In 2013, J.R. Willett unleashed the ICO concept — a fundraising system where companies sell their new cryptocurrency tokens in exchange for Bitcoin and Ether. Since Solomon vs Solomon ruling in 1896, segregating the liability of a person from the company, this ICO concept would be the biggest corporate structure innovation.
ICO (Initial coin offering) is the advance sale of a project’s crypto-currencies or tokens, to be used within their platforms or outside, in advance, to fund the development of their platforms. These tokens can be easily sold and traded at anytime, on all crypto-currency exchanges depending on their demand. So, an ICO is when a company raises money in Bitcoin or other crypto-currencies for the technical development of their projects. These tokens are essentially the incentives, for several market participants to use and grow the platform in a decentralized manner. Such incentives are paramount in making a decentralized eco-system operate sustainably. This allows for formation of new economic systems; possibly even capable of transforming / improving wider systems like “capitalism”.
Lets review the Good, Bad and Ugly of the ICO world.
ICOs have worked and grown due to several key factors, including,
- The willingness among the community to decentralize control, away from large corporations, and have all stakeholders aligned to work towards a common goal with the economic incentive.
- As a successful reference from the past, in open source movements like Wikipedia, Linux, crowdsourcing has worked well even without the economic incentive.
- ICO is the advanced sale of a platform’s crypto-currencies or tokens, to fund the development of fund raising company’s platform and product. These tokens can be easily sold and traded at anytime, on all crypto currency exchanges depending on their demand, providing liquidity to investors and vital early stage funding for entrepreneurs. These tokens are essentially the incentives, for several market participants to use and grow the platform in a decentralized manner. Such incentives are paramount in making a decentralized eco-system operate sustainably. ICOs help blur the boundaries between stakeholders, leading to the Token economy as depicted below.
- Investors are participating very early on in the process, hoping to repeat the success of early stage Bitcoin investors who saw its value rise from a few cents to $5,000+ within 7 years, creating generational wealth for some investors.
- The surplus money people generated from early investments into crypto currencies are being re-invested into new crypto currencies.
- A genuine desire to fund some interesting causes and projects that are closer to the crypto-investors’ hearts.
- Limited liquidity (supply) of tokens means that as the use of token and platform grows, the value of tokens should grow as well, generating strong returns for the early-stage crypto-investors. ICOs are also beneficial to smaller investors as early stage crypto-investments are not limited to private investors or VCs, anyone can take part in a token sale, similar to the concept of Kickstarter, where people fund or support projects which they feel would be successful and effective.
Inspite of their great advantages as highlighted above, 46% of funded ICOs from 2017 have already failed by Q1 2018. There are several reasons for this,
(No disrespect, but) ICO investors are typically those who got lucky with the Bitcoin and Ether price boom in the last few years. Bitcoin and Etherium were most credible and honest attempts to disrupt the world for better. Hence, they did well over a number of years. And many early investors made a good return on their investment. And they got excited, when they saw other tokens in ICO opportunities in 2017; which were not well thought through, did not have the right business models, lacked a strong experienced committed team, and were doing ICOs because they could, rather than to solve a real underlying problem. It was hard for those investors to identify the value in such ICOs, and they would just invest in “well marketed” whitepapers, or celebrity / “influencers” endorsed ICOs, hoping to make a quick buck on their investment; without necessarily evaluating the business fundamentals before investing. Most ICO investors were not able to ask the following critical questions before selecting the ICOs to invest in
- Do they have an MVP (minimum viable product), and team, and clients / users? This should help one differentiate from idea stage investing versus business scale up investing?
- How “all in” is the team behind the ICO. Are they investing themselves? And locked in for returns in form of tokens?
- How will the company use the funds in building / scaling their business / project?
- Are the tokens integral to platform’s success?
- Consider getting a third party crowd sourced technical reviews (Github for example) on token structures as well as token privacy / security
- Are these tokens legal?
This lead to not well analyzed investments, and failures later.
Cryptocurrency news site Bitcoin.com has surveyed last year’s ICOs and found that of 902 tracked by TokenData, 142 failed before raising funding, and another 276 failed after fundraising, whereas another 113 projects “semi-failed,” because their teams have gone off the radar or their community has withered away. That jumps the failure rate to 59%. Many ICOs have ended up in litigations too.
Poor teams running the ICOs for unachievable projects
ICO project founders focussed on attracting investors, and not enough on the underlying project or the security of the ICO platform. The projects were either created for the sake of raising money, or completely blue sky, or just plaigirised from existing ideas.
