You may have noticed that ICOs are not as popular as they were in 2017 — what happened, and why is the idea of an ICO still so important?
What Are ICOs?
The earliest investors are taking the most risk, and so they are normally able to purchase their coins or tokens at special prices in return for being unable to sell them for a pre-set time period. When the project fully launches, the tokens become available on multiple exchanges and investors can sell or continue to hold.
ICO vs IPO
The ICO funding model turned the world of entrepreneurship upside down. Until this point, an entrepreneur needed to successfully overcome problem after problem. They had to create a business plan, build a working prototype, test that prototype on some potential customers to try and find a fit to the needs of the market, find investors, hire staff, make sales, build a business, grow quickly and much more. This process would normally take many years and a huge amount of skill, effort, commitment and sacrifice.
This is an incredibly difficult journey and by definition, most people fail.
At some point in this journey, if everything was going well, the entrepreneur would look to personally make a lot of money by either selling the business or floating it on a stock exchange. A floatation is called an IPO which stands for initial public offering. Wealth planners call these “liquidity events.”
Let’s not kid ourselves, not everyone can do all that — it takes some confidence, technical skill and money to pull off -— but the whole process took a few months end-to-end, not the decade or more that would normally be needed to IPO a business.
If you were an entrepreneur comparing ICO vs IPO funding as a way to personally get rich, an ICO was very attractive!
You Get What You Incentivize
Quite clearly, the incentives changed dramatically for entrepreneurs that had launched an ICO. If their end goal was to raise a lot of money and get rich, well, they had essentially done that without needing to go through the annoying process of building a successful business. So then why bother?
A lot of the projects fell into this category. They may have started with good intentions, but spending millions of dollars is substantially easier than building a business that earns millions of dollars. In addition to this, there was (at best) very minimal oversight, which meant that the money could be spent as they wanted. It was mostly held in crypto, after all.
Complex Technical Projects Are Complex
This new ICO fundraising process put lots of money into the hands of very inexperienced entrepreneurs. It is not easy to build a business that requires both substantial technical infrastructure and software. Running an effective software development team is hard, and many of the project founders were simply unprepared for the challenges.
As if these challenges were not enough (they were!), the ICOs had all unwittingly entered another business that required substantial knowledge and skills: fund management. By raising such large amounts of money, they needed to make critical decisions and build systems and oversight to look after that money — they needed to run a treasury department.
This, of course, runs counter to the normal experience of starting a business. The founder normally needs to try and do everything they can with a tiny budget, spending their time juggling resources and carefully selecting tasks to prioritize.
At first, fund management was easy! The crypto market was in a bubble, prices kept rising every day and the money raised was turning into more money. Then the market turned, and in mid-January 2018, prices started to fall and fall and fall. Suddenly, critical choices needed to be made about how to manage money, and many of the 2017 ICO projects failed this test, ultimately running out of money as they had to sell their BTC and ETH at increasingly lower prices.
There were also a lot of scam ICO projects. Separate to the founders described above that started with good intentions, it was relatively easy to raise multiple millions of dollars with no business plan. Many people did just that and then quietly closed their project months later without having tried to build what they had promised.
Since the crypto space was almost totally outside of the normal laws of society in 2017 — governments had not been able to decide who was responsible for policing the space — almost all of the scammers were able to get away with their crimes.
Why Has The ICO Funding Model Changed?
In the United States, the Securities and Exchange Commission has decided that the majority of ICOs (almost all actually) are securities that ought to be covered by the law. It is a crime to launch securities and not know the full information of the investors in the United States.
Since ICO investments were coming from BTC or ETH wallets, the founders typically did not know who any of their investors were. To ensure that they were not in breach of SEC rules, founders needed to be sure that no American citizens or residents were buying their tokens, which is obviously impossible to do.
Suddenly, the ICO funding model looked very much like the old angel and VC investor model of old. Funds raised needed to come from known, experienced, registered investors. To do that, the minimum investment needed to be much higher (it is now often US$500,000). This squeezed out the small private investors and, as you might expect, fully popped the ICO bubble.
The projects that have made it from 2017 to the time of writing in late 2020 have clearly shown that they have some or all of the skills required to build the kind of project or business that they promised. The overall ICO failure rate will be incredibly high, but there are some strong projects that were born and the money they raised will help to push the cryptocurrency and blockchain space forward.