This article examines the hot trend of initial coin offerings (ICOs), which have transformed the financing markets in the past few years. As yet there is limited corporate venture capital activity within ICOs, but this is starting to change with a number of large corporations considering their own ICOs and with the rise in the use of ICOs for financing taking a bigger share of the venture capital market.
What is an ICO?
An ICO, or token sale, is a fundraising tool in which a new cryptocurrency project, typically a blockchain startup, sells part of its new cryptocurrency tokens for cryptocurrencies of immediate liquid value, the most notable two being Bitcoin and Ether, the unit of cryptocurrency used on the Ethereum blockchain. This is typically conducted over a predefined period of a week, a month or in some cases longer. The ICO will typically sell only a portion of the overall cryptocurrency in circulation and the target investment level is typically set as a goal in fiat or other cryptocurrencies. If the ICO is popular and more is raised than intended, it is said to be oversubscribed. Sometimes a cap will be set, and when that cap is reached, the ICO will complete before the defined end-date.
ICOs provide a way for cryptocurrency project creators to raise money for their operations, an alternative to turning to traditional venture capital or angel investment. Tokens created in an ICO can be traded easily, much like shares created in an initial public offering (IPO), which traditionally has been reserved only for well-established respected startup companies. However, unlike shares, tokens created in ICOs do not confer ownership rights and are not regulated or registered with any government organisation, and therefore usually hold no investor protection. The investor in an ICO hopes that the project’s success will cause the tokens to rise in value, a premise that results in much market speculation.
Cryptocurrencies
Several tokens offered in ICOs will not create and maintain their own blockchain. Most will use meta-tokens built on top of a branch of the Ethereum, Bitcoin or other blockchain source code. This helps simplify the token-creation process.
The chart overleaf shows the amount raised by ICOs overlaid on the market capitalisation of the 10 largest cryptocurrencies in the world. As can be seen, both Bitcoin and Ethereum, the two most commonly used cryptocurrencies in ICOs, have well outperformed the rest of the cryptocurrency market and have increased substantially in value over the past year. Part of this performance can be attributable to the booming ICO market.
A disruptor of venture capital
The rise of ICOs as a funding mechanism has opened new avenues of project financing for startups and other projects. The traditional financing model, in which only institutional players, high-net-worth individuals, venture capital firms and other insiders can participate in financing new ventures through restricted-access share purchases in unlisted companies, is being disrupted. The ICO promises to democratise this model by opening these investments to a much wider audience, which in turn could make the venture capital financing model for startups less used or even obsolete.
This is already happening – the numbers speak for themselves. The ICO market is booming, with no sign of slowing anytime soon. Tens and hundreds of millions of dollars of capital have been raised by projects backed by little more than a whitepaper describing the intended cryptocurrency-backed startup project.
Novum Insights has tracked more than 1,000 ICOs to date. Last year 52 notable ICOs were completed, whereas in the first eight months of this year, 216 have been completed. In the short time of their existence, ICOs have attracted $2.6bn in investment to date – surpassing all venture capital funding in the blockchain space. In the first eight months of this year, ICOs have already raised a staggering $2.2bn, roughly three times that of traditional venture capital investments in blockchain startups. There is no doubt this is a paradigm shift.
ICO investment analysis
At the start of last year there were only a handful of notable ICOs, Ethereum itself being one of them. At the end of the year, 24 had already raised more than $1m, the largest being Waves, which raised $16m. At this point, no ICO from 2016 is among the 10 largest ICOs – none is even in the top 20. The largest have taken place this year. EOS, with an estimated $289m raised, is the most funded ICO yet, even as it continues to raise more funds. Filecoin, with $252m raised, including its pre-ICO of $52m, closely follows in second place.
The future of ICOs
It is currently hard to judge the success of the ICO market, as the majority of funds have been raised within the past year and it takes many years to see the success of a startup project. Time will tell how many companies that have raised funds through ICOs in 2016 and 2017 will have survived, but there is no sign of the market slowing.
One can only speculate on the impact of regulation. Will early regulation benefit the long-term health of the market? Will implementing regulation too early and too strictly deflate the bubble or kill the concept? Will this be the case in China with its latest ban on cryptocurrency trading and raising ICOs? Can regulation be implemented in some jurisdictions and not others without creating a regulatory arbitrage and driving companies to less-regulated markets? Will there be a global standard and how could it be enforced? When the regulations come in, will they be backdated to include companies that have already completed their ICOs and could hence incur huge fees, as seems to be the case in China?
Whatever the answer, similar to the dot.com bubble, most likely there will be a market correction soon, and many companies born from this boom in ICOs will crash as fast as they have risen. However, a handful will rise to the top and stay there, to create the next generation of Googles and Facebooks.
This is an edited version of one of the ICO chapters in market monitoring company Novum Insights’ blockchain special report. Contact toby@novuminsights.com for more information. Lewis is a former editor of Global Corporate Venturing.