ICOs: Crowding-in Blockchains?


Nowadays, ICOs (or Initial Coin Offerings) are all the rage. Unlike traditional IPOs, ICOs allow startups to streamline the capital raising process while at the same time enhancing the number of potential investors.  While venture capital is still part of the equation, other non-traditional investors and stakeholders are more than welcome to join. How is this possible? Is venture capital being democratized?

By default, blockchain technology (BCT) has built-in financial incentives. In the now classic case of Bitcoin, such incentive is the generation of a cryptocurrency. Users mining the Bitcoin blockchain to process network transactions get rewarded a certain amount of Bitcoins for their efforts which are computationally expensive and power hungry. Without such incentive, Bitcoin network members will have little to no interest in undertaking such elaborate task.

However, since many new BCT initiatives and startups are focusing on providing goods and services rather than digital money, the role played by cryptocurrencies has evolved. Here, we can distinguish at least four different but related personalities of the cryptocurrencies generated by BCT. They are 1. Means of exchange; 2. Financial assets; 3. Convertible tokens; and 4. Securities. This evolution has led to unexpected investment innovation when it comes to financing BCT startups, innovations that say the 1990s dot-com boom startups did not have at hand. ICOs are the best example here.

ICOs make extensive use of the token personality of cryptocurrencies. BCT startups first generate a certain amount of blockchain tokens that are then offered for sale to the public for a limited period. ICOs go well beyond crowdsourcing and crowdfunding. In fact, most of them are being labeled as crowdsales to indicate that any potential investor is welcome to purchase the tokens. Unlike crowdfunding, acquired tokens have an internal economic value that can fluctuate according to the overall conditions of the cryptocurrency financial ecosystem. Buyers could also sell or exchange their tokens shortly, based on previously established agreements.

Needless to say, financial risk tends to increase as some ICOs might just be fraudulent. Checking the status of the BCT startup involved in the ICO is thus critical but cannot be done easily at the moment. While regulation is still lagging behind, new private initiatives to improve ICOs have recently emerged. However, most of them do not offer ways to verify the quality of BCT startup offerings. These efforts seem to be targeting the demand side and limiting ICO access to certified investors. So much for crowding-in ICOs.1 In mainstream economics crowding-in relates to government involvement in the economy. I am using the same idea sans government.

In any event, capital raised by ICOs in the last six months or so is now close to half a billion dollars, and it is expected to continue growing in the short term. There is nor doubt ICOs are running on the coattails of the explosive growth of Bitcoin and other cryptocurrencies as financial assets.

The graph below depicts a selected sample of ICO that have raised at least 5 million dollars in the last six months or so.

While no unicorns are captured in this sample, the now typical power law distribution does show up: A few startups are raising relatively large capital amounts while most do not reach the ten million dollar mark. In any event, a few million for a BCT startup that still is brewing up its products and services is not too shabby.

In the end, the big question is how many of these startups are going to deliver the goods.

After all, this might just be yet another tech bubble.

Cheers, Raúl


Endnotes   [ + ]

1. In mainstream economics crowding-in relates to government involvement in the economy. I am using the same idea sans government.