• by William Mougayar
    Venture advisor, 4x entrepreneur, marketer & strategist. I live in Toronto, curate a lot, blog a bit, and help startups.

Watch Out, the ICOs Are Coming

Comes Everybody imageFirst came Bitcoin, then blockchains arrived. Cryptocurrencies and decentralized protocols followed.

Now, the ICOs are coming. And the ICO funds are also arriving. And a crash will be forthcoming.

To paraphrase Clay Shirky’s famous book title, Here Comes Everybody, a moniker describing how crowds form online as quickly as wildfire.

New tokens are being listed every week. Dozens of startups are planning their ICO’s, and funds that specialize in these tokens are feeding the investment and speculation frenzy. Even websites offer out-the-box services to create, promote, run and list your ICO with, describing the process to being as easy as microwave cooking.

The regulators are watching, mostly without taking harmful actions (so far), which is interpreted positively by startups who would rather ask for forgiveness than permission. Let’s do more. The door is open, and no one is shutting it.

Companies behind these ICOs are promising the moon and the stars, putting out polished websites, white papers, advisory boards, Slack channels, GitHubs, peppering with some legalese language, and topping it with the full dressing support enchilada they can think of; in order to appear as legitimate, as hard-working, as smart and as credible as possible.

Don’t get me wrong. ICOs are a good alternative funding model that holds an exciting promise, as I’ve explained in How Cryptocurrencies and Blockchain-based Startups Are Turning The Traditional Venture Capital Model on Its Head, in addition to outlining some steps and criteria on how to evaluate them.

But I see some issues with the current environment.

Startup diligence is pretty light

Diligence is tilted towards appearances, parabolic claims, white papers, a minimum of legal and lots of online dressing-up. There is relatively little involvement from traditional venture capitalists who typically dispense startup investment. VCs aren’t always right, and granted their model is being disrupted by the ICOs, but they generally have a sense about startups anatomies.

Previously, you were funded because your ideas, teams and initial product progress were worthy of it, at least someone thought so. Now, companies publish a paper making the case for their idea, open some docs for reviews, and ask for money in return for a promise to deliver something maybe in one or two years, that may or may not be accepted by the market.

Along the way, they drag a crowd of investors who buy into it, without necessarily being well informed, nor having used the product. During that process, there isn’t much talk about execution abilities, operational experience, or the rest of the team that will end-up being hired. Much of the analysis is on the surface, often tough to prove or disprove, in part due to a rushing and artificial urgency.

The 3 typical characteristics, team, product and market seem to have taken a secondary position to the 3 new magical words: tokens, blockchain and decentralization.

Token utility linkage is not always there

The assumption that everything with a potential network effect is going to work with a decentralization starting point is not entirely true. The blockchain is not for everything.

The solution or product being developed needs to have a solid business model linkage that has a particular value when decentralization and/or tokenization of actions take place. The promise of a new model needs to be very compelling.

In the name of decentralization, the promises are big. You can’t just slap a token to anything, and expect magic to happen.

The token is not the business model. The value proposition or utility that is enabled by the token is the business model, and that linkage needs to be there early on. If the direction is not right, the chosen path will not lead to a good place.

The marketing hype is frightening

Some ICOs are being marketed like a rocket ship, but in reality, no startup is a rocket ship. A lot of the communication is biased towards the most optimistic assumptions, but nothing goes up in a straight line.

With an ICO, 3 asynchronous periods seem to have blurred and collapsed into one: early stage, go-to market, product-to-market fit. Just because it makes sense in theory doesn’t mean that it will make sense when the market realities enter the picture.

True that some level of speculatory fever can help to fund projects and give them a longer runway life, but if the expectations get far ahead of reality, the gaps may be harder to bridge, resulting in a downward spiral snap.

For good or bad reasons, raising lots of money can hide a lot of mistakes along the way, and there is some of that going on.

Financial engineering has its traps

A rule of thumb for many ICOs has been to allocate 85% of the tokens to the market, and keep 15% for developers and company, but this is a risky ratio. It is equivalent to raising all your funding at once. In the best cases, companies assume that the token will go up in price, which would enable the company (or protocol operator) to never need to raise money again. But not every company is like Bitcoin or Ethereum, just as not every startup is like Facebook or Twitter.

