How ICOs Changed the Way Companies Are Built

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With cryptocurrencies now becoming a household name, investors are starting to look into plays they can make that are more off the beaten path. The market for initial coin offerings (ICO) offers just that, albeit with a dash of risk that traditional initial public offerings (IPOs) do not offer. 

Restrictions on Venture Capital

If you want to make money in Silicon Valley, you need two things: connections and capital. Connections are required, because a lot of projects end up oversubscribed anyways, and you need an advantage over many of the other investors. It also helps if you can provide aid to the company additional to just giving them your capital (e.g. advising on product, marketing, or hiring). The unspoken rule is that you do usually have to be located in Silicon Valley to do well as a startup investor.

Large amounts of capital are also required for regulatory and convenience reasons. Venture capital is considered to be very risky, and as such, it is generally restricted to be accessible only to accredited investors, who must have either an income greater than $200,000 per year or a net worth greater than $1,000,000.

Additionally, most companies didn’t have the bandwidth to deal with having hundreds or thousands of smaller investors, because of the meetings, due diligence, and paperwork required. It was much easier to take larger investments from a small group of people, and keep things simple.

Democratizing Venture Capital

For both these reasons, the number of people who have benefited from the gains in massive technology startups have been very few. Now, with ICOs the possibility arises that investors may join in on the gains, thus democratizing the gains and spreading them out throughout the country and world.

The ability to make asymmetric bets (wagers where there is a high possible upside, but limited downside) has been restricted for a long-time. Lottery tickets are the closest example of a purchase you can make that could result in a 10,000x return, but with the downside capped at the size of your investment.

In a world where income inequality and wealth distribution is a constant source of conflict, the spreading out of these returns could prove to be increasingly important for making sure it doesn’t get worse.

Structure of an ICO

As Hacked readers are no doubt aware, an ICO generally occurs when a cryptocurrency startup wants to raise money. They either have something they’ve already built, or they have a white paper that outlines their business plan and how much money is needed to create and scale the project.

The ICO is carried out by exchanging fiat currency or other cryptocurrency for the “token” in question. A token is considered equal to equity in the company in this analogy, although most firms contend that the tokens are not securities for regulatory reasons (see: Howie test).

ICOs are popular for both investors and traders, as there is an expectation in an increase of market price after the ICO, as well as high volatility (which traders love). Looking at a website like Coin Schedule, you can see the amount of hype that is floating around ICOs at the moment.

Recent Trends in Fundraising

As ICOs become more popular, many companies are going through similar experiences during the fundraising process. Some companies are asking for such high valuations right off the bat that there is little upside for the investors, and a greater chance they will lose money.

If excessive amounts of money are raised before a product has even been built, there is much greater risk in the project. Additionally, there are fewer investors who have made enough money on a project to justify staying invested during a bear market. Compare this to Bitcoin, where some have owned it since its price was in the single digit range, and you can see the difference.

Projects that are heavily inflated upon ICO’ing are losing out on the longer-term opportunity, unfortunately. Some people forget that the most well-known cryptocurrency of all began using an organic mining process rather than an ICO. Although there is almost no money inflow when this is done, it creates a rabid community of supporters who believe in the product, rather than short-term speculators. This solution would not work for all ICOs, but for some, it might be a viable solution.

More than Just an ICO

The ICO is the most well-known part of the process, but often these projects will require money to get them to that point. This is where the Pre-ICO and Pre Sale come from. The Pre-ICO is similar to the “friends and family” money that any business starts off with. It is what is required to get the project off the ground. Then you have the Pre Sale, which is where larger investors who are going to help build the companies product and profile get to buy tokens at a lower price than the ICO price in exchange from their help.

Finally, and it is very necessary to make this clear, all of these projects carry a ton of inherent risk, and a significant amount of research should be undertaken before any investment is made. Where many of the past IPOs had undergone a massive amount of due diligence and had backers who understood the technology, we are seeing many investors hop on the investing train without fully understanding how everything works.

Featured image courtesy of Shutterstock.

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