The cryptocurrency world is going mad for token offerings. So far, over $320 million have already been raised this year through what is called Initial Coin Offerings (ICOs) – the blockchain community’s version of crowdfunding. Many regard them as a promising new funding model that has the potential to disrupt traditional venture capitalists.
But how does an ICO actually work? Basically, a company issues a certain amount of digital tokens, kind of an own cryptocurrency, to gain funding from potential investors. These tokens – which are similar to shares issued in an IPO – are sold in exchange for Bitcoins or Ether, but it can be fiat money as well. To do so, the startup firm must create a document that outlines key aspects such as
- The overall idea of the project
- Ways in which company seeks to generate value
- Amount of money needed to undertake venture
- Running time of the ICO campaign
Investors hope that the startup will become a success, which will lead to a value increase of their tokens. In fact, there have been already some very successful ICO projects in the past, such as Ethereum that managed to raise $18 million in 2014. Accordingly, ICOs are more and more seen as an efficient way to kickstart blockchain-focused projects.
However, insiders increasingly warn that ICOs become a hype and investors do not critically assess the companies they are investing in. In many cases, startups are launching an ICO without having a working product. Example: EOS. The company raised 650,000 ETH, which is the around $200 million, within the first five days of its ICO campaign. EOS could convince its investors with the idea of building a platform that is similar to Ethereum – just better, without transaction costs and faster processing. However, so far, it is just an idea and the startup has not come up with a working product yet. Accordingly, it is highly unclear, whether investors will ever get a return on their investment.
In general, a potential problem of ICOs is that they are unregulated, which means that they are not overseen by financial authorities like the Securities Exchange Commission. Thus, investors have no protection in case of fraudulent initiatives. Paired with a lack of careful upfront research and analysis, as investors blindly follow the temptation of potential huge returns, ICOs may in fact become a ticking time bomb…
References
Coman, A. (2017, June 25). ICO Review of: EOS (EOS tokens on Ethereum blockchain). Retrieved October 18, 2017, from https://medium.com/@EthereumRussian/ico-review-of-eos-eos-tokens-on-ethereum-blockchain-8984c975cd48
Marshall, A. (2017, March 07). ICO, Explained. Retrieved October 18, 2017, from https://cointelegraph.com/explained/ico-explained
Momoh, O. (2017, September 05). Initial Coin Offering (ICO). Retrieved October 18, 2017, from http://www.investopedia.com/terms/i/initial-coin-offering-ico.asp
Wong, J. I. (2017, June 05). The new cryptocurrency gold rush: digital tokens that raise millions in minutes. Retrieved October 18, 2017, from https://qz.com/994466/the-new-cryptocurrency-gold-rush-digital-tokens-that-raise-millions-in-minutes/
Hi Christopher,
Great to read about this topic – so relevant from so many angles! Personally, I definitely think there is a bubble at play. Not regarding blockchain, but definitely regarding the coins. A unit of currency is only valuable insofar as it holds value and can be used as tender for a sufficiently large amount of goods or services. As far as I know, none of these cryptocurrencies have those properties. So what’s driving their value? Hype, and speculative investment. It’s probably a good short term investment, but my bet is that in the medium to long run, the large majority of these coins will be worthless.
Hi Christopher,
Thanks for you post, great to read more about initial coin offerings. Personally, reading your story makes me think about a bubble as well. Especially as there is no regulation whatsoever protecting the investors. Over the past years however, cryptocurrencies have grown enormously. Now that everyone knows about them and starts to invest in them, many of them have thrived.
Connecting these “appealing” investments with no regulation is not new. Think about the mortgages crises caused by collaterised debt obligations. That were mortgages combined in pools and sold according to the best rating. As It turns out, there was insufficient regulation, no one really understood how it all worked. Nevertheless, no one cared, due to the money that was being made.
Do you see the same thing happening here: cryptocurrencies are too complex and unregulated, are they a bubble of the same magnitude? What do you think?
Hey Christopher, really good read! I agree that Initial Coin Offerings right now are a bubble and will soon pop, mainly due to the non-regulated situation in which these coins are sold and the speculative nature of the market. Another important factor is that ICOs can be created without much impediment and therefore many companies are doing it in order to raise money, which is what is making the bubble even worst. Nonetheless it is important to understand that many of these companies are using ICOs as a way to fund their ideas and project, and the value of the coin is tied up to the company´s performance. Furthermore, since ICOs have become more popular new procedures such as AML and KYC are being used in order to prevent money laundering and to know that the coin is being bought by a large population and not just a few whales.
I also believe that many of these ICOs are actually creating very valuable applications using blockchain and smart contract technology and as any other bubble in the past, these coins will become major player in the new blockchain market.
Hi Christopher,
great post! When you ask whether the current hype in ICOs is a ticking time bomb we first have to assess whether what we see in the ICO market right now is sustainable. The answer should be no. I think that people are largely investing in ICOs, because they are afraid to miss the next big thing: as the bitcoin price rises and rises, speculators (not investors) have to find other bets for the future. The problem here is that people who are purely financially-driven risk the future viability of ICOs – which inherently are a good thing as they enable the monetization of open source projects. In fact, if too many ICOs fail this could even become a risk for Ethereum itself. People currently have no experience in how to differentiate between good and bad projects, therefore they often just invest because their friends or friends’ friends invest. To date, such herd behavior was almost always an ingredient in the recipe of a market failure. Ethereum founder Vitalik Buterin is sure that “a lot of projects will fail and people will lose money”. I hope it’s not you, Christopher 😉
Hey Niklas,
concerning your remark that people investing in ICOs are afraid to miss out on the next big thing, you may want to check out this: http://fomocoin.org 😉
Hey Christopher,
Thanks for sharing your thoughts! Although I fully agree with your observations, I believe there are two sides of the coin.
On the pro side, ICOs indeed provide some critical advantages. For example, traditional venture capitalists invest in a startup and receive equity in return. Often, the money invested is locked for many years. With ICOs, investors can trade the altcoins on a secondary market and may pocket in some good returns. Accordingly, ICOs provide liquidity. Furthermore, ICOs allow normal investors like you and me to participate in the early funding process of young, promising ventures (and not only VCs or PEs). Thus, ICOs democratize fundraising.
On the con side, I would like to refer back to the first point I made: liquidity. The secondary markets on which the tokens are traded are unregulated and more or less a black box, which means there is zero transparency. Furthermore, there may also be a reason for the fact that early funding is given in the hands of professional investors. Startups and their often inexpe-rience founder teams do need the social and human capital provided by VCs or business an-gels. Speculative investors are certainly no source of helpful advice. As a result, many promising startups financed by ICOs are likely to fail as they miss the necessary advice and support of experienced investors. So indeed, together with the lack of transparency, ICOs may in fact become a ticking time bomb.