Of course, a smart company would not release more funding to itself until milestones are reached, but few will exercise that type of discipline. Fewer ICOs make a provision for subsequent funding events beyond the ICO.

All and all, funding a startup is not a one shot deal. Too much financial engineering is just that. I would urge anyone planning an ICO to re-read the excellent Security Laws Framework for Blockchain Tokens paper, especially the Appendix.

ICO success doesn’t equate to company success

Success means many users with continuous engagement, steady ecosystem activity, visible benefits from the service or product, and some early revenues or wealth creation to prove that the product-to-market fit alignment is working.

All of these take time and several steps along the way that typically happen gradually and commensurably. No startup ever nails everything from the first go. Iterations and evolutions are the norm, and ICO companies need to be realistic about it.

The best ICOs will be the ones where users have a stake in the future of the business, and where their actions does something to increase the value of the network or underlying business. For example, token holders can be direct participants as users of the product or service. That is the ultimate incentivized setup (assuming that the service is bonafide valuable), in addition to figuring out the circular economy aspects of the business model.

The legal grounds are still shaky

Despite appearances of success in circumventing legal or regulatory hurdles, some practices just don’t make sense.

Why are tokens allowed to trade before the protocol or product is even out in the marketplace? Heightening expectations with the hope that token prices rise months and years ahead of going to market can go so far before the regulators start raising their eyebrows on that practice. Not all companies can survive the price fluctuations, volatility and speculative waves that will be expected when there is nothing but speculation and trading that drives your token price. Look at the volatility of BTC, ETH and STEEM, and these are examples with actual products that work and have thousands of users.

Still, too many regulatory unknowns remain: Will there be a cap on total amounts being raised? Will there be tighter overall compliance requirements? Will tokens be allowed to trade, ahead of product availability? Are reporting or audit requirements likely to be enforced? Are reasonable vesting and liquidity requirements likely to be mandated?

The irony about listing tokens too early is that now consumers who trade them can lose their money many times over (via multiple trades), not just once via a buy and hold pattern.

It’s too early to play the hedge fund game

Most hedge funds are clueless in terms of business insights and experience with picking startups and working with them. Speculating on uncertain instruments is like turbocharging a car that is already headed into a ditch. The accident will happen faster.

Hedge funds act based on what they are fed in a prospectus offering, or by their superficial understanding of a company’s prospects, let alone the market surrounding it. They optimize their operations around quantitative analytics, trading prowess, and recently machine learning or AI-supported decision-making.

Some are gaming the token initial buying with automated wallet-crawlers and other mischievous tools that allow them to automatically grab tokens early (by beating the average buyer), and subsequently claim a “gain” a few hours later. Some funds are being aggressively marketed based on these short-term exploits and paper profits about ICOs that aren’t even operational yet. The fund’s relationship with the ICO founders is mostly transactional.

Smart founders are better served with smart money or benign crowds as influential points to their destiny, and they should not let funds that have been set-up for trading purposes to take large positions in their token distribution.

ICOs should attract partner-funders that can help them, and not be at the mercy of those can trade them and pump them, because they will later dump them at their own will. If you are familiar with the over-the-counter penny stock environment and the on-going needs to promote stocks with press releases and superficial announcements, we are in this territory.

The type of diligence that funds undertake on a token offering is not the same as the diligence that is needed on a company, idea, or product.

Most funds are going to feed the speculative train without caring (or knowing) about the real underlying business. Funds that focus on cryptocurrency trading could become that artificial de-stabilizer and the tipping point for a subsequent crash that eventually will bring us back to reality.

Crashing the party or priming a launch

Yes, I want the ICO party to continue, but I’m seeing participants that are just there for the ride. I’m seeing companies and ideas getting ICO-funded on a wing and prayer chance of being successful. Some others who have even previously failed to raise in private circles, are now opting for the ICO route. As I said earlier, here comes everybody. When the party gets overcrowded and unwanted visitors want it louder and bigger, events can turn to the unpredictable.

In technology, nothing great is often achieved without irrational exuberance, but when the pendulum swings too far, there will some damage. In the long term, we hope that benefits far outweigh the pitfalls that are encountered along the way, and maybe that is the only way that good things happen.

