LONDON — Startups around the world are raising hundreds of millions of dollars by issuing new digital coins, a trend that has made people both excited and concerned.
Over half a billion dollars has been raised through so-called “Initial Coin Offerings” (ICOs) since the start of the year, according to Richard Kastelein, a partner at the Cryptoassets Design Group, a company that helps launch ICOs.
It’s an incredible amount considering that ICOs were unheard of just five years ago.
The speed at which companies are raising money is turning heads too. Gnosis, a prediction market for digital currency Ethereum, raised $US12 million in just 10 minutes in April. Brave, a new web browser startup set up by the founder of Mozilla, made that look pedestrian, raising $US35 million in less than 30 seconds selling “Basic Attention Tokens” last month.
“The space itself started heating up in the back end of last year,” says Jan Isakovic, the CEO of new ICO platform Cofound.it. “It really caught fire since April of this year. We believe this is only going wider and wider.”
‘We’re selling tickets to a movie but still fine-tuning the last third’
To raise money through an ICO, a company issues a new digital currency that can either be spent within its ecosystem, a bit like Disneyland dollars, or used to power part of the business, like the fuel you put in your car.
“The Cofound.it token will be used on the platform by startups applying to join the platform,” says Isakovic. His business raised $US14.8 million through an ICO last month and is building a platform that to connect ICO-funded companies with experts who can help grow the business.
“They will use token to pay expert evaluations on the platform. If you want to work with the project you have to put a certain amount of Cofound.it tokens in escrow. It’s like an internal currency.”
With token crowdfunding, you can get thousands of engaged supporters who are extremely motivated to see your company succeed
What is unusual about most ICOs — sometimes called Crowdsales — is that, in most cases, the coins being sold are for marketplaces or businesses that have yet to be built. Investors who are buying them are betting that the businesses will become successful and the coins will become more valuable as people flock to the platforms.
“We’re like selling tickets to a movie but we’re still fine-tuning the last third while the audience is filling into the movie theatre,” Isakovic says.
He was drawn to ICOs because of an unhappy experience he had with venture capitalists who funded his previous venture, a retail startup called Storesense.
“Unlike with the traditional VC system where you lose six months to a year raising, here you don’t lose any time — the opposite,” he says.
“When you get money from a VC you get money from one person or one perhaps their team. Everybody says, ‘we have the connections, we will help your startup grow’, but that really seldom happens. Whereas with token crowdfunding, you can get thousands of engaged supporters who are extremely motivated to see your company succeed. They are your early adopters, they’re your evangelists.”
‘They will thaw a lot of frozen capital and lead to a lot of innovation’
Setting up an ICO is relatively easy, with most companies piggy-backing on the Ethereum network. Ethereum is a blockchain-based public system that lets people write “smart contracts.”
Isakovic says: “A smart contract is effectively a piece of software, a piece of code. In our smart contract, it says we are selling 125 million tokens, our cap is at 56,000 Ether or something. The crowdsale lasts until the cap is reached or until four weeks is done. Calculate the contribution and then send tokens. It’s two or three pages of programme and Ethereum does everything else.”
Ethereum’s developers, in fact, carried out one of the first ICOs back in 2014 to fund the project, selling digital currency Ether. Joseph Lubin, one of the people who helped build the network, says ICOs are “the first killer use case for Ethereum, in that they will thaw a lot of frozen capital and lead to a lot of innovation.”
“You have a global context of the potential buyers of the token and you have a lot of college kids who have $US50 and they’re excited about this technology or a particularly E-Sports project, and they throw $US50 into the token,” Lubin told Business Insider. “The amount of capital that that will free up to create innovation, to create growth, is amazing.
“On the other side of that equation, [there are] a number of two people [startups] in a dorm room putting together a project that was never going to get an email back from a venture capitalist. But they can permissionlessly VC themselves.”
‘If you had an analyst look at it, this is a typical kind of bubble’
Not everyone is so excited about ICOs. David Rutter, a Wall Street veteran who now runs fintech company R3CEV, told Business Insider: “I think people are way over their skis when it comes to these various digital currencies.”
“There’s approximately 200 coins now. If you had an analyst look at it, this is a typical kind of bubble, in that folks that have made money in bitcoin are trying to parlay that into other kinds of cryptocurrencies and now they’re moving out of those.”
What Lubin sees as thawing capital going to dorm room entrepreneurs, Rutter sees as dumb money going into flimsy startups.
“Many of them are based on powerpoint decks and not a lot more, not fundamentally sound business plans,” he says. “Of course you would, if you can go and make $US10 million or $US15 million or $US20 million on an ICO in a matter of hours, based on a really well put together powerpoint — if you think that’s good for the economy and the world and young entrepreneurs, that’s fine. I don’t.”
Isakovic disputes this: “There has not been a project yet that has only had a powerpoint and raised more than, I don’t know, £1 million. All of the projects that have raised large amounts have really competent teams and products behind them.”
Still, he adds: “I think we are in a period of inflated valuations, but not a bubble.”
Isakovic believes money is flocking into ICOs because people have seen the incredible price rises in bitcoin and Ethereum, as well as rises for ICO coins, and want to make money. Unlike buying shares in an early stage company, investors in ICOs can trade the coins almost immediately on a number of exchanges, rather than waiting for a company to list on a stock market. This attracts investors looking to make a money, which is pushing up valuations.
There is, of course, the possibility that many of the coins could become worthless. Tulip bulbs became extraordinarily valuable in the Netherlands in the 1600s in an incident known as “Tulipmania” before the market collapsed abruptly.
‘The Wild West of financing’
Rutter is also concerned about the lack of investor protection in crowdsales. The issuing of digital currencies exists in a legal grey area outside of securities law and there are no rules governing what a company should do with the money it raises.
“There’s a reason securities laws exist and that is to protect the consumer and to make sure that what you’re offering is actually fundamentally of value,” Rutter says. “These initial coin offerings I would never participate in, I don’t see how they’re compliant with current securities regulations.” (Some have been structured to comply with securities law.)
Cryptoassets Design Group’s Kastelein described ICOs as “the Wild West of financing” in a recent piece for the Harvard Business Review and, at a recent finance conference in Copenhagen, I heard many people voicing concerns similar to Rutter’s about the space.
Isakovic says, in practice, investors are protected as startups must have a dialogue with them in order to raise money and make their project a success.
“For us, our strategy really depended on instant and very comprehensive communication with our investors,” he says. “We had endless discussions with people on Slack, on Reddit, in person with people who helped us craft our roadmap. That is what is our supporters recognise. First, we developed a bond with them but also they saw we were willing to listen and adapt.”
ICOs remain hugely popular with both startups and investors. Europe’s first ICO conference took place in London on Friday, with over 200 attendees expected from more than 20 countries.
An email sent to Business Insider this week highlights no fewer than 5 ongoing or upcoming ICOs. The companies include Loci, a distributed database for patent research, and DAO.Casino, a startup aiming to “bring provably fair gambling to the online industry.”
For now, most of the companies raising money are tech and blockchain focused. But Isakovic says: “I think in the long run this method [ICOs] will work for most startups. But in order for it to work — it’s not just about the mechanics, it’s about persuading potential investors. Right now most of the supporters are early adopters or even innovators. They are interested in software and they are interested in blockchain so right now they are the projects that get funded.”
“But I think once this method of funding start ups gets more and more popular, I believe that we’ll be seeing more and more different projects that will come into this space. But we’re not there yet, perhaps in a year.”
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