A new method of fundraising exploded in 2017: the initial coin offering (ICO). According to a tracker at CoinDesk, more than $3 billion has been raised in ICOs to date, almost all of it in 2017. This despite the fact that ICOs are high-risk, and in many cases likely fraudulent.
In an ICO, an Internet startup raises money by selling tokens that can be used within its own ecosystem. Investors buy the tokens using established cryptocurrency like bitcoin or ether, the token of the Ethereum network.
The future value of the token should go up or down based on the perceived value of the company, not unlike a stock. But unlike buying stock, investors in an ICO typically have no voting power and no ownership in the company. You only have your tokens, which may prove worthless. And most of the companies raising hundreds of millions of dollars in an ICO have not actually launched a business yet when they do their ICO, but have merely published a white paper detailing their business plans.
One example that provides a cautionary tale: Tezos, which set a record when it raised $232 million in its ICO this year, but is now at risk because of infighting among its founders and a class action lawsuit.
And yet: Tim Draper, an influential Silicon Valley venture capitalist and cofounder of the firm Draper Fisher Jurvetson, has hopped aboard the ICO train.
On a panel this week at Web Summit 2017 in Lisbon, Portugal, moderator Connie Loizos of StrictlyVC asked Draper, “How can people invest safely in these things?”
Draper answered: “Oh, safety is not in the ICO vocabulary. If you’re investing in ICOs, you better understand the entire cycle of the coin, the token. Is there a real use for it, is there a reason to buy it? How does that whole cycle work, is it a valuable cycle? Is it one that’s going to increase the value of the token… and who are the people behind it?”
In too many instances, those questions are unanswerable. But people are buying in anyway, handing companies millions, often in a matter of minutes. And it’s not just crypto companies doing ICOs: Kik, a chat app that launched in 2010, launched an ICO to create a token, Kin, for use on its app. Kik raised $100 million in its ICO.
“The cool thing about ICOs is that they’re banking the unbanked,” Draper raved. “Banks are so heavily regulated that if you want to put a small amount of money, 3 euros, into a bank account, the bank will push you away because it costs them $200 to handle the regulation of your account. So all of a sudden, we’ve created a liquidity for the rest of the people of the earth. And this is a big deal, and it’s so exciting.”
On raising tens of millions in a token sale before product market fit, many entrepreneurs now say "why not if I can?"
It may become clear why not after several large-scale blowups
— Nick Tomaino (@NTmoney) November 8, 2017
Joseph Lubin, cofounder of Ethereum (the backbone on which most ICOs are offered), was on the panel with Draper and cautioned that companies ought to have multiple, smaller ICOs when they need money rather than all at once: “I think that an ICO should be just the first of many offerings, so that people can raise money as they need it whether than raising it all at once. If I raise the $240 million that Tezos raised, and it sits in this weird, convoluted legal structure in Switzerland, what do you do with that? How do you manage that money when you only really need $2 million or $3 million a year to run the software?”
For now, the best recipe is to only invest in an ICO if you feel certain you’ll want to use the platform you’re investing in, and thus use the token you’re buying, rather than buying and holding.
“People who are interested in buying a utility token,” Lubin said, “should be buying that utility token for the usage of the platform that it enables.”
Disclosure: The author owns less than 1 bitcoin, purchased in 2015 for reporting purposes.
Daniel Roberts covers bitcoin and blockchain at Yahoo Finance. Follow him on Twitter at @readDanwrite.