ICOs (Initial Coin Offerings) raised over $5.6 billion worldwide last year. And less than half of them were even successful. It’s clear this new fundraising method- almost unheard of just a few years ago- has become an insanely popular way for startups to raise much needed early seed capital. (Watch this 1 minute video to see the explosion of funding.) Blockchain technology, lessened regulation, liquidity, and crowd mentality have come together in a perfect storm for startups looking for quick capital.
But ICOs are not for everyone. Fraudsters are taking advantage of this craze (I’ll discuss that further in my next article), but there are also legitimate practical reasons that ICOs may not be the best choice for a firm’s fundraising strategy.
So what can traditional firms learn from this trend? Can we take positive attributes of the ICO, like transparency and liquidity, and layer them with solid, tried-and-true methods of traditional fundraising?
Token Sales are the logical next wave of crypto-based investing. Mainly executed so far by Hedge Funds and Venture Capital firms like us, Token Sales combine the best aspects of traditional investment models and ICOs. In this article, I’ll describe the differences between ICOs and Token Sales.
Technology product vs. finance service
ICOs are for technology companies; Token Sales are for finance companies. While a technology company issues coins in exchange for operating cash, Tokens are sold for a service.
In order to produce a product, startups are using ICOs as a substitute for equity that would normally come from business angels and venture capital firms. In contrast, finance companies, including hedge funds and venture capital firms, aren’t producing a product but can use blockchain-based Tokens to make their finance offerings globally accessible.
Ideas vs. business models
Almost every ICO I’ve observed is based on ideas and concepts. Very few startups launching an ICO have a running business model, revenues or significant traction. If you invest in an ICO, you should believe in the idea, team and product potential. That’s why I invested in the current Ocean Protocol ICO, for example.
Token Sales are backed by a solid business model. Venture Capital firms have a clear and proven way to make money. They collect capital from their investors (traditionally called limited partners), invest this money in strategically-chosen companies, hold the shares until the underlying companies are worth significant value and finally sell the shares at the highest possible price. Earnings are then paid back to the limited partners. The same goes for Hedge Funds.
By using blockchain-based, transferrable Tokens in lieu of limited partnership interests, Venture Capital firms can offer their investors the best of both worlds, ICO and traditional VC. And soon we’ll see more finance products based on blockchain Tokens like bonds, stocks, derivatives, insurances and real-estate-funds. The blockchain is the perfect use case for the finance industry.
Unregulated vs regulated
ICOs are mostly unregulated or act in a legal grey zone. Many teams setup a tax-favored foundation in Singapore to launch the ICO, then transfer investment money back to Europe or the US. Sometimes there’s a pit stop in the Caymans for even less transparency. Currently, China and the USA are the only countries in the entire world actively regulating ICOs.
In contrast, as finance products, Token Sales are already regulated. In Venture Capital, we have existing standards for consumer protection, data security, anti-money-laundering and investment criteria. These standards were created and proved long before the emergence of ICOs and therefore provide a solid framework to support the evolution of Token Sales. Sure, there are ways to avoid regulations, and I know a handful of players who do it. But we at Asgard, for example, go for full regulation and transparency by working closely together with European financial supervising agencies.
By the way, I’m pro-regulation concerning money matters. Regulated companies have a lower likelihood of failing or committing fraud. Your investment is safer with them. Although policymakers sometimes go overboard, regulation (like in health care) provides trust and security.
Crowd vs professional investors
ICOs are a crowd investment, a successor to platforms like Kickstarter, Indiegogo, Companisto or Seedmatch. Thousands of backers make small contributions, usually less than 1.000 € per person, adding up to meaningful sums because of sheer masses.
In contrast, Token Sales target professional investors, often requiring a minimum investment of 50k €, or 200k € in our case. As a consequence, the firm’s focus is on the merits of the fund, not swaying the fickle crowd. A Token Sale is a blockchain-based financial offering with increased transparency for those who are aware of upside potential and downside risk.
Professional investors don’t go for a quick buck. Instead, they do their homework (called due diligence) and play the long game. The terms of a Token Sale are market standard and provide rights for Token holders. On the other hand, ICOs often provide no rights, no security and no guarantees for the crowd.
If Token Sales mimic anything about the ICO crowd mentality, it’s that they seek input from their investors who are keenly interested in what’s going on in the fund. For our Token Sale, for example, we expect to attract AI enthusiasts and those who believe our AI companies are the future. We welcome our Token holders’ ideas and feedback!
It’s important to note that use of Tokens on the blockchain, instead of traditional limited partnership interests, allows for smart contracts and compliance processes that are less costly, cross-border, fully digital, quick to implement and decentralized. Thick paper documents that used to take weeks to sort through are now uploaded quickly and understood by everyone, not just the lawyers. Token ownership is tracked transparently and securely on the blockchain. In this way, the benefits of technology used by ICOs are incorporated into the traditional Venture Capital model. This is why we believe Token Sales will change the entire investment industry.
Funding to spend vs capital investments
Companies use ICOs cover their costs. ICO capital pays for rent, team, agencies and other operational expenses.
Token Sales are designed to collect capital for investment. Token Sale capital increases the value of an underlying portfolio that can pay back profits to investors.
With an ICO, a backer hopes the product idea takes off but also that the coin will be exchangeable for a quick profit based on demand for the coin itself. This quick selloff on the secondary market is really just more frenzy. This is a much different strategy from a Venture Capital backed Token, where the underlying investments/growth of portfolio companies are indeed the focus of profit, not pump ‘n dump hype.
High volatility vs. low volatility
High volatility vs. low volatility a huge advantage for ICOs and Token Sales is the possibility of buying and selling coins and tokens on a secondary market. As mentioned above, this often creates a volatile pump ‘n dump situation for ICOs. Backers are looking for a quick profit, and startup executives are holding their breath there’s not a sell-off when holding periods expire.
For Token Sales, the secondary market simply provides flexibility and more liquidity potential than the traditional Venture Capital model that has little to no secondary market, holding periods and other ways of tying up your money. Trading Tokens on the secondary market is cost effective and efficient. VC firms can take a lesson from the ICO playbook by using Tokens, since their secondary market provides more liquidity to investors while maintaining the integrity of the underlying funds.
What is right for me?
ICOs are for those who seek the thrill. Those who like to trade daily and want super returns for high risk. ICOs can also be worthwhile for those who believe in the mission of a product and are willing to lose their entire investment to support that vision. However, be aware that up to 80% of coins may never return their capital, so only invest money that you don’t need back.
The value of Tokens will grow slower and therefore can provide more stable returns. Tokens are issued by companies with clear regulation and a long-term perspective. Token holders buy real value, not only ideas. Additionally, the incentive structures are aligned between Token buyers and the management team.
No matter how you feel about them, you can’t deny that ICOs have brought much-needed technology to the startup world. It’s time for traditional investment methods to catch-up. We truly believe that Tokens are the natural advancement of the Venture Capital business model.