Initial Coin Offerings (ICOs) Versus the Financial Establishment
Initial Coin Offerings provide a superior alternative to traditional fundraising by offering lower costs, less regulation, and fewer intermediaries.
Late 2017 to early 2018 will go down in the history of cryptocurrency as the year of the ICO. ICO stands for “Initial Coin Offering” and describes a new type of crowdfunded currency created via the Internet. By issuing their own token, a group of people or company can quickly raise capital without having to rely on investment banks or venture capitalists. Investors, on the other hand, can buy initial shares in the new cryptocurrency in hopes of rapid appreciation or just to have a stake in a developing ecosystem.
Declaring War on Wall‐Street
ICOs mirror, in some ways, what are known in the traditional world of finance as initial public offerings (IPOs). The latter is done by companies when they are publicly listed on stock market exchanges. Therefore, it is quite tempting to regard an ICO as the digital counterpart to a classic IPO. However, this is not correct. Not everyone who buys a token through an ICO is automatically granted shares in the company. By contrast, voting rights are inherent to owning shares of stock and profit‐sharing is common. While it is theoretically possible to grant both voting rights and dividends through tokens, they are not legally guaranteed.
Nevertheless, the American ICO market accounted for as much as 45 percent of the traditional IPO market in the second quarter of 2018. That was 31 percent of the total volume of the venture capital market. Expressed in U.S. dollars, this means that according to official figures, the total ICO volume was around 7.2 billion U.S. dollars, while the US IPO market had a turnover of 16 billion US dollars over the same period. The venture capital market’s turnover was 23 billion US dollars.
But during the summer months of 2018, ICO revenues began to dry up; by September, they stood at a virtual standstill with just over $31 million invested. The main reason for this decline were the fixed costs and other development expenses finally catching up with previous ICO projects. They had raised incredible amounts of capital during the ICO craze earlier in the year, but now they had to rapidly liquidate much of their early holdings. This led to immense downward pressure on prices and the market value of all crypto assets plummeted.
Initial investors in numerous ICOs found themselves underwater on their investments. Yet, what many people forget while bemoaning their losses is that the spate of ICOs in 2017–2018 proved that it was possible to raise a great deal of money in a fast, efficient, and fully digital process, one which also bypassed the established financial system.
An Act of Self‐Liberation
During peak ICO hype, investors lost a lot of money and many also fell for fraudsters and charlatans. Of course, some investors were very careless and disregarded even obvious red flags. However, the fact that dubious ICOs were able to attract so many investors in such a short time frame is a clear indication of just how over‐regulated capital markets are in the conventional world.
In fact, legal requirements make fundraising through traditional avenues — even for over‐the‐counter investments — a very complex procedure. Anyone seeking capital must not only submit a promising business plan, which seems self‐evident, but must also comply with a number of publicity and accounting regulations. While that provides a sense of security (although perhaps only the semblance of it), the net effect of these requirements is to make the world of investing a mostly exclusive club for already wealthy, accredited investors.
This is one reason why the number of publicly listed companies has been falling for years. Even up‐and‐coming start‐ups are going public later or sometimes don’t go to Wall Street at all because an IPO might be more bother and expense than it would be worth.
The consulting firm Partners Group estimated in a 2018 study that the board of directors of a listed company wastes a quarter of its time on complying with stock market regulations and bureaucracy. It is therefore not surprising that the Swiss entrepreneur, Nick Hayek Jr., has considered taking the Swatch Group, the largest watch company in the world, off the stock market, partly because of time‐consuming accounting regulations. Although many of these measures are designed to protect investors and make markets more efficient, all too often they minimize an investor’s potential yields along with their risks.
Therefore, ICOs have been hailed as a way of breaking free from the shackles of Wall Street and avoiding the inflated transaction costs of the established world of finance. Money invested through an ICO arrives directly at the start‐up; intermediaries such as stock exchanges, clearing houses or notaries are not needed. In addition, tokens are traded without delay. Therefore, legitimate ICOs are superior options both for companies seeking capital and for risk‐taking investors.
Think of just how revolutionary ICO investing can be; never before has a 16‐year‐old from, say, Brazil, India, or Mongolia been able to invest the equivalent of a few U.S. dollars in a start‐up company from Switzerland, Israel, or Singapore. And while revolutions are prone to exaggerations, exuberance, and excess, to ban ICOs completely, as China has tried to do, is the wrong approach. ICOs can be a valid alternative to traditional fundraising models.
To make a comparison, while Bitcoin offers an alternative to fiat money created by central banks, ICOs are an alternative to the centrally organized capital market. Investment banks have always acted as intermediaries between capital seekers and investors. Now there is a technical way to bypass these expensive financial intermediaries.
Of course, established players are not giving up their lucrative business models without a fight. In the world of finance, unregulated ICOs are going to be replaced with regulated Security Token Offerings (STOs). This is already happening. Surely, financial experts reason, risk‐averse investors will prefer STOs to ICOs because the former is regulated.
And from the perspective of regulators, the establishment of STOs will diminish the demand for ICOs. That might be true. But what regulators don’t get about ICOs is that they were not so much an upgrade to conventional investment vehicles but rather an indication that conventional capital markets were being slowly suffocated by regulations. Which is why ICOs will not entirely disappear regardless of what happens with STOs.