ICO fundraising has surpassed traditional early stage venture capital fundraising (angel & seed rounds). There is more to the story than comparing recent funding by dollar amount contributed, however, because the nature of funding from an ICO is different than funding from a venture capital firm. In this piece, I will explain a few key differences between the two.
Why This Is Happening
First, it’s important to address how ICOs work and why they have become a popular fundraising option. For a more complete explanation of ICOs, read this: https://hackernoon.com/understanding-initial-coin-offerings-icos-a61064170150
ICOs have emerged as a popular funding tool because they offer advantages to cryptocurrency projects that traditional venture capital firms cannot. In particular, many cryptocurrencies rely on attracting developer and user interest and the process of raising funds also serves as part of the user acquisition and developer community creation process. This is particularly important for cryptocurrencies that allow developers to build on top of the coin, like Ethereum.
Additionally, ICOs are a low cost option because they do not require intermediaries and can be completed very quickly compared to the time it takes to raise traditional venture capital.
Practical Implications and Considerations
There are important differences between ICO funding and venture capital funding:
- ICOs offer new benefits but also introduce new problems: Once a cryptocurrency project launches and is listed on an exchange it trades live around the clock. While this is great for investors because it creates liquidity and real-time risk pricing, it may impact the long-term focus and productivity of a project team. One reason that startups decide to stay private is to sort out important issues before facing the daily public scrutiny that comes with being a publicly listed company and the 24/7 news cycle that thrives on reporting disaster. Teams may find it hard to focus on long-term success when the pressures of real-time pricing may lead them to focus on things that will sooner impact the price of the cryptocurrency, like shipping many small updates to show progress rather than tackling a larger long-term security issue.
- The nature of ICOs attracts different participants: ICOs attract different participants than venture capital because after an ICO is completed the coin is listed on an exchange shortly thereafter, usually within weeks or months. This means that an investor in an ICO can cash out shortly after investing and the ability to do so attracts speculators that do not need to believe in the long-term potential of the project to profit. In contrast, a venture capital investor does not have the same liquidity and must usually hold for years until the company goes public in an IPO or is acquired by another company. This changes the mindset and venture capital investing does not make sense for price speculators. The ability to profit quickly from funding an ICO increases funding interest, even though not all of it represents a long-term belief in the cryptocurrency being created.
- Venture capital funding usually comes with more than just a contribution of funds: It varies firm by firm and investment by investment, but usually venture capital firms provide more to companies than just funds in return for equity. Venture capital firms can offer startups the benefits of giving them strategic guidance, providing introductions to other investors and sales leads for enterprise focused companies, and helping with hiring. ICOs may replicate part of this value by creating a pre-sale round for institutions and offering a discount to firms that provide advisory and guidance.
Will This Trend Continue?
Whether or not this trend will continue is to be seen. It is likely that additional regulation will come to ICOs (right now there is practically no regulation) and this may change the funding landscape materially. For some projects, ICOs will continue to be the best fundraising option because of the need to spread awareness of the project and get users and developers involved. For this reason, ICOs are likely to remain a common financing tool used for cryptocurrency projects.
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