Blockchain is the most disruptive technology of this century. A premature statement, perhaps, given we’re only 17 years in, but I stand by it for now. Distributed ledgers will bring efficiency and security to many sectors, but so far none so much than to the financial industry. Beyond cryptocurrencies, smart contracts, money transfers and many others, lies the tokenisation of any financial asset that allows virtually anything to be traded, including shares in early-stage ventures. Enter the ICO, the modern day equivalent of an IPO for companies that don’t want the burden associated with listing on a regulated market, but do want the hype (and a lot of it).
Backing up just a bit, an initial coin offering (ICO) is actually a misnomer for most of the fundraises making headlines. The term ICO initially applied to the launch of new cryptocoins, but the more common launches you hear about today relate to shares in a business, not a coin, and therefore should really be referred to as ITOs – initial token offerings. Unfortunately the media, and hypepreneurs, have latched onto coins – maybe it gives them more street cred, I don’t know. So we’re stuck with ‘ICO’, but bear this in mind: when you invest in an ICO for shares of a business, regardless of the fact that you are able to buy and sell those shares on an exchange, just like bitcoin, litecoin and all the other coins, you don’t own a coin and you’ve not invested in a cryptocurrency.
Now that we’ve got that straight, let’s go back to crushing on the possibilities that blockchain/ICOs bring to early-stage finance. For companies, an ICO is a way to bring your fundraise to a global audience. Issuing an ERC20 token – the current standard for ethereum-based tokens – enables a company to list shares on the rapidly increasing number of exchanges setting up to allow the trading of tokens. In theory, a small mom and pop show in Fraudmekistan could list and subsequently be traded on exchanges in every part of the globe, in real time. Putting aside the logistical nightmare of trying to coordinate the effort, just imagine the cost of trying to list on all the publicly traded markets around the globe. Then add in the cost necessary to maintain the required reporting for each market, the headache of passing resolutions or issuing new shares on each market, and the nightmare grows.
Even looking at it with a single market in mind, the cost and burdens associated with being on a regulated listed public market put off many established businesses from going through the process, let alone early-stage ventures. Issuing a token is more time- and cost-efficient, and has the added benefit of global exposure (to some degree), making the appeal of ICOs almost too good to pass up. That’s why so many companies are turning to ICO as a panacea for all of their early-funding requirements. And, investors are just as excited.
The main problem investors face when investing in early-stage investment opportunities, other than a high likelihood of most of them failing, is the ability to cash out when they think the time is right. Angel investors are often locked up for five to ten years, sometimes even longer, in businesses that are doing well as there is no easy way to sell their shares. Sure, they can go door to door trying to find a private buyer, but generally they are forced to wait until the IPO or trade sale takes place and then they can cash in on the exit.
Secondary markets have been tried and so far they are essentially bulletin boards for people wanting to buy or sell. It’s a very manual process. The beauty of listing tokens is that the secondary market is effectively inbuilt. The companies that provide the ICOs are also geared to being exchanges and any other exchange that can offer the ERC20 tokens is able to offer their members your tokens; the market grows.
The big but
Technologically, the ICO is the way forward. But – and there is a massive ‘but’ – there is no real sense of regulation or process in existence on the due diligence side. Much like when equity-based crowdfunding first started, people bought into the hype and they paid over the odds for shares in companies that promised the world, but have so far not delivered an incredible amount.
Investors are being drawn in by the sexiness of the technology that the ICO happens on and not necessarily what the underlying company is doing or what they are capable of. This really worries me. Project viability seems to be slightly overlooked as investors plough into the hype of owning a strangely named cryptocurrency that in truth is not a currency but a token!
The SEC has already filed two causes against fraudulent ICOs and I can only imagine how many more will follow suite. China has banned ICOs for lack of transparency on who is raising and who is investing.
Things need to change, and they will – just like what happened with equity-based crowdfunding – in order to ensure the ICO’s reputation is not mired to the extent that the technology gains a bad reputation (not blockchain necessarily, but the issuing of tokens on a blockchain network). Lessons learned from equity-based crowdfunding need to be implemented, lead investors should be brought in, structured due diligence conducted and screening (KYC/AML etc) must be part and parcel of the process.
I’m optimistic that these changes will come into play, but until they do, I’d be sceptical of jumping on the bandwagon, even if there is the odd case where investors do make a fortune. Just because there is a secondary market doesn’t mean there are investors who will buy your shares at a higher price – or at all.