Many people within the fintech industry have heard of ICOs, but how many can honestly say they understand how they work? Our guess – not many.
One of the fastest growing markets within fintech in the last couple of years has been blockchain and cryptocurrencies. Trying to understand how any of it works, let alone attempting to take part in the so-called ‘blockchain revolution’, has so far been reserved for those in the know. However, the winds of change have started to blow with the emergence of a new way of raising funds – initial coin offerings (ICO). While the particulars behind ICOs are just as difficult to get your head around, developments in this field have the potential to create a more accessible and inclusive global financial market and help blockchain change how all of us live our lives.
According to research by Stellar and LHoFT, organisations have raised over $1.8 billion through ICOs since January 2017. Findings in the research suggest “The ICO has skyrocketed in popularity as a fundraising model for new businesses, particularly those in the blockchain industry. The success in fundraising through ICOs is driving more and more organisations and initiatives to use the model as a means to achieve their funding objectives; many ICO campaigns have raised tens or even hundreds of millions of dollars.”
What are ICOs?
Stellar and LHoFT define an initial coin offering as an event in which an organisation sells digital tokens for the purpose of obtaining public capital to fund software development, business operations, business development, community management, or other initiatives. A token is a cryptographically secured digital representation of a set of rights. Depending on the token, this could include the right to access and use a network or software application, the right to redeem the token for a unit of
currency or a good, the right to receive a share of future earnings, the right to vote on decisions made by the organisation, or more. However, most ICO tokens currently do not offer voting rights, ownership rights, or rights to a share of future earnings. Instead, they have utility: they convey rights to access, use, and/ or consume the organsation’s service or product.
ICOs provide an alternative, accelerated option to raising funds for a business. While the usual A-B-C-D fundraising rounds can take years to complete, some ICOs, have raised millions in a matter of weeks.
While Filecoin and Tezos have seen the most money raised in the shortest amount of time, they are far from being the only ICOs who have benefitted hugely from this innovative method of fundraising.
In June 2017, the Bancor Foundation raised $153 million in less than three hours, which, at the time, made it the largest token sale ever. Bancor aim to revolutionise the way cryptocurrencies are currently traded by cutting out the middleman who usually matches buyers and sellers, and using instead smart contracts coded into the token to do the matching automatically.
In the same month, Status (a decentralised interface for accessing ethereum cryptoassets) raised $99 million in a matter of hours. Ethereum itself was one of the first big ICO success stories. Back in 2014, the blockchain-based computing platform raised $18 million in 42 days. The beauty of the blockchain and cryptocurrency technology is that it opens up the market to players from outside of the world’s strongest financial strongholds. The decentralised nature of the tokens and the global interest in investing has meant some unlikely stats have emerged from the space.
So, what’s the catch?
The downside of quick funding is the risk involved. The lack of regulation in this rapidly growing market has led to it being dubbed the ‘Wild West’ and the presence of more than a few ‘cowboys’ operating in the space, which has caused some investors to lose out.
One of the most outrageous of the Wild West stories is UET. This ICO raised $40,000 in three days, which may not sound like a lot, until you realised that UET stands for Useless Ethereum Token. That’s right, it is a ‘joke coin’. Such is the hype surrounding cryptocurrencies and ICOs that buyers were not deterred by (or perhaps didn’t even bother to read) UET’s sales pitch: “UET is a standard ERC20 token, so you can hold it and transfer it. Other than that… nothing. Absolutely nothing.” While UET could be considered a success story (depending on who you ask), the reality is that 99% of all ICOs will fail. Investors who are not cautious with their money, are almost guaranteed to lose out. This was the case for another joke coin, which became a very serious proposition, before failing shortly after. Dogecoin started out as a joke in 2014, but quickly amassed a passionate community around it, which became known for using the currency in charitable acts. After coming out of two hard forks stronger than even, it all came crashing down when the founder of Dogecoin exchange Moolah shut down the service and disappeared with everyone’s money. The coin crashed and has not recovered since. Dogecoin is only one of many examples of scammers taking advantage of the excitement surrounding cryptocurrency and the lack of regulation.
One of the most notorious cases of this is PayCoin. Launched to great promise in 2014 by Josh Garza and GAW miners, the coin’s white paper called for new variations of blockchain technology that would produce a new breed of cryptocurrency. However, Garza ended up converting PayCoin into a generic altcoin clone to allow him to push it into the market faster. While the launch of the coin went without a hitch and it quickly became one of the largest cryptocurrencies in the world, it was not to last. GAW repeatedly failed to fulfil its promises to buyers and the currency began to sink as people lost faith in its merit. The bitter end came in 2015, with the shutting down of GAW, a federal investigation launching and Garza fleeing the US. While the coin’s community have made valiant attempts to restore its value by redesigning it to meet its original specifications, they have not been successful thus far.
Unfortunately, there are many more stories of people who have lost both money and face due to bad ICO investments. However, with new players joining the cryptocurrency game daily, authorities have realised it is time to start regulating activity.
According to Mihai Ivascu, CEO of blockchain-based platform Modex “there’s a clear need for regulation in this space, because the top ICOs with the proper teams, who are spending a lot of money to do things properly, are affected by what the cowboys are doing. This is why we are creating a trade organisation now for ICOs and we are joining forces to protect the contributors in this space.”
Another issue appears to be that the platform has become too big for its boots. Bancor’s record-breaking sale created so much congestion in the ethereum network that some providers reported hours-long queues to complete transactions (ether, the coin of cryptocurrency ethereum, was the currency used in the sale). Bancor recommended buyers use MyEtherWallet and the service, which was not scaled to deal with that level of traffic, couldn’t cope with the demand. The same happened during Status’ ICO, with the ethereum network overloading, causing many transactions by would-be token buyers to freeze, stall or fail, and an avalanche of complaints to flood in. These blockages have caused many sites and exchanges to distance themselves from ICOs and even remove ether and ERC-20 tokens from their service altogether. Unless a sustainable solution can be found to accommodate large scale token sales by top ICOs, the practice may be brought to its knees by the lack of available platforms on which to operate.
The future of ICOs
While, up until now, ICO fundraising has mainly been done by small blockchain based early-stage startups, as the technology and resources around it continue to grow and mature, it is likely more established companies, including those with an already thriving project, will join in. Mihai Ivascu says – “we’re going to see huge loses in this space, but we’re going to see a clean-up in the next five or six months. And that will come in two ways – the regulators, and also the maturity of the investors – they will start to see that you need more substances. And what we, and two or three other top ICOs, want to do is raise the bar a lot, raise the barrier of entry – so, you need to be able to spend a minimum of 1 million in three or four months in order to run a proper ICO, you need to have proper staff, proper marketing, proper communications – you need to run your own events and all of that stuff. So, it has to be a big boys’ club, not a kids club.”
With more companies taking on the technology and more ICOs entering the space on a regular basis, it seems that cryptocurrency propositions are going to become more widespread and available for a wider audience to benefit from. The
upcoming regulations will hopefully help to stabilise the market, removing some of the risks which currently plague it.
If you haven’t dipped your toe in the ICO pool yet, but are considering it, now might be the time to take the plunge. The Fintech Times is currently developing a framework for a rating system to help you pick the best investment out there, so make sure you stay tuned.
Managing Editor of The Fintech Times