ICOs are supposed to be like an IPO with a cryptocurrency, but in reality, these are early-stage funding bets. Most of these companies won’t stand the scrutiny of public markets (which they entered, whether they like it or not), while they wished they had the private lives of early stage startups.

An ICO is the beginning and the means to an end, not the end itself. The ICO is not the great enabler of business models and incredible innovation. The blockchain is. An ICO is an alternative funding, operational and ownership model. You still need to bolt a sound business to it. You don’t get a pass there, and you need to get a few things right.

Take everything with a grain of salt, two pinches of hype, and three sprinklings of wishful thinking.

  • p-air

    Do you realize that you have contributed largely to the hype cycle of confusion and unqualified enthusiasm for this new model. Putting aside my “I told you so” comments in the post you reference above, when I re-read that post at no point did your comments show restraint or meaningful caution, but were rather a display of irrational exuberance that made bold assertions on the future of this new funding model. What’s funny is that you preached it like you had discovered it, and as expected the game grew, but it did so as many of us expected they would (with more scammers whether they knew this at the time of their ICOs or not), and now you fein despair over the large number of shaky and less than useful models that have emerged.

    Aren’t you a big fan of USV and a16z’s latest wunderkind investment in Polychain Capital? You know, the new and improved hedge fund? Truth be told, I’m a big fan of Polychain but for its unsavory nature. It’s my assertion that he (Olaf) is getting “first dibs” at ICOs so that he can then sell them after the “pump” to the greater fool (also known in high-frequency trading as “front running”). This has worked out well for ShapeShift and will work out well for Polychain. I don’t for a second pretend that it is ethically sound, just that he has asymmetry of information so he can get in and out better than the the average retail investor (perhaps even better than soon-to-come institutional ones too) all because of his access.

    ICOs will not be the preferred financing vehicle of those who can gain legitimacy from more vetted investors. Yes, it will provide “the little guy”investor access to deals, but that little guy does not have the experience nor have they seen enough deals to fully assess the viability of many of these startup ideas. I’m glad you wrote this piece (better late than never), but i find it a tad disingenuous given your record as flag bearer for this ICO model. A lot of investors will lose money and have no legal recourse against those who perpetrate the fraud against them, and that’s sad and disappointing. By the way, in none of your writing have we seen you name one successful project to have used these new funding models, oh wait, except perhaps SteemIt, though the jury is still very much out on that one. Perhaps you need to write a follow-up to your “Business Blockchain” book to address these issues.

    • Thanks for the critique.
      I still believe that the ICO model is a good one, worthy of its benefits, if done well. But the gist of my article is that I’m seeing some projects already funded or about to get listed that don’t hold a lot of promise, in my opinion. I am also seeing amateurish attempts from funds that see the speculatory side.
      Nothing is black and white here. And my book’s contents are as sound and just as ever.
      (Feel free to email me so I can better engage with you and understand where you are coming from; wmougayar@gmail.com)

      • Cory Stevenson

        I have a question. What do you think of this model? I work in the event hosting industry (specifically specialty concerts) and this caught my eye today. From my knowledge of promoting concerts, it seems like an excellent plan to get to a threshold of users necessary to make this work. This is the first DAP that I can see the path to mainstream success. Anyway any opinion you can offer I would appreciate…. https://blocktix.io

      • p-air

        What is your basis for saying that it’s a good model? There is no evidence to support that claim. Your point is exactly that which I’m highlighting, “projects already funded or about to get listed that don’t hold a lot of promise”. I’d like to see the examples of projects already funded or about to get listed that *do* hold a lot of promise…and please don’t say Ethereum, as that has yet to show any sign of delivering value or any use viable use case. There are no production applications that have any kind of traction using this model, and it as a standalone ecosystem has a long way to go before it is shown to be sufficiently robust.

    • I agree with your general sentiment but you are not taking into account that access to VCs is mainly a North American advantage and most countries around the world (even Europeans ones) are underserved. In this context a new way to fund your startup is welcomed.

