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Founders are not giving up equity. Investors are not gaining ownership. It all begs a very large question: what exactly is happening here?
[inc.com] By John Koetsier Mobile economist, TUNE @johnkoetsier – Initial coin offerings have raised over a billion dollars for early stage startups in the past year. And they’ve done it with blinding speed: Status.im, a browsing/messaging app, raised $100 million in under three hours. Brave, a browser startup launched by former Mozilla CEO Brendan Eich, raised $35 million in under 30 seconds.
The pace of this almost magical wealth creation seems to be doubling on a monthly basis, according to CoinSchedule stats:
All of which begs the question: what’s really going on here? And, is this a bubble?
Or, for those who are watching the ICO scene with ever-increasingly dropping jaws: how can I do it too?
It starts with understanding cryptocurrencies
Cryptocurrencies like Bitcoin and Ethereum are digital currencies created and regulated — in terms of currency creation — by encryption techniques. In a sense, it’s simple: solve the code to unlock the cash, which can then be used to buy and sell goods and services, or be exchanged for U.S. dollars or any other currency.
Where initial coin offerings enter the picture is when a startup creates a new cryptocurrency that people buy with the more common and established Bitcoin and Ethereum:
“An ICO … provides for an unregulated means of fundraising for new cryptocurrency ventures,” says New York lawyer Gary Ross, who works with many ICO projects. “Developers sell a percentage of a previously-publicly unavailable cryptocurrency to early backers of the project in exchange for real currency or other cryptocurrencies.”
But, ICOs aren’t standard money
Even though an ICO raises funds, the “coins” are not currency. Rather, they’re code … code that forms contracts. You can think of them as tokens for value that can be exchanged for other tokens.
And, in many ICOs, “investors” have no guaranteed rights and the tokens they purchase have no purpose, functionality, or features, and they “are not an investment, currency, security, commodity, a swap on a currency, security, or commodity or any kind of financial instrument.”
Instead, tokens investors purchase in an initial coin offering can be used to transfer value within the new coin’s ecosystem, or to other cryptocurrencies’ ecosystems.
And, eventually, if you wish, to standard government-backed currency.
Most “investors,” however, seem to be simply hoping for a jump in the price of the new currency, much as we’ve seen from Bitcoin and Ethereum, the two established players.
“Individuals choose to invest in ICOs typically because they believe that the tokens will have value either in and of themselves as currency (e..g., Bitcoin) or because the tokens will have value on the platform to be created (e.g., Ethereum),” says Chicago lawyer Christian Auty.
Launching your own currency: how it works
Starting an ICO is not unlike starting a crowdfunding venture.
Entrepreneurs and startups that want to launch an ICO typically create a company, build their startup to an early stage, announce their plan to launch a token sale, and publish a white paper about what they intend to create, how they intend to do it, and how much money they need to make it happen.
Then you simply launch your initial coin offering.
It helps — just like in crowdfunding on Kickstarter or Indiegogo — if early investors get a good deal. That provides an incentive for early adopters, which then generate momentum for larger number of investors to follow. It also helps to generate positive PR and social chatter, all of which can create a groundswell of activity that will make your ICO successful.
This all sounds very easy to scam …
It all seems like ridiculously easy money, and even perhaps a bit scammy. And there are, no doubt, some cryptocurrency scams.
“Absolutely! ICOs like ‘jokecoin’ and ‘uselesscoin’ are still seeing hundreds of thousands of dollars invested,” CEO John Wise told me when I asked if there were ICO scams. He’s planning an ICO to raise money for Loci, a patent search engine, in late July.
But there are legitimate players as well:
“The big difference is that many very legitimate companies are coming down the pipeline now,” he told me. “With more companies like Loci that have a completed product, sales, institutional investment backing, SEC filings, IRS filings, and transparent due diligence packets, the scams will quickly be weeded out.”
Another company founder who is planning an ICO echoed Wise’ words.
“Scams, while not rampant, are out there, and they tarnish the image of all ICOs,” Harbourcofounder and chief strategy officer Dylan Dewdney told me via email. “To combat this, our ICO is also creating a rating system and proof of verification system along with Harbour.”
Clearly, the better ICOs are well-backed by strong teams. But that’s not always the case.
“When a ‘company’ raises $150 million solely with a white paper, you know something is definitely wrong,” Hyun Lee, a growth manager at Qminder told me via email. “It’s dumb money.”
Is this just a tulip bubble boom?
With the massive pace of ICOs launching and raising money, some are calling this boom a bubble.
“Yes, there is a bubble factor and there will be many tears along the way as the market matures and we go through the natural cycle of greed, fear and poor risk assessment,” says Token Advisors CEO Daniel Santos.
That has inherent risks for investors and speculators, says lawyer Christian Auty:
“There is no question that many of the ICO’s receiving investments now will not succeed. This is not to suggest that they are scams necessarily, but the fact remains that many new ventures in any sector fail and this will be the case with blockchains as well.”
The problem with bubbles, of course, is that they pop.
This is exactly what happened with the mortgage crisis of 2007 to 2010 and the dot-com boom and bust from 1997 to 2001. In the process of the dot-com bubble, hundreds of thousands of investors lost huge sums of money, companies were destroyed, and workers lost jobs. In the housing crisis, the entire global economy suffered as millions lost their homes.
Andrew Zimine, CEO of Exscudo, a “gateway between cryptocurrencies and the traditional economy,” doesn’t mince any words:
“The situation when some entity is traded on the market without any relation to reality reminds us of the derivatives of the US mortgage crisis, the ‘popping’ of which affected the world economy for a few years. So when the market sees the light about real values this bubble will pop. And that is not a question of years but of months.”
Of course, startups that raise capital via cryptocurrencies are not just taking bubble risk, they’re also taking exchange risk.
For example, Tezos raised $220 million in four days, but when Bitcoin went down in value, it dropped to $142 million, even as the company continued to raise. As Bitcoin recovered, the amount went back up … but the risk remains.
And even “secure” and “mature” cryptocurrencies like Bitcoin and Ethereum could be dragged down in the wake of a massive loss of confidence in ICOs in general. Just this past week, the entire cryptocurrency market cap dropped $13 billion in a single day, thanks largely to disputes within the Bitcoin community over how to scale the technology for the future
So: should you launch an ICO?
If you have a real company and a real product — or one in the making — an ICO can be a great way to raise significant amounts of capital quickly.
But (and this is a completely personal piece of advice): I would take the funds raised and transfer them to a more secure form of storage very, very quickly.
Although cryptocurrency fanatics tend to look down on government-backed currencies like the U.S. dollar, calling them “fiat” currencies, they are generally a lot more stable container for wealth at this point.
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