(Part 2)
Looking beyond the fraud bubble towards a better understanding of crypto capital raising models
2017 and 2018 were the years Initial Coin Offerings or ICO’s shook the traditional crowdfunding industry, surpassing venture capital investments in internet companies. ICO’s opened up a way for retail investors to get involved in the private equity market, a market which before ICO’s were mainly only available to accredited investors. While ICO’s brought in much money for startups using blockchain technology to fund their tokenized projects, they also gave an opportunity for scammers to steal millions from investors. A common thing to occur in new and rising technologies.
Eventually, the word ICO was seen as a red flag for investors with news reports headlining 80% of them as scams. [1] The scam bait headlines have to lead to new tokenized crowdfunding models looking to distance themselves from ICO’s — the STO (Security Token Offering) and the TBO (Tokenized Business Offering). Yes, the ‘O’ family is growing.
Are 80% of ICO’s scams? If so, is the entire crypto asset industry a scam? Are STO’s and TBO’s the answer?
The real story behind the 80% ICO scam statistic
The presence of scams and hacks in an industry alone does not correlate to a criminal enterprise. Quite the opposite, fraud follows money and innovation. Financial innovations in the railroad industry in the 19th century “saw scams everywhere” including political scandals. [2][3] To say that the entire crypto asset industry is a scam as a result of ICO scams would be an overstatement.
The 80% of ICO’s are scams statistic originated in a Bloomberg report researched by the Satis Group, LLC in July of this year. In that report, researchers gave two perspectives on how to analyze the quality of ICO’s. When researchers measured ICO’s by the # number of projects, yes, 80% of them were categorized as scams. However, when they measured by the $ amount of funds raised, over 70% went to higher quality projects. That perspective gives an entirely different and more positive picture of the ICO market. Most media does not reflect that picture of ICO’s as scam headlines tend to attract more readers.
“The global ICO market now stands at ~20% of the US IPO market YTD”. [1] Considering ICO’s have only become popular in the last two years 20% is no pittance. What does this all mean? Even though many ICO scams entered the scene, money continued to be raised through them, and most of that money went on to fund successful projects. At the same time, most of the $1.3 billion taken from scam’s were primarily a result of three ICO’s — Savedroid, Arisebank, and Pincoin. According to other reports, the first two were not scams but bad projects where most of the money taken was refunded. [4]
Given that ICO’s were mainly used for start-ups looking for a more cost-efficient way to raise funds without the use of intermediaries, comparing ICO’s to the start-up industry can help paint a picture of what projects are up against.
90% of start-ups fail
According to Forbes magazine, nine out of ten startups fail. [5] The primary cause of the failure is due to the lack of a market need for the product. [6] Similarly, with ICO’s, according to Richard Wang with Draper Dragon Venture Capital, “one of the areas that some teams miss is doing a good market survey.” [7] The failure to implement such basic business tools is primarily attributed to the lack of experience behind many ICO teams along with the lack of regulatory clarity in the crypto space. [8]
Does this mean working on a start-up or ICO is doomed to fail? No. It does say that the bar to succeed for both start-ups and ICO’s is high.
Success in new tokenization models — TBO’s
STO’s like ICO’s are a crowdfunding model through tokenization of assets. Except in the STO case, the token is actually backed up by something — the companies’ profits or shares — since it is a security. In an ICO investor’s buy tokens with the promise that the product will work and then earn a profit. To learn more about STO’s read part 1 of this series. The problem is not at all tokenized assets are securities and to issue a security is a long and arduous process that will need to undergo regulatory review. Bitcoin and ethereum, the top two crypto assets according to market cap, are not securities but utility tokens.
Enter TBO’s. According to Nicolas Krapels, professor of finance at East China Normal University and head of China business development at DarcMatter, who coined the term a few months ago, TBO’s [G85] [G86] “create a tokenized ecosystem based around an existing platform solution that requires an easily verifiable utility token to unlock features of the platform. They may often require staking those tokens on a blockchain before users are able to perform work in the ecosystem”. [9] The benefits of TBO’s compared to traditional utilities in a closed private network is that in an open network, [G87] “network participants [are aligned] to work together toward the growth of the network and the appreciation of the token.”
One of the main differences between TBO’s and ICO’s is that the former leverage an already existing business and user base that is being optimized via a blockchain. In this way, TBO’s are a much better term to use than ICO’s, as the team behind them have the experience and credibility to run a business reducing the chances of fraud. Krapels gives the example of the Telegram (TON), and Huobi Token (HT) capital raises, which were two of the four successful capital raises in 2018. Both raises, he argues, are examples of TBO’s.
While the terminology is essential to clarify use case and ownership in the crypto world, it is important not to judge an industry by headline alone. For years media headlines pushed the idea that bitcoin was only being used for illegal activity. Now that headline is being refuted by none other than the DEA (Drug Enforcement Agency) in the U.S. According to DEA special agent Lilita Infante “criminal activity accounts for only 10% of on-chain bitcoin transactions”. She goes on to state that she prefers criminals to use cryptocurrency transactions as “the blockchain actually gives us a lot of tools to be able to identify people.’’ [10]
Historically, market innovation brings great opportunities, but, with great rewards comes great risks and a critical eye must always be applied before investing.
Sources:
[1] https://research.bloomberg.com/pub/res/d28giW28tf6G7T_Wr77aU0gDgFQ
[2] https://www.forbes.com/sites/jeffreytucker/2018/08/28/beware-this-evil-crypto-scam/#1bae3b954d89
[4] https://cryptobriefing.com/crypto-scams-false-stats-statistics/
[6] http://fortune.com/2014/09/25/why-startups-fail-according-to-their-founders/
[8] https://nulltx.com/why-do-so-many-icos-fail-heres-what-the-experts-say/
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