Tuesday, July 18, 2017

Initial Coin Offerings: High-Risk Big Money for Startups

Initial Coin Offerings (ICO's) have been raising record funds at mind-blowing speeds. A browser startup raised $35M in under 30 seconds. Last week, Tezos, a new blockchain project, raised $232M, making it the largest ICO to date. Startups have raised over $1,3 billion in digital coin sales this year.

An ICO is an unregulated process that allows to raise funds for new cryptocurrency ventures. An ICO's big advantage for startups is that it allows to bypass the rigorous regulated capital-raising process required by banks or venture capitalists. There is no need to register an ICO with the SEC, no obligation to deal only with accredited investors, no need to verify the source of funds. In an ICO campaign, some of the new cryptocurrency is sold to early backers of the project in exchange for other, more established, cryptocurrency (usually Bitcoin) or actual money. In other words, they give you some new crypto bucks in exchange for real bucks or Bitcoins. You buy because you hope the new crypto offering will have value as currency.

But when they are offered to public, they are not currencies. They are more like tokens that can be exchanged for other tokens but give investors no guaranteed rights or functionality.  This way they can remain unregulated because they avoid falling under the "securities" definition of law.

So, how to launch an ICO where you get real currency in exchange for tokens of no guaranteed value or rights? It's similar to crowdfunding. You get your startup to an early stage, announce a plan to launch a cryptocurrency sale, publish a white paper about what you will create and how much money you need for it. Better structured startups can also publish an Offering Memorandum.You then register your token sale on a platform like CoinList (it's like Kickstarter for ICO's). You can offer incentives for early investors, so that they generate momentum for a larger number of investors to follow.

Of course, a number of ICO's are scams. On Monday, hackers stole $7M from an ICO. I is possible that there is an ICO bubble (when we read about startups raising $100M+ based on white paper alone).

A number of ICO's receiving investments will not succeed, which is true for all types of new ventures. There is also volatility problem. For example, the aforementioned Tezoz that raised a record $230M in four days, saw it drop in value to $142M when Bitcoin went down in value (although recovered later).

So, is it worth launching an ICO? It can be a great way to raise significant amounts of capital quickly. But it's probably a good idea to transfer the funds raised into a more secure and stable form of storage.