Insider Reflections on The ICO Bubble

According to Forbes, more than $2.3 billion has been raised in token sales, aka “ICO’s” so far in 2017. As an entrepreneur who has raised more than $300 million of venture capital equity financing in my career, and whose company is holding an ICO in just a few days, I have mixed thoughts about the current ICO bubble.

Like many, I’ve been enthralled by the technical elegance and enormous potential of blockchain technologies. And, one cannot help but be fascinated by the amount of capital flowing into cryptocurrencies and ICO’s.

Like many, I’ve also been repulsed by the ICO scams and hype marketing, turned off by the pay-for-play ICO cottage industry, and frightened by the speculative dynamics of cryptocurrencies and token markets.

In a previous post I discussed some of the cringiest moments we’ve encountered during the ICO process.

In this post I present some of my thoughts on the ICO Bubble, implications of the increased ICO volume and noise, and my suggestions for the community to adopt requirements for better ICO’s.

This is a work in progress, intended to spur conversation, and I encourage and welcome everyone’s feedback.

“There’s something happening here
What it is ain’t exactly clear “ — Buffalo Springfield

The ICO Bubble in Context

From a macro perspective, bubbles serve as an acceleration purpose in technology cycles. The capital markets are currently sizing up cryptocurrencies and blockchain technologies much like they did for the emerging Internet companies in the late 1990’s. Back then, hundreds of dot-com companies raised globs of money pre-revenue on big ideas alone and went public long before they should have. Most of those companies didn’t survive, while a handful of the dot-com bubble babies like Amazon and Google went on to dominate. However, any way you slice it, the capital markets’ appetite for speculating on the future value of Internet technologies fueled a massive wave of innovation that fundamentally improved and connected the world. And, many of the ideas that initially failed were recast and reborn years later as successful ventures, once ideas caught up with technical realities and consumer adoption.

Bubbles reflect investor excitement and optimism for game-changing ideas and outsized returns.

Bubbles also educate markets. Many consumers first got intrigued by the Internet by following booming Internet stocks, just as many consumers today are first becoming familiar with blockchain and crypto by learning of booming Bitcoin prices.

Blockchain today is like 1993 internet — we’re still at the early stage of building protocols and middleware — albeit with 1999 bubble hype. The current cycle is more compressed than the 1993–2000 dot-com cycle because blockchain technology is based on immediately recognizable economic value, whereas Internet companies were valued based on potential future profits and stock prices. The dot-com bubble was fueled by investor enthusiasm to get into those zero-to-one projects, much as the crytpo bubble is today.

Just like the long term potential and societal impact of the Internet was mostly speculative twenty years ago, the long term impact of blockchain and cryptocurrencies is elusive today — which further drives the mystery and excitement for it. 20 years ago we had no conceptualization of a Facebook or a WeChat or Amazon Web Services. Twenty years ago there was no Google, no Salesforce, no Twitter, no Snapchat. Today is ground zero for Blockchain. No one knows which of the current crop of Blockchain companies and projects will become breakout hits. No one knows which cryptocurrencies — if any — will become global standards, and if one of them might even overtake some national currencies in prominence.

If the past is any indication though, many of the current projects will fail, while the ones that succeed could achieve outsized market position, similar to how the FAANGs (Facebook, Apple, Amazon, Netflix, and Google) now combine for more than 50% of the entire NASDAQ marketcap and 10% of the S&P 500.

What is very clear to me though is that there is a long term cultural shift in the making that we may not fully grasp the meaning of for another ten or twenty years. Millions of people around the globe are starting to embrace cryptocurrencies based on data and digits and proof of work over national currencies, and the blockchain ideals of decentralization over institutional middlemen. It’s a rejection of long-established nation-state norms. It’s a belief in a global society and borderless data. It’s an expression of personal ownership over one’s digital identity and contributions.

The first 20 years of the Internet brought us a universally connected society with more free speech and convenience than ever before. The next 20 years could recast generation-old assumptions around nation-state economies, human rights, legality and ownership.

The Current ICO Noise

The ICO bubble has introduced a ton of noise into the market while the market is simultaneously trying sort out its appetite for Ethereum based tokens vs. Bitcoin.

What was recently a handful of mostly well though-out blockchain infrastructure projects, has turned into thousands and thousands of potential ICO’s. Too many of the recent batch seem more motivated by greed and pursuit of a quick buck, rather than a bonafide cryptocurrency purpose and utility. Volume has gone up, while quality (in some part) has come down. At minimum it has become exponentially harder for educated buyers to evaluate projects.