      • p-air

        My problem is not not with the idea of a new funding model, but rather with the idea that ICOs as they have mostly appeared to date are less a funding model and more of a scam. Would you fund a company to the tune of a few million dollars w/o seeing at least a working prototype, a product or some traction? Most reasonable investors would not consider this. The reason it works for Kickstarters, is generally because the product being funded is something people want. But most of these ICOs whether for more purely speculative cryptocurrencies or “appcoins” are espousing companies for very esoteric services. Everyone investing is trying to make up for having missed the rise of bitcoin and are simply speculating their way to getting rich. Most don’t care at all about the product/service being supposedly developed with the raised funds. Many of those projects are years out. Tangible examples include MaidSafe and Synereo.

        Once these projects raise money through an ICO, they’re stuck on trying to focus much attention on keeping the value of their speculative instrument up. That’s quite distracting, and for a startup to focus on both this and the need to develop the originally promised product or service, is near impossible to either either or both well. The lack of funding options is not a reason to go this route because as an entrepreneur you’re either scamming knowingly or scamming unknowingly, but either way you’re scamming. Funding comes when a startup can demonstrate a viable business opportunity. Even if that’s not yet created, there has to be some basis for the business beyond the entrepreneur’s say so. It’s that which convinces investors to participate. None of that is happening. When you read the ICO white papers, they’re are pure comedy/fantasy w/little basis in reality and certainly no business to speak of.

        BTW, none of the ICOs that have taken place are delivering on venture fundable opportunity, so it’s not like any of these could have raised money from professional investors. I see zero overlap between the companies that have raised money through an ICO and those fundable by VCs. Even one of William’s shining examples, SteamIt, would not likely have been able to raise professional funding with the proposition they created. Perhaps a few milestones from now they’ll be able to prove something, but it’s not clear that will be the case from my vantage point.

  • Jake Vartanian

    Don’t risk more than you can lose. Do your own due diligence. Understand how markets work. No one is forcing anyone to act.

  • Excellent summary. I think the potential opportunities with this model are exciting but I don’t trust startups which spend a lot of time and money promoting the ICO instead of working on the product. All these trigger a scam red light.

    What I want to see are real products launched, useful for users, even when they don’t have any participation. It seems like the purpose of the startup is to launch an ICO instead of using them as a complement.

  • An interesting article, I read it early this morning on the Coindesk website.

  • awaldstein

    i love that you don’t bother to define ICO in this that I can see.

    This is written only to those that understand what it is.

    • Ah, but I linked to another one of my articles that defined. But you’re right that I should spell out the acronymn early in the post, and I will update that. Thanks

      • awaldstein

        all a matter of who you think your audience is.

        without context you are narrowcasting which honestly is what most of the people who write on this segment do.

  • Anonymous

    I notice you lumped Ethereum, which raised $30M in an ICO, in with Bitcoin, which (obviously) had no ICO. Satoshi Nakamoto did not hype Bitcoin before its public release and then go on to launch a full blown ICO replete with intense calls to action marketed directly to unsophisticated US investors. And to add insult to injury, Ethereum’s directors reassured their ICO to US investors by claiming there was zero investing going on, and that all ICO investments were to be seen as “strict donations”. They then detailed their very elaborate offshore scheme which was clearly designed to thwart regulators.

    And now, the Ethereum investors are complaining that other companies are doing the EXACT SAME THING.

  • creative group

    William Mougayar:

    Our late contribution to this blog doesn’t reduce our interest and how important your topics are in this space.

    The criticism that you receive should be fuel for correcting any oversights or overlooks. The arrogant person (which you are not) usually double downs on what concerns are raised. The sophisticated take action in midstroke to correct what may be perceived as a mistake.

    When people are invited to the investing table before the unconnected there appears to be a wrath of jealousy that fuels the critique. It is understandable but unwarranted in the free market society. This is what has always been the capitalist tool for getting ahead that never appears fair to the unconnected. But in 2017 better application of transparency needs to be presented. If something is broken just fix it verses doubling down on explaining why what is broken should be excepted until it is decided to be fixed.

    Critiques are opportunities to not only fix what is broken but to receive unsolicited assistance to help fix what is broken. Make critiques your opportunities. When you request communication offline it appears you are not comfortable fixing what is broken. But massaging the critique.

  • jeff

    hi WIlliam
    Do you think ethereum will overtake bitcoin in market cap in the near future?

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