Initial Coin Offerings: Investor Gold Rush or Major Liability?
With the recent closing of the highly successful ICO for Iconomi, which raised a little over $10.6 million making it the 11th highest funded crowdsale project of all time, it is useful to assess whether ICOs present risks for all involved or represents a new way to turn the conventional financing methods for startups on its head.
Thanks to the trustless security blockchain technology have provided cryptocurrency users, many new startups with big ambitions are turning to ICOs as a source of funding rather than seeking funds from traditional sources, such as venture capital or bank loans.
Travis Scher, an Investment Associate at Digital Currency Group, realizes the potential disruption ICOs could cause, but is also hesitant regarding the issues ICOs have in their current state, stating that, “This new fundraising approach, while still in its infancy, is being hailed as a way to decentralize and disintermediate venture capital, creating new sources of funding for entrepreneurs and new investment opportunities for individuals.”
With that being said, Travis continues to say that there are four issues that repeatedly occur with through the various ICOs that have launched in the past couple of years; regulation uncertainty, over-capitalization, lack of controls, and the lack of business use cases.
Concerns with Initial Coin Offerings
It is suggested that many of the people behind ICOs do not actually understand the Howey Test and its implications, an examination to see if something is subject to SEC regulation and requirements. This alone could make investor’s funds disappear if the SEC decides to crack down on ICOs or if new regulations come on to the scene.
The ICOs also seem to be overvalued, with “Founders with ideas that would struggle to raise a $500,000 seed round from experienced venture capital funds … raising millions in tokens sales.” This problem will subside as cryptocurrency as a whole matures and more investors than “overly-enthusiastic early Bitcoin and Ether holders” participate in such crowdsales.
Travis’s third concern is related to the ‘leap of faith’ users must undergo during an ICO; very little is defined with regard to profit sharing or investor rights. While smart contracts are usually created to provide some assurance and security for the investor, these can easily be removed through a simple change in code or hard fork.
Lastly, the ICOs do not provide a solution “to a real problem on a significant scale.” That is not to say that sometime in the future an ICO for a DApp is launched that receives mainstream adoption, but it is something to think of. While many may argue what a “real problem is” but even ones with somewhat valuable objectives “have been marred by an overly-complicated set of rules.”
So while there are strong arguments made against ICO’s, there are also strong arguments advocating this new way of raising funds. Initial Coin Offerings offer much more flexibility for both the founders as well as the investors, with accelerated returns, new ownership models, new exit methods, as well as creating new business models.
A Digital ‘Gold Rush?’
With Venture Capital funds traditionally taking seven to ten years for investors to realize a return, the accelerated return horizons of one to five years that ICOs offer are very enticing for investors.
Not only are options to liquidate usually available at a much faster pace, but returns on ICOs have the potential to be much more rewarding; Ether, for example, was trading at around $1.00 this time last year.
With Ether trading at $10.71 at the time of writing for an over 1000 percent increase in just a year, cryptocurrency has made astronomical return rates, only heard of in dreams, a reality. Ethereum and other ICOs are also more liquid. Once one or two exchanges list the token investors can exit if they desire, as well as opening the door to a much larger user base that may have wanted to participate in the ICO but were not able to for whatever reason. That is not to say generous amounts of funding are unfeasible through traditional methods. This is exemplified by Verse, who recently secured $8.3 million from their Series A funding round, with a total of a little over $10 million of funding in total, a similar amount to the aforementioned Iconomi ICO.
Continuing on this theme of flexibility, ICOs can accept funding in as many different currencies as they desire. For example, Iconomi received investments in five currencies, with two of them being fiat: USD and Euro via wire transfers, as well as Bitcoin, Ether, and Lisk. This acceptance of several currencies allows more potential investors to participate, compared to traditional venture capital funding which is usually denoted in a single currency.
Lastly, ICOs are can typically be differentiated from traditional venture capital and angel investing projects as they often focus on creating new business models with circular economies utilizing their token, compared to improving an existing service or selling a product.
Not only will this lead to long-term growth, but also an economy that is self-sustaining with a primary focus on an ICOs token, it is also an attractive proposition for investors. A focus on developing new business models will also be an effective way to see what consumers are looking for from the market, and once a chord is struck, mainstream adoption will be soon to follow.
Most of the risks associated with ICOs in its current state is down to the process being quite a new concept for investors and there is little precedent or regulation surrounding them. Many of the liabilities of ICOs will lessen in the next couple years, as they become more commonplace and regulations to protect both the founders as well as investors are put into place.
Just like Bitcoin and cryptocurrency as a whole, ICOs are a high-risk, high-reward scheme. While it is possible to make returns unheard of in traditional investing in hours or days compared to months or years, it is also possible to experience losses of similar proportions in the same timeframe as well.
Of course, investors can circumvent some of the risk associated with participating in numerous crowdsales by diversifying and doing diligent research on the token sale at hand. As the use of cryptocurrency technology only becomes more prevalent, so will the use of ICOs to kickstart aspiring projects.