ICOs: What you need to know about this new market disruptor

A new report from Mangrove Capital Partners reveals the disruptive potential of Initial coin offerings (ICOs), but are VCs prepared?

Initial coin offerings (ICOs) are en vogue, but is the industry making the most of its growth potential? A new report from Mangrove Capital Partners reveals that ICOs have consistently performing well, but not many investors are capitalising on their disruptive power.

The performance of ICOs ‘has been nothing short of outstanding’, according to the report. Blind investment in each ICO, including those that failed, generated an average return of 1,320 per cent. The research also found the majority of large-scale ICOs, those over $10 million, is focused on either the blockchain economy or financial services industry.

The report explains how ICOs could dramatically change capital raising for start-ups by allowing founders to raise significant capital (perhaps even all the capital they could ever need) in one early round of fundraising without giving away any equity in the business.

For investors, benefits of this disruptive new funding mechanism brings more liquidity, accountability and transparency to investing in private companies.

While the report acknowledges that the performance of ICOs is linked it the rapidly ascending value of ether – which has risen from around $8 at the start of the year to a high of $390 in September, it attributes ether’s rising value to the growth in ICO fundraisings and increasing demand for tokens. The report also predicts the value of ether will continue to rise as more businesses opt to issue tokens and the ICO market matures.

The growing market for ICOs may lead less demand for venture capital, according to the report. The balance of power would likely tip from the investors to the entrepreneurs, in this case, with mid-to-late stage financing hit hardest. ICOs could have significant implications for the VC operating model with venture firms losing their various rights, which cover everything from board and governance issues through to economic rights in certain situations. They may also need to adopt a more active trading strategy like hedge funds, as investment in private companies becomes more liquid.

“ICOs do not put VCs out of the game. They are free to take capital and invest in startups of any kind, and, subject to authorisation from their own investors, could just as easily invest through Crypto into ICO as with FIAT into equity or convertible debt. However, the rhythm of a weekly partners meeting and a monthly investment committee won’t work in an active environment responding to real world events,” said Skype’s former chief operating officer Michael Jackson, who is now a partner at Mangrove Capital Partners.

Interestingly, many projects today fit into existing regulatory frameworks and, with small changes to implementation rules, could easily be accommodated without anything other than a better understanding, according to Jackson. “In the mid term, it would be logical that a parallel structure to existing stock exchanges will be created – likely geographically and then vertically.”

Background on ICOs

The ICO market has since grown at a dizzying pace – with over $3 billion raised through issuances of token-based digital currencies since the start of the year.

San Francisco’s Protocol Labs Inc., for example, raised $253 million in an ICO to build a network with blockchain technology on which digital storage can be bought and sold using the Filecoin tokens

ICOs have of course attracted considerable controversy and for good reason. ICOs currently lack a robust regulatory framework and do not confer any of the ownerships rights and legal protections that regulated shares do.

In September China banned ICO funding, stating that it had “seriously disrupted the economic and financial order”

UK regulators have warned consumers they are “very high-risk, speculative investments” and that investors “should be prepared to lose their entire stake”. 

What is a token?

A token is a digital asset based on blockchain technology that can be transferred between two parties without the need for a central intermediary. Tokens created using the Ethereum blockchain can have a variety of attributes attached and, with “smart contracts” added, they articulate, verify and enforce agreements between parties. The ERC-20 token standard, defines a common list of rules for all Ethereum tokens to follow and has made launching tokens on top of the Ethereum blockchain very straightforward.

What is an Initial Coin Offering?

The use of ERC-20 tokens has led to a new method of raising capital known as an Initial Coin Offering (ICO) in which projects issue tokens to investors in exchange for digital currency such as bitcoin or ether. The tokens allow investors to use the digital services that the startup plans to produce or even sell them if they appreciate in value.

Praseeda Nair

Kellen Rempel

Praseeda was Editor for GrowthBusiness.co.uk from 2016 to 2018.

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