Are ICOs the new Venture Capital ?

By Cyril Bertrand

We — VCs — love ambitious entrepreneurs eager to disrupt huge industries.

But we VCs don’t like a lot to ask ourselves about how our own industry could be disrupted in turn. VC is essentially an intermediary business, between Limited Partners and entrepreneurs : is it not the sweet spot of the digital youngsters (those we like to finance) to cut the man-in-the-middle?

Still, some of us have been busy with this question for a while. AngelList and crowdfunding were once considered competitive threats, but ended up as complementary options. Then came the mighty VC platforms, certainly a disruptive model but affordable only to mega-funds. And more recently, around 2016, ICOs or Initial Coin Offerings.

This article, derived from the last XAnge University, is the opportunity to present XAnge thoughts on the subject: Are ICOs the new VC? You can find the whole presentation below made by Bartosz Jakubowski, but let us share with you the key points.

First of all, you need the “C” of ICO, ie the coin or what is called a cryptocurrency.

Most Cryptocurrencies are based on the blockchain technology. Blockchain is about solving problems of traditional money (corruptible, politically biased and opaque) with a distributed, cryptographically secured and transparent database:

  • No central authority in charge of trust: no single point of failure and no corruption
  • Empowered users: in control of all their informations ;
  • Durable and reliable data;
  • Process integrity: users can trust that transactions will be executed exactly as the protocol commands ;
  • Ecosystem simplification: 1 single public ledger, reducing the complications of multiple ledgers;
  • Faster transactions: interbank transaction can take days vs. minutes, working hour vs. 24/7;
  • Lower transaction costs: elimination of the third party => reduced overheads costs (Lawyers, law enforcement, …).

Since the first research in 1991, the blockchain protocols have had many iterations, starting with reliable timestamping of documents. Then around 2008 the Bitcoin protocol solved one of the critical stumbling blocks of the digital currencies: double spending. In other terms, the Bitcoin protocol has — so far — a spotless track record of guaranteeing that a bitcoin spent on one transaction cannot be digitally copied and (double-) spent on another transaction. It took around 5 years to the crypto community to consider that the protocol was stable and trustworthy. In 2013 a more ambitious protocol was launched to include Smart Contracts, Ethereum. More than a payment protocol, Ethereum allows to execute automated “scripts” within its blockchain, and settle transactions with the attached coin called Ether. That became the basis on top of which many new projects were launched in 2017 — the so called “DAPPs” or Decentralized Applications. Such DApps do not even need to incorporate themselves as companies, often they live and die as open-source projects.

But one thing remains unchanged: in order to thrive, these projects need money — to attract and retain the best developers. Around the end of 2016, some of the Dapps launched “ICOs” or Initial Coin Offerings. In practical terms, these projects realised that they could entice their users to execute the payments on their platforms with a private currency, a so-called “coin”, much the same way some giant gaming platforms of 90’s were carrying out all transactions in some sort of internal currency. An ICO consists in offering a fraction (big or small) of this internal currency for purchase to the outside world.

And it’s not a small thing.

In 2013, there were 8 cryptocurrencies above $1 million of market cap (and of course, one of them dominating all others, Bitcoin) for a total market cap of all cryptocurrencies of $1.5B.

There are today 392 cryptocurrencies above $1M and the total market cap is around $177B.

As of Aug. 31st 2017, in the french stock market index CAC40, cryptocurrencies as a whole would be the largest capitalization far above LVMH and Total. Virtually all digital businesses as we know them, Uber, Airbnb, Dropbox etc have their tokenized counterpart. It is of course too early to tell if these new projects will be meaningful challengers for the digital behemoths but many of them have raised more than $100M. And perhaps more importantly they appear to attract the best software dev talents, with a mix of sheer technology challenge and potential financial rewards: a developer working on a token project may receive a part of his package in the currency of the project, thereby incentivizing him on the success of the project (ie the growth of the users and of the usage intensity), which leads in turn to an appreciation of the related token.

Let us look at a few reasons why ICOs are a threat to the VC model.

The sheer amounts speak for themselves (source: /

Clearly, ICOs may save a lot of headaches to entrepreneurs, compared to the usual VC fundraising processes:

  • shorter roadshows — ICOs need to be carefully prepared weeks or months in advance, but their execution happens in a matter of hours
  • no board member / governance — no shareholder agreements, no board, no SEC IPO legal documentation
  • no liquidation pref, no liquidity clause — none of the usual VC protections
  • no power law/fund size VC excuses — ICOs can be as small or as big as the project makes it necessary

Even better, ICOs are currently giving access to massive amounts of funding: Bancor, Tezos, EOS, Status all raised more than $100m pre-launch. Yes you read well, they raised those amounts at a stage of their development which VCs would call ‘Seed’. And not to forget, these amounts — before switching to the mysterious intangible world of crypto currencies — are good old dollars, post-tax real cash.

So who are the participants? Is this a community of experts, knowing perfectly well what they are doing? Or is small minority taking advantage of the credulity and greediness of the dumb majority? On thing is clear: in order to simply participate to one of the current ICOs, you have to be technically savvy — the ICO “user interface” is far from mainstream. So it seems that the community supporting and boosting the ICO wave is at least well equipped on the software / infrastructure side. They understand the mechanisms and add a touch of utopism — “power to the crowd! .. and until we get there, let me make a maximum of money”. That may have bootstrapped an early adopting community of incentivized adopters. Then most probably reality will catch up and 80% of the projects will fail, as usual. But stellar execution will generate the new Betfair’s or the new Firefox’s of this world.

Unfortunately VCs will struggle to participate to this (potential) bonanza, here is why:

  • first of all, our LPs and fund policy prevent most of us to play those games for the next few years. By the time we correct that, most the market inefficiencies will be corrected;
  • the legal structures of those projects is unclear. Or perhaps better said, they don’t bother with legal structures, so they have none;
  • most people excited by cryptos in established VCs are junior, so their excitement may generate more (or less) money for them, but won’t move the strategies of the funds
  • the taxi companies syndrome: we deny disruption until it’s undeniable, ie until we are effectively disrupted.

And yet there are many reasons why ICOs aren’t an immediate threat for VCs:

ICOs are far from being a perfect financing platform:

  • There is an element of magic in those ICOs which simply cannot defy gravity forever: right now ICOs are the perfect mix of VC valuations (on steroids) and public market liquidity. There needs to be disappointment.
  • ICOs are not regulated, yet they take real money out of the pockets of real people. So regulation will kick in to protect investors, it’s a matter of time.
  • Some ICOs will turn out to be mere scams. Some others will turn out to be legal but perfectly engineered to enrich a few smart marketers. We see that happen already a lot.
  • And obviously not every company, not every business can do an ICO: to start with, there needs to be a user benefit to transact in a non-fiat cryptocurrency. Most businesses will be happy to run their business in $ or €.

At the end of the day, it’s probably going to be more about cooperation than competition :

The most creative VCs bring more than just money and therefore already get invited either in pre-sales of tokens or regular equity funding :

  • USV in Numerai (data science based hedge fund), Protocols Labs (Filecoin ICO to come);
  • BlueYard Capital in Userfeeds;
  • USV and Andreessen Horowitz in Polychain Capital

In summary, this industry is nascent, wild and technical. It shows early signals of having the potential to be big — big hopes, big risks. Should that be the case, it would enforce a new level of selection on the traditional VC funds — some will go belly up, but some will come out even stronger, with a more crispy message about the value they bring to the startups — beyond money.

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