internet in the past months. Many now see a move back towards more traditional funding, such as Security Tokens or STOs, as well as stablecoins, open finance, and institutional adoption, as the more regulated, secure way to move forward and bring maturity to the crypto space.
Meanwhile appetite for ICOs has decreased. A combination of the bear market, mixed with regulatory uncertainty and negative media attention surrounding ICOs, played their roles in driving down investment in the second half of 2018.
The purpose of this article, however, is not to add to the STO echo chamber. Instead, I want to explore whether we should be so dismissive of ICOs and what we stand to lose if we do so. This is an open discussion and if you have additional arguments on either side, please feel free to share them in the comments below.
Do we need token-based networks?
Decentralized networks can provide plenty of new models for digital services. If these are the Web 3.0 incarnation of the internet, then they have potential to become the competition to today’s centralized tech monopolies like Amazon or Facebook: in much the same way that that these companies changed the course of Web 1.0, disrupting the monopolies once held by online service providers such as CompuServe, Prodigy and AOL.
These new decentralized networks have value because they encourage innovation and create an open playing field for all innovators to step up. They foster competition through supplying open-source software that others can copy which helps to prevent concentrations of power within proprietary and closed systems. They provide more data integrity and security because the data cannot be manipulated by one central party. They also create direct economic incentives for all participants to actively contribute towards the network’s success: and they do this through tokens.
Tokens are the native currency of the decentralized network.They provide an incentive for people to fuel the supply side of the digital service. Tokens also provide a mutual incentive for everyone involved to care about and improve the network. They have a strong network effect because as the network users also own the tokens, everyone benefits as the network’s value grows. Even more than this, the same people have the power to make the network useful since they can earn tokens by providing work for the network. Essentially, as soon as someone owns a network-based token they have a good reason to want that network to become successful and they also have the means to contribute towards its success.
There are already good examples of successful network-based tokens, such as the Basic Attention Token. The challenge to ICOs is, then, perhaps not whether there is value in a network-based token, although there is little value in a badly designed token, which will not enable the network to grow. Rather the challenge is whether there is really a need for these projects to issue their own unique tokens. Given that 70% of ICOs were running on top of the Ethereum blockchain by 2017, we could argue that they could have simply used Ether instead of raising funds to build something additional. The tokens would then already have a value and there would be no need for token sales. As Nick Grossman argues, who is himself a crypto investor at VC firm Union Square Ventures, each network-based token will rise and fall relative to its own utility and the value of the network. ICO tokens built on top of existing blockchains such as Ethereum can have very specific uses and target sub communities. This, Nick argues, makes it possible to isolate the economic impact and really see the value of a unique token.
So is there a need for token-based networks? Yes, because tokens give us a way for these networks to function effectively, while the networks give us a way to create innovative digital economies.
Is there any place for ICOs?
ICOs bring blockchain technology together with crowdfunding and it’s possible to see why they could be seen as blockchain business ventures: a way to make money by essentially selling shares. Tokens can behave like currencies or commodities or derivatives. But they can also provide a utility combined with an incentive mechanism, creating not token businesses, but token economies. The potential digital services that can be built on blockchain will disrupt the centralized services we know today by creating new ways to meet people’s needs and providing user experiences that other technologies have not thus far met.
Thinking of token-based networks as digital businesses is a legacy way of thinking and it doesn’t necessarily work to therefore apply the same approaches as launching a digital business. Yes pitching and securing VC and angel investor funding based on the promise of profit and a solid business model worked for Web 2.0. But decentralized networks are digital economies built on blockchain technology. They use this technology, combined with token-based incentive mechanisms, to create new forms of value that are distributed across their participants. Bear in mind, those participants, miners and curators, for instance, didn’t even exist before. Their roles within these economies need to be designed and developed. And all this requires well designed mechanisms and governance to ensure that all participants act in the best interests of the economy. So this is not the same as launching a tried-and-tested startup model.
So how do you approach launching a digital economy? It takes capital, and ICOs are a way to find the funds to develop a decentralized network. If the tokens end up distributed entirely amongst private investors treating it as a speculation then this is really no different to the old fundraising models. This is not necessarily a bad thing, but it doesn’t help create a decentralized system. Instead, the tokens need to be distributed among the people who will actually engage with the network and earn tokens. More than speculators, these are the people that will have an interest in working together to reach consensus and in improving, shaping and developing the network and its value. These are the people you need to adopt the token.
Decentralizing the distribution of tokens too early, however, before they have a utility on the network, can also cause problems. Without a way for people to use the tokens, they may sit on them until unexpected fluctuations or drops in the market cause them to sell quickly and completely rock the stability of the network. It’s important, therefore, to establish a balance between kickstarting the economy with long-term investors through a centralized token distribution, and then distributing tokens to the various participants who will use and add value to the network, once the timing is right. This is enabled through a public ICO token sale model.
ICOs have a place in enabling token-based networks to be developed through strategic funding, while distributing the tokens amongst users i.e. the people who will keep it functioning effectively as a decentralized system, once the network is launched.
Tokens have a place in providing the incentive — and deterrent — mechanisms to ensure that people continually behave in, and therefore continually protect, the best interests of these new digital economies. This of course hinges on the design of the tokens and we are still in the early days of understanding what best practice really looks like.
Two sides to every coin
We could continue making the current shift away from ICOs towards more traditional funding models.
But before we put all ICOs in the dock we should understand the implications of doing so. If we dismiss ICOs now then we shut down a new staged approach to funding decentralized digital economies before we’ve had time to understand its potential. And we stand to lose out on future innovation by narrowing down the playing field for innovators to bring their vision to market.
Can ICOs — albeit with more clarity around regulation but without kowtowing to the same old business and funding models — play a role in the future of crypto?
I say yes. There is a place for public ICOs that achieve the needed balance between both long-term investment and token distribution among users.
I’d love to hear what you think too.