More money, fewer people: The changing ICO landscape
This article attempts to briefly explain how the Initial Coin Offering landscape has changed over the past year. It documents the shift from a venturous free-for-all toward a more structured process resembling traditional investment methods.
As a form of startup funding, the Initial Coin Offering is still in its infancy: the first ICO took place in July 2013 to finance a project called Mastercoin, and it wasn’t until 2017 that ICOs really took off. Nevertheless, hundreds of companies have already used it to raise billions of dollars, with many more billions to come. The ICO has become one of the primary means for making blockchain-based ventures a reality.
The growth is undeniable. To put things into perspective, the $5.6B raised in 2017 exceeded 2016 and its $240M over 20 times. This year is showing no signs of slowing down: based on our aggregate data, 454 companies have already received more than $13.2B. The amount is all the more impressive considering we’re only halfway through 2018.
However, it’s not only the numbers that have changed. The way ICOs themselves are conducted has evolved significantly, and a typical coin offering of a year ago looks very different from the ones taking place now. Let us go through these changes, one step at a time.
The concept of Initial Coin Offering is quite simple: a few people (we will refer to them as founders) come up with an idea; because realising ideas is expensive, they ask other people on the Internet to help fund it; the founders do it by releasing a new token, which can then be exchanged for a more established cryptocurrency, usually ether or bitcoin; people buy the token because they believe in the project and expect it to raise in value. A public sale takes place.
Up until late 2017, the public sale was essentially the only step of the ICO after announcing the project. Some managed to quickly get the necessary funding. However, many others found it hard to raise enough money in time. At some point, companies decided that they needed new incentives to attract investors—and so, the pre-sale was born.
Carrot on a stick
The pre-sale is an event that takes place before the actual public sale. People buying the company’s tokens during it would get all kinds of bonuses, such as a lower price, exclusive access, and so on. Not only that, but pre-sale tokens would usually have no lock-up period; it means that investors could sell them as soon as they became tradable for a quick profit. To top it off, only a small part of the cryptocurrency supply would be put up for sale, driving demand even further. These reasons have led to some pre-sales being wildly successful, sometimes even enough to remove the need for a public sale altogether.
The pre-sale turned out to be a great tool for jump-starting a project and preparing it for the public sale. That said, it still commands a sizable investment: the founders need to build a team, write the white paper, perhaps whip out a working prototype, and make themselves visible in a time when attention is scarce. If they are ambitious, expenses can run up to hundreds of thousands or even millions of dollars. Few people have the means to shoulder such a burden by themselves; luckily for them, there are always those ready to lend a hand, given the right conditions.
The need for an initial investment brought to ICOs a concept embraced by traditional startups—seed funding. The name is highly metaphorical and comes from agriculture: like farmers, investors plant seeds, hoping that they would grow and one day bear fruit. The risk is high, but so is the reward. A seed investment yields several times more tokens for the same price compared to a public sale or even pre-sale. Also, it rarely has a vesting period, meaning that the tokens can be liquidated as soon as they enter public exchanges. This significantly reduces the risk and makes investing much more attractive.
At this point, the structure of the ICO has become quite complex. It can begin with a round of seed funding, followed by a pre-sale, and finally a public sale—all to finance the endeavor. The addition of these steps has allowed to solve some of the problems founders faced, such as raising the initial funds or gaining traction. But it has also created a new headache: as an early backer, why should I hold my tokens for a year if I can sell them in a month’s time, earn a quick buck, and move on to another project?
To make matters worse, the explosive growth of the industry finally started turning heads of the lawmakers. In an effort to keep up, they attempted to impose old rules on a new frontier. People could no longer invest without going through a rigorous identity verification procedure, and there was (and still is) a constant threat that the Securities and Exchange Commission will declare your freshly minted token a security.
Enter the private sale. It takes place early in an ICO’s lifecycle, usually before or instead of the pre-sale. The purpose is the same—to raise capital for a project—but the means for achieving it are very different. Though pre-sales tend to attract larger investors and often have a higher entry threshold than public sales, they are still relatively open. On the other hand, private sales are limited to institutional investors: venture capitals, investment funds, and other big players.
Having strict selection criteria and few but powerful backers makes it easier for founders not only to avoid pump-and-dump schemes, but also navigate the uncharted regulatory waters. The SEC still does not have a clear stance on cryptocurrencies as securities. To prevent another DAO verdict, companies have started adopting the Simple Agreement for Future Tokens. It is a security contract offered to accredited investors. The SAFT gives a right to tokens that haven’t been issued yet, but will be once the developers give them some kind of utilitarian use.
The private and pre- sales can be conducted with the public sale. However, nowadays more and more companies opt to have them in its stead. This stands especially true for the private sale:
Image source: Astronaut Capital
As big-gun investors enter the market and the regulatory climate remains everything but certain, the increase of interest in private sales is hardly surprising. It does raise some considerations, mainly in terms of disseminating tokens to the public and the impact of centralization on the industry. Founders are attempting to address the former by sending small amounts of tokens to random wallets (a practice called airdropping), while the latter is a matter of values and is better suited for a philosophical discussion.
To sum up, the ICO landscape is changing at incredible pace. Like any frontier, it has reached the point where the establishment is starting to catch up. Whether you like the direction ICOs are taking or not, it is a sign that the market is maturing.
Written by Monethian – Aivaras