The noise has also increased the cost of conducting an ICO. Marketing and PR costs have skyrocketed based on the demand and difficulty to stand out. Lawyers, accountants, and service providers have increased their fees. A sizable cottage industry of consultants and advisors has popped up to offer all sorts of pay-for-play programs. Want your ICO listed on an ICO listing site? That’ll cost you a sizable amount of ETH or BTC. Want your ICO reviewed? That will cost you some more ETH or BTC. Want us to write an article about you?… you get the point.

The noise and speculative nature of ICO’s has also raised the awareness and attention of regulatory bodies. This is a positive development in my opinion. It has been a wild-wild west in ICO-world until most recently and the industry should welcome oversight, ground-rules, and structure — especially when it comes to consumer protection.

At the same time, many of the projects that ICO’d over the summer are now trading at lower than their offering prices. I chalk this up to projects taking advantage of frothy markets and raising too much money at high prices vs. the actual state of their product implementations. This is also a positive development in my opinion. Tokens are not equity and should not represent the future value of the project or future cash flows. Rather, token prices should mirror the actual demand for the tokens.

As a result of the bubble, my sense today is that the ICO market is beginning to shift — in a good direction — and that we are going to see a much needed tightening in the industry around some much needed minimum viable norms for ICO’s.

A Modest Proposal For Better ICO’s

Rather than waiting for the regulators to come in and set the rules — I’d like to see the crypto community self-police and agree to some principles for what makes for a worthy ICO project.

To that end, here are my proposed must-haves for ICO’s.

There must be a real utility for the token. Minting the token and establishing a market-price for the token is required in order to make the underlying software protocol and the token economy model function. If the purpose of the token sale is solely to raise capital for the project, that is not enough. Capital can and should be raised via equity and debt instruments, not by selling token assets.

The utility of the token must be proven, demonstrable, and replicable by others before holding the token sale.

The source code for the protocol must be made available via open source.

A demo of the token utility in-action on a blockchain must been presented.

Anyone should be able to replicate the demo and implement it.

The token must not be just a cute substitute for fiat. You should not be able to just replace the token with fiat and accomplish the same functions. If the only value ascribed to the token is as a payment rail, it’s a currency not a utility.

The project must present a clear case for why a blockchain is uniquely necessary for the solution — i.e., the “secret sauce.” In other words, what is it about blockchain that uniquely enables the solution?

The project adheres to key blockchain principles such as open and decentralized where technology allows for it.

There is a viable token economic model for how the token will be used and how ongoing demand for the token will be derived. The token economic model and forecasted demand for the token supports the price and market cap of the token economy.

The token sale is raising a reasonable and justifiable amount to establish the token economy. Again, the token sale should not be an end-around to equity or debt financing, rather the token sale should be to establish the economy and the endowment for the ecosystem it intends to support. Raise equity to run the company, sell tokens as if it was software — to get it into the hands of your desired users.

The token sale is designed to maximize benefits to the purchasers and users of the utility, not to speculators.

The token sale is designed in a democratic fashion to get the token into the hands of as many possible end-users of the utility, rather than into the hands of a few people who could exert significant influence over the price of the token. Returning to the software analogy, you wouldn’t want a couple of your largest customers being able to influence prices for everyone.

The token sale strikes a fair balance between benefits to large pre-sale purchasers and public sale purchasers. Large pre-sale purchasers can be afforded reasonable discounts/bonuses relative to their purchase sizes — similar to how corporate software purchasers get volume discounts, but should be locked into long term vesting schedules to limit their ability to dump the tokens onto the market.

The smart contracts for the token sale have been published and audited by credible independent auditors.

A credible team who can achieve the mission of the project, supported by credible advisors who have contributed their expertise and not just their name. Backed by a top tier legal team with experience in securities law and regulations.

The team has obtained legal opinions and regulatory guidance in all relevant jurisdictions and has adhered to local laws and policies.

The project has established independent oversight and controls over resource allocation — both for the funds received and for the token supply that has not distributed.

Unsold tokens following the token sale are either burned or distributed proportionally to the buyers.

Transparency. The project has committed to transparency and demonstrated in the run up to the token sale, distributing all of its work online for the community to review and evaluate and maintaining active presence in social media channels.

Thank you to Benjamin Bollen, Nishith Shah, Francesco Pacella and Ignas Pečiūra for your contributions to this article. Fred Wilson has also written extensively on similar themes and I took inspiration from some of his posts. Urszula McCormack and the team at KWM and Lowell Ness and the team at Perkins Coie provided valuable input.

I welcome and encourage all comments and feedback.