An Initial Coin Offering (“ICO”) is a method by which entrepreneurs raise money via cryptocurrencies. In the typical ICO, a company floats a proprietary digital token on a network such as Ethereum and accepts Bitcoin, Ether, or another cryptocurrency in exchange. These new tokens represent either shareholding or participatory privileges in the fledgling business. Ethereum has been a game changer for such enterprises, having served as a platform for most issuances.
These ICOs represent the beginning of a fundamental shift in how high-technology businesses are funded. In the past four decades, angel investors and venture capitalists got behind great ideas and funded them. Private equity funds then took up the gauntlet in second stage funding and ran to the IPOs. By the time these companies listed on stock exchanges and shares made their way into the hands of individual investors, the venture capitalists and the private equity funds had locked in massive returns on capital. Few individual investors could hope to match the kind of profits that early investors generated. Well, one could certainly invest in a Private Equity fund, but in most regulatory jurisdictions, you would need about a million dollars to join.
The game is changing. Today, lay investors with a rudimentary understanding of how Cryptocurrencies work have the opportunity to make early-stage investments with as little as USD 100. The ICO revolution puts early-stage investing and its profit opportunities within the reach of ordinary investors. For instance USD 1,000 invested at Ethereum’s ICO in 2015 would today be worth USD 230,000!
There are risks though. Venture capitalists are high risk takers, and are comfortable with the possibility that their entire investment in a particular company may be lost. Even Private Equity funds, though somewhat more conservative, play similar odds. For an individual investor with a focus on capital preservation, this may be a poor thesis on which to build one’s retirement portfolio, but this does offer a credible and low-cost opportunity to add some high-reward risk to a conservative portfolio.
The fraud risks are immense. Information on internet directories suggests that the time of writing, there are over 100 companies at various stages of the ICO process. Naturally, performing adequate due diligence on these is a huge challenge. The only resources that investors have are the LinkedIn profiles of the principals of these companies and a webpage that contains information about the supposed product. As the frenzy kicks up, it is entirely possible that fraudsters conduct an ICO and divert the proceeds. The decentralized nature of Blockchain enterprises will make such fraud impossible to investigate or prosecute with the current state of Law, as investigative agencies lack jurisdiction across international borders.
Regulatory risks abound too. Though multiple governments are warming to cryptocurrencies, these are largely considered to be a fad among technology enthusiasts. As interfaces with the traditional financial systems increase and cryptocurrencies become more influential in moving markets, the possibility of stronger regulation increases, and “investments” in these tokens may be challenging to liquidate.
The biggest risk though, is that most Blockchain startups are based on arcane concepts that are beyond the understanding of the average person. While these systems and platforms represent engineering genius, as a utility, they are irrelevant to 90 per cent of the world’s population. Furthermore, many of these projects are conceptualized and executed by young and passionate entrepreneurs. While their technical skills and intentions are beyond doubt, it remains to be seen if their business skills are up to the mark in riding the wave of disruption that they are about to unleash. Browsing through these ICO Prospectuses (or white papers as they’re called), it’s obvious that most of them are aimed at solving fundamental problems related to service delivery, financial inclusion, and even healthcare – however, whether these platforms will actually make the change that they envision is up for debate.
Cryptocurrencies, as an asset class, have delivered outstanding returns in what seems to be blowing into a bubble. Thankfully, newer digital assets such as Ether, Gnosis and Aeternity tokens have a functional aspect that will add fundamental value to them as time passes. For instance, Bitcoin has notional value like paper money, and there is a possibility that the currency will collapse once mining it becomes unprofitable. Conversely, Ether is the sole mode of payment of transaction fees for a growing number of applications on Ethereum. As these apps increase in number and grow in user base, the fundamental value of Ether will increase.
In conclusion, if the idea of owning a piece of a high-potential technology business is appealing to you, looking up ICOs may be worth your time.
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