Where there’s smoke, there’s fire. Initial Coin Offerings, or crowdsourced token launches as lawyers generally call them, are on fire. After plodding along at $26 million in 2014, $14 million in 2015, and $222 million in 2016, ICOs raised a stunning $1.6 billion in the first seven months of 2017. Of that, nearly half came in the last several months in conjunction with a handful of headline projects like Tezos and EOS. Since I wrote a deep-dive industry analysis on ICOs on July 7th, ICOs have since raised another $400 million. That’s almost as much as the $525 million total that was raised from venture capitalists for all blockchain and Bitcoin startups in 2016.
ICOs are themselves becoming an alternative fundraising mechanism for startups instead of raising early-stage venture capital. They rely on blockchains, the organizational structure that first emerged as part of the architecture for the Bitcoin digital currency. A blockchain backstop is intended to ensure that the ownership of these assets can be certain at all times, even as they are easily tradeable without the involvement of a traditional intermediary like a stock exchange.
As a source of capital, they sit somewhere between VCs and Kickstarter. Unlike traditional equity investing, in which an investor buys stock in a company, “investors” instead buy tokens. These are merely a software abstraction but they may be entirely functional, like a casino chip for a not-yet-existing casino. Or they can have attributes more closely related to securities and investment contracts, since some promise to issue dividends. But tokens are generally not a claim on the ownership of a company, and are so new that they are not subject to well-established corporate law.
Nothing is sure about the legal status of these offerings, other than that law firms are getting paid to find workarounds to existing regulations. Regulators are also chewing on how to create useful legal definitions without stifling innovation. Not surprisingly, financial havens Singapore and Switzerland are cryptoeconomy friendly, while the United States and the rest of the Western world are generally attempting to implement restrictive consumer protection and securities laws governing how tokens must be issued and managed. Russia and China are looking for ways to muscle in to gain government control of public blockchains in order to give their economies a global competitive advantage. Innovation has already begun in the U.S. as well, with Delaware recently instituting a law, as Techonomy reported recently, to legalize the use of blockchain for tracking financial transactions (though it did not directly address ICOs).
Easy Money and Crypto Whales
So where is all this cheap money coming from? Underneath the daily turbulence of volatile virtual currency markets are the crypto whales. These investors in some cases are early Bitcoin developers, whose $10,000 in Bitcoin may have become $10,000,000 over the past 5 years. Or perhaps they are scaled proof-of-work miners, the groups that have up to now done the computational heavy lifting that has created security for Bitcoin transactions. Many of those have amassed large reserves and are greedy for more. (Much of the “mining” has taken place on computer arrays in China.)
Lately, an increasing number of ICO investors are entities funded by traditional investors in alternative asset classes. Bain and Fortress, for example, have started the Digital Currency Group and Pantera Capital respectively. New cryptocurrency hedge funds are popping up like mushrooms, taking advantage of wild enthusiasm, inefficient existing exchanges, and the many inexperienced hands involved in many of these emerging ecosystems. And of course, frauds and scams proliferate as all sorts of characters see an easy way to raise money.
Money is cheap in the cryptoeconomy, in part because so much of it comes from capital gains acquired out of the Bitcoin economy in the last 2 years. As overall cryptocurrency markets (including Bitcoin) surpass $100 billion in capitalization, some proportion will naturally look for diversification.
Just assuming that newly wealthy Bitcoin owners want to diversify and move a mere 5-10 percent into some other asset class would thus mean roughly a $5-10 billion demand for ICOs. That’s still a lot of room to go from a group of atypical investors not particularly focused on traditional concepts of valuation and fundamentals.
Using traditional venture capital to grow a company might mean that an early stage company with a prototype and team of five developers would raise $1 million in a seed round at a $3 million valuation. But if that same company were instead doing an ICO using a cryptocurrency they created themselves, as is often happening now, that team might grab $50 million in if their website is well-designed, their advisors well-known on social media, and their idea half-believable. And they get to keep all the equity. Typically, ICOs are raising not dollars but Bitcoin and Ethereum, the other most popular and successful existing cryptocurrency.
Popping Bubbles and Sentient Ecosystems
Every traditional cash-flow-concerned investor, accountant, and lawyer has been predicting for some time that the music must necessarily be about to stop. Aren’t these things scams, they ask, perpetrated by a shadowy network trying to do business away from governments and without regard to traditional anti-money laundering regulation? Surely, they say, these early-stage projects will burn up their billions of free cryptocurrency, go out of business, and get caught up in class-action law suits.
Yes, but. There were nearly 900 tech company Initial Public Offerings between 1997 and 2000, and 86 percent of them disappeared by 2010, according to data from McKinsey and Autonomous NEXT. And yet, Amazon, Netflix, and a not inconsiderable number of other now-important companies were born during that turbulent moment. Today, Amazon threatens all of retail at a nearly $500 billion company value, while Netflix has annihilated its Blockbuster competitors and has its own $70 billion valuation. The infrastructure that the public blockchains and ICOs are building today certainly may fizzle, burn out and disappear. Or they may instead become the foundation of our future economy.
Forgive me for you may consider science fiction, but here is one such vision. While the traditional economy will continue to struggle to accept Bitcoin and Ethereum as useful money, the alternative cryptoeconomy will continue to grow on its own. Instead of trying to find a way to bridge into the real world, it will build a world entirely of its own.
Just watch the games, exchanges, banks, social networks, and virtual reality companies already being built on crypto, not on the U.S. dollar. And as artificial intelligence automates as much as 80 percent of the human labor used in today’s jobs, and relies more and more on smart evolving software ecosystems, it will need its own internal currency and utility functions. Blockchain-based AI agents will interact primarily with other blockchain-based AI agents, not humans, in order to keep this new economy humming. The majority of economic activity may begin to occur entirely outside the realm of traditional human productivity. Today, we may be seeing the beginning of those economic spheres evolving on the Internet, with ICOs an integral element of the establishment of this new economy.
Where there’s smoke, there’s fire.
Lex Sokolin is Global Director of Fintech Strategy and Partner at Autonomous NEXT.