Finance

‘Underground fundraising’ is keeping investors up at night

By Bonnie Halper 10 July 2017
Summary

The rise of the 'Initial Coin Offering'.

Initial Coin Offerings, or ICOs (pronounced ‘eye-cos’) have taken the world by storm.

Instead of turning to traditional investors, burgeoning blockchain-based firms are creating new digital tokens and swapping them for cold hard cash.

ICOs are used exclusively by blockchain-based companies.

It means bypassing the usual checks and balances used by VCs and banks, and it’s about to potentially change the world as we know it.

The roots of the new disruption

First, it’s important to understand the basics – the blockchain itself is a coding breakthrough.

It’s used to maintain a continuously growing list of records, or blocks, each of which is timestamped and linked to the previous block.

The result: a public ledger that records transactions between two parties across a network of computers.

There is no central authority. No single person, party or government controls it or has the power to tamper with it or alter it.

It’s how bitcoin and other digital currencies were created, which are now inspiring the creation of other applications.

To those who compare these new financial systems, the underlying technology (blockchain) and the applications that are emerging to the early internet – wrong.

It’s better to look at it the situation through the lens of Star Wars. There’s a rebellion in full swing.

“It’s really a core disruption on the relationship between capital and trust,” said investor and ScienceVest co-founder Ramphis Castro.

“Blockchain is a trustless system; it doesn’t trust anybody. With blockchain, we can trust everybody. Everyone has a copy of the ledger. That breaks apart this obscure process of investing. Blockchain allows everybody to know what everybody else is doing.”

Crowdfunding Bitcoin

With ICOs, it’s a case of crowdfunding meets Bitcoin, where new cryptocurrencies such as bitcoin, as well as the blockchain, have the potential to literally change the world.

“Entrepreneurs can raise millions very quickly by simply writing a few white papers and creating some buzz on social media on why people should participate in their ICO,” Aishwarya Balaji, an angel investor who is currently working in the blockchain space, told The Memo.

“Unlike with traditional investing, the entrepreneur gives up zero equity.”

Considering that one recent ICO – for the Basic Attention Token – raised $30m in 24 seconds, and is just one of a growing number of ICOs raising record amounts at record speeds, it’s a very big deal.

The power shift

Some experts, however, are already sounding the alarm.

A lack of transparency around who’s creating new currencies is a concern for both investors and regulators, since they’re currently unregulated and the rules around ICOs are more or less being written in real time.

In the traditional investing world, investors need to be accredited by the Securities and Exchange Commission, the American financial regulator, but not so in the world of ICOs.

What is being created is not only a level playing field: if VCs do decide to invest, they, too, receive no equity or say in the company. This is yet another huge departure from the traditional investing model.

It was engineers and speculators who first invested in bitcoin and Etherium, whose value overall has been rising exponentially. This created millionaires in the crypto-currency space.

If they traded out for ‘fiat currency’ (what we call regular money), that money would be taxed. Instead, at least some of that money is going into ICOs, where its value will hopefully increase.

With ICOs, anyone can be an investor.

Union Square Ventures partner Fred Wilson at CBInsights Future of Fintech 2016 NYC.

Changing relationships

Make no mistake: investors, like Union Square Ventures partner Fred Wilson, are paying attention.

“The challenge right now is US regulations,” says Castro. “Because ICOs do not trade in traditional currency, or traditional stocks or shares, there cannot be an expectation of making money. And yet people do, with the hope that it will be a very valuable asset in the blockchain future.”

“You’re buying with the expectation that the value will go up.”

There’s no way to know where the regulation will end up, or if the company can actually deliver on its promise. After all, nine out of 10 startups do fail.

ICOs and the blockchain future

It’s not simply a new way of financing a company. With ICOs, everyone’s financing pieces of a completely new ecosystem.

“It’s like building the world from scratch,” said Castro. “It also really changes the power dynamic: you don’t need VCs anymore.”

“The engineers who were the first to invest in Bitcoin are thinking, ‘Now I can fund my friends. Worse case scenario: I lost this virtual currency that exists in the ether and that I didn’t have anyway.’ It’s all fantastic!”

Rebel, rebel

ICOs are rebel territory all right, freeing coders to build the projects they want to build, not only creating a whole new world, but one in which users own their data, stored on the decentralised blockchain.

With the internet, that information is in the hands or on the hard drives of cloud storage providers, governments and tech behemoths, like Google and Facebook.

Someone could develop a blockchain-based global directory, like a Facebook, but the users would own and have control of their personal information, rather than it being in the hands of the company, where it can be sold to third parties, aka, advertisers.

It could literally decentralise the world – yet another power shift, driven by ICOs.

Blockchain, crypto-currencies and ICOs may be marking the return of the true rebel disruptors, who are operating on a global scale, outside of governments and regulators.

Only time will tell if the empire strikes back.