Hackers successfully take advantage — the more hyped and large-scale the ICO, the more attractive it is for attacks. Putting a number on that amount, we’re talking $400 mln stolen by hackers. The smart contracts used to raise funds are themselves poorly coded. According to Fortune magazine, up to 10 percent of all the money raised by ICOs between 2015 and 2017 was either lost in the crypto ether or stolen in hacks.
Larger than life celebrities following in the ICO scams
Capitalize on the crypto craze that is sweeping the world has culminated in a number of weird and wonderful advertising campaigns, featuring some interesting celebrities and big businesses, including; world-renowned footballer Lio Messi was used to endorse a company producing Blockchain hardware, while flamboyant boxer Floyd Mayweather entered the fray with an Ethereum-based ICO last year, along with Paris Hilton and footballer Luis Suraez. Stevan Seagal promoted ICO was halted after a regulatory order
These celebrities endorsed ICO in exchange of Hefty amount of money and ignore a major aspect of the project such as its viability and legitimacy.
Besides celebrities, several entrepreneurs, corporate guys, became wannabe “ICO Advisors” and lent their profiles for ICO projects, in return for ICO tokens and other fiat / crypto currencies. This helped project a better image of the ICO project, and sort of mislead the retail investors.
Not just retail investors, even Venture Capital firms got into the hype and invested millions of dollars into several ICOs, which did not lead to anything substantial. Besides, the corporate ownership of the ICO platform / project / company, still belongs to the shareholders, and not the token holders yet.
No mechanism for fair pricing of the tokens
Token prices were based on high random “finger in the air” valuation created by the ICO founders. Anybody could launch 100 million, or 10 billion tokens, and price them at $1 and discount it back with up to 70%. Its unbelievable how retail crypto investors psychology worked and they bought many such tokens. Some people even borrowed money to invest in cryptos in second half of 2017. There was no fundamental valuation of the project, no discounted cash valuation model with appropriate startup discount rate applied. Several average team ideas were priced at $100m or more. Investors fall for jargon and speculative mumbo jumbo. As a result such high-risk ICOs bank on investors fear of missing out (FOMO).
Lack of Regulation and Oversight
Crypto issuance finds itself in a grey area of regulation. This is the biggest issue in terms of avoiding scam ICOs. Some jurisdictions like US are more advanced in classifying certain tokens as securities or utility tokens, in order to regulate them better. But most other jurisdictions like Korea etc. had been allowing for any ICO to happen.
Lack of Accountability
There is no formal process to audit ICO organizations. Many teams conduct token sales before making significant progress in building out a functional product. Coinist has ranked the 6 worst ICOs of all time, under the headline “Poor returns, failed technology and outright scams make ICO investors leery”. Given there is no accountability of the founding team, advisors, and other beneficiaries, several ICO projects have,
- raised money and did not invest into the project appropriately
- or syphoned off the money into their personal assets, away from the project
- or even disappeared completely
Illegal structures — investors are not even aware that they are breaking rules
The risks of ICO and cryptocurrency investment are so high, that they warrant double warnings from governments including including Singapore, the UK, Iran, Germany and Ukraine.The Securities and Exchange Commission (SEC) has enforced actions against ICOs believed to be related to fraud. It is alleged that the tokens sold to US investors during Tezos’ ICO were actually securities.Tezos raised a record-breaking $232 mln during its Initial Coin Offering (ICO) in July 2017. The project has since been a subject of scrutiny and multiple lawsuits over the question of its compliance with the U.S. Securities and Exchange Commission (SEC) regulations, among other things. Since the company has not registered them with the SEC, this would constitute securities fraud.
The Future — Light (regulation) at the end of the tunnel
One obvious way that ICOs can achieve their full potential is if they get lightly regulated. This should not be confused with Blockchain, that is meant to be decentralised and not regulated; ICO is the fund raising process, which needs “some” regulation to make it “safer”. Easiest process would be to apply similar to Crowdfunding guidelines in UK or US, and the ICO platforms that help raise ICO funds to be regulated like Seedrs, for instance.
Some jurisdictions have started the regulatory process.
– In Switzerland, FINMA introduced new guidelines on ICOs, each falling within one or more categories: payment, asset, utility.
– In Spain, the People’s Party is preparing legislation including possible tax breaks for companies using blockchain technology.
– Gibraltar, Estonia and Japan are among few countries that have also simplified / allowed for ICO fund raising.
– US SEC is also debating on easier regulations for ICOs