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ICOs from innovation to abuse

In past 2 years market for ICOs have boomed like a wild flower and the flower is everywhere. Only later you’ll realize that it isn’t the flower it is the weed. The concept of ICO was noble and it was trying to avoid the bullying that was going on in the start-up funding markets by VCs and Angel investors. Before I start talking about VC bullying or Angel Investors extortion, let me be very clear these were few cases that were getting the whole ecosystem a bad name. Some bad apples make fresh start-up founders fear what to expect and even a good intentioned hard bargain used to be seen as a hostile attempt to steal the idea.

Ecosystem before ICOs

Tokenization wasn’t the norm earlier in the start-up community. The standard way to raise money for any start-up or an individual was to come up with a potentially sellable idea, product or service, prepare a strong business plan, a good compelling elevator pitch and if the founder didn’t have the money to bootstrap the idea or the company then he/she had to go out there in their networks and try to find an Angel investor or a Venture Capitalist (VC) to fund the idea.

This was hard work, as you’ll have to convince people with different perspectives, intentions and motivations to look at your idea objectively (which is difficult due to inherent biases of many people) and agree to put money in the venture by agreeing to take a piece of start-up equity in return. If the idea works well and start-up is able to establish itself as profitable, the investors will get a handsome returns.

Why it was hard to sell the idea to investors in first place? It is purely because, Investors and VCs understand that only a few of their invested ventures will be able to reach the goals they dream of achieving. Many first time founders are new to the challenges of running a company, leave alone managing the various aspects of a firm like finances, hiring right team members, keeping a strong control on expenses and still try to keep the efforts on track to get towards the goal of building that perfect product or service they had an idea about. Also, the operational challenges or technological challenges that weren’t envisioned earlier derail the overall effort, even with best intentions.

This makes VCs and investors extremely sceptical of the ideas they hear, and more and more they come across people coming to them with ideas they sometimes get vary of similar ideas coming from multiple people or very ambitious ideas being pitched by founders with no prior experience, which investors know won’t fly off that easily in the market. To structure this process many investors came out with their set of questions that will shake the founder to ensure he/she has fully thought through the scenarios and is not just excited to launch a firm because he believes idea is good. Founder must have thought through the expenses, the revenue streams and cash flows also.

This process with time became well established and many founders used to find it daunting even to think of taking the idea forward as a long checklist of items were there for them to provide answers to before even meeting any single investor and using him/her as sounding board. This also gave opportunity to some investors who used to use these tough questions to shakedown the confidence of the founder, just to ask for an unreasonable stake in the venture.

Instead of standard 20-35% of start-up equity sometimes VCs used to ask for 49%-51% or 50%-50% stakes and in the next series of funding used to get the majority stake and kick the founder out of their own firms, on the grounds of lack of experience to run the bigger company and put their chosen person to run the company. Growing such cases were found in many start-up ecosystems and this bred the growing mistrust towards VCs in the founders’ communities.

ICO as an alternative

Due to Bitcoin and Ethereum becoming popular and many projects were raised under the crypto currency domain, towards which the standard VCs and investors were very sceptical and unclear regulations weren’t helping either, the new generation of founders looked at giving certain amount of Bitcoin or Ethereum as a pledge if they get the funding to build their crypto currency and project comes to life. Logic behind this exercise was simple, once the project is at the MVP level, this cryptocurrency will be hosted on some exchange and will be pegged against the underlying crypto currency founder pledged it to be traded for.

This whole process was to democratize the funding process and instead of going to a tightly knit community of VCs who if not find a suitable price may give a bad feedback to other VCs for the idea and getting funding will be even more tougher, but to go directly to micro investors who were holding Bitcoins or Ethereum amounts and are willing to invest them for potential profits. This gave founders a major leg up and they were able to build dream projects and subsequently their cryptocurrencies successfully.

In a capitalist ecosystem, any good idea with potential is bound to get abused at some point of time. The underlying weakness of this ICO system was that all these projects were as risky as any start-up would be, because operational challenges were still the same. Working with new team members, new technology stack and inherent weakness of some ideas were exposed soon as the well-established vetting & shakedown process of good intentioned VCs was missing here. All the founders have to prepare is a good looking business plan, a whitepaper (to describe the problem they’re trying to solve) and VOILA some unsuspecting investors will fall in trap.

As many people saw this space closely and identified the weaknesses of the system, there are companies that have come out to game the entire system, by creating fake user bases, proxy questions and even fake applauders on telegram forums to fool the investors and getting their money invested into scam ICOs.

Conclusion

Please be reminded, ICO space is not yet regulated by any financial regulators or auditors. The only regulation present is a soft community regulation that keeps an eye on fraudulent individuals who have duped the system earlier or rely on the feedbacks of diligent investors when they raise red flags on certain whitepapers or ventures. This system is bound to get a major shakedown at some point in future, but until that happens, I suggest you to be very diligent before investing anything on any of the ICOs and do your homework well with the project teams, financials they offer and the unending bonus token sale they offer to lure more and more people to their scheme.

 

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Shailendra Malik

Shailendra Malik

IT Ecosystem & Platform Delivery

Optimum Solutions

Member since

25 Apr

Location

Singapore

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