Analysis: It’s in the Numbers – the ICO Market is Cooling Off

Of the 169 ICOs that took place in October, only 69 managed to reach their fundraising goals.

In September of this year, Ethereum founder Vitalik Buterin said that he “indeed [thinks] that we are in a bubble because all the cryptocurrencies are rising and people have a feeling that they will always continue to rise.” However, “In the end the market will need to cool down….A lot of projects will fail and people will lose money.”

That cooling appears to be taking place right now. Cryptofinancial research firm Smith + Crown reported that the amount of ICOs planned to close over the last four months has been increasing – there were 31 in July, 45 in August, 59 in September, and a whopping 169 in October – that’s more than five new ICOs every day for that month.

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However, only 69 of those 169 October sales actually managed to reach their fundraising goals before their closing dates. According to Smith + Crown, the rest of them ended up “either extending, postponing, or cancelling outright their own proposed sales.”

Buterin pointed out that “if most ICOs fail, that is a risk (to Ethereum itself)”. A series of weak (or perhaps even fraudulent) ICOs could cause the world to take a step back from the practice. However, the current cooling off of the market may be a good thing in the long run – an important step towards reaching an ICO climate in which only the best-built coins are likely to succeed.

Indeed, Smith + Crown has said that the results of the recent saturation in the ICO market point toward several conclusions. The first is that “the average project proposing an ICO is simply not raising $10 million with nothing but a whitepaper and a website.” Additionally, the presence of a lot of strong projects seeking to raise between $10 million and $30 million has simply saturated the market.

Smith + Crown also says that the weakening of ICOs can be interpreted as the rise of a more discerning, rational market that is more selective about the projects that it chooses to fund.

How do ICOs work?

Participating in an ICO is like buying a ticket – or a bunch of tickets – to an amusement park that hasn’t been built yet. The park’s planners have conceptualized and designed a bunch of awesome rides; they just need the funds to buy the supplies and put everything together. ICOs support companies and cryptocurrencies that have been conceptualized, but not yet developed or implemented.

An ICO asks people to contribute funds, usually in the form of BTC or ETH, in exchange for ERC20 tokens, which will be distributed after the ICO is completed. The ICO will close once it reaches its goal or after four weeks – whichever comes first. Once the tokens purchased begin to increase in value, whether it’s because of practical adoption of the coin and its network or pure speculation, the investor has profited.

The main difference between purchasing tokens in an ICO and purchasing stocks in a company, token owners do not have any ownership in the company that created them. This can be beneficial from the perspective of the company, as they do not have to hand any sort of power over to a venture capital fund or other financial backers.

Tokens purchased through ICOs have been widely regarded as high-risk investments, and not without reason. While there are plenty of ICO participants who have made eye-popping returns on their contributions (like those who have taken part in the Ethereum, OmiseGO, and Qtum ICOs) there are an increasing amount who have not had such sparkling results.

Vitalik Buterin said that he himself does not participate in most ICOs because he “[thinks] they are done at too high valuations.”

ICOs and Venture Capital

The disruptive nature of the ICO model has had some venture capital funds getting nervous. In the past, startups who were not chosen by the superior judgment of the VC industry had to rely on “crowdfunding or bootstrapping”, according to Recode. Nowadays, ICOs have the potential to bring in unprecedented amounts of fast cash.

Even while the ICO scene seems to be cooling off, the new model of funding is likely to remain a part of the startup funding landscape. As a result, Smith + Crown’s Brian Lio says that “every VC firm is going to have to take a long hard look at the value they bring to the table and how they remain competitive. What do they have other than prestige? What are they offering to these companies that are more advantageous than going to the community?”

Some VC firms, like Sequoia Capital, have embraced ICOs as a form of funding. The buzz around ICOs has given them a fair amount of cultural clout. In a poignant tweet, Adam Draper (founder of the San Mateo-based Boost VC), told of the trend:

 

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Of course, VC firms who choose not to participate in ICOs may not have quite so much to worry about as the practice becomes less popular and more regulated. Although, the rise in the trend of crowdfunding in general is a good indication that the venture capital industry may be changing, if not declining; people can decide to directly fund the products and companies that they would like to see do well in the world.

The ability to sidestep the VC industry in the quest to achieve startup funding is a mixed blessing for investors and for the beneficiaries of the investments. According to Vitalik Buterin, “a lot of projects are raising more money than what they would be able to in the normal VC market, and sometimes there is no match between the necessity and usefulness of the project and its ability to raise money.”

As such, one of the issues with ICOs is a general lack of understanding and information. Blockchain technology is so new and so abstract that it can be difficult for anyone who hasn’t put a decent amount of time into understanding how the technology works to discern between a good company with solid programming and marketing, and a company who has just splattered a WordPress page with buzzwords like ‘decentralized’ and ‘blockchain’.

“This market is still young and people still don’t know how to differentiate between projects that will exist in the long term and those that won’t,” said Buterin.

Scams and Trouble

While it can’t necessarily be said that there is an overabundance of cryptocurrency-related scams, they are certainly a part of the world of cryptocurrency, which has been largely unregulated until the very recent past. ICOs have been of particular interest to governments around the world as a regulatory target. As with any sort of investment, participants in an ICO are essentially making a bet that the company will act responsibly with their money, and that the money that they have put in will multiply.

However, the lack of legal structure surrounding ICOs leaves investors particularly vulnerable to scams, and with few rights when it comes to compensation for the purchase fraudulent tokens.

For example, the Confido ICO, which raised $375,000, is now being billed as an exit scam after the company’s founders appear to have taken the money and run away with it. Following a cryptic announcement of legal trouble on a Medium post that was later deleted, the website and all traces of social media accounts related to Confido were wiped away, although cached versions of the pages still remain.

TokenLot, the firm that hosted the Confido ICO, has since gotten the FBI involved in figuring out where the money and the company’s founders disappeared to.

Not every ICO that ends in losses for participants is an outright scam; some companies that raise a lot of money through an ICO may lose it or mishandle it through simple incompetence. Others may mix in a few shady dealings to an otherwise legitimate operation. In other words, there’s a bit of a spectrum; not everything is black and white.

One of these sorts of grey cases is the ongoing saga of Tezos, a cryptocurrency that caught worldwide attention for its record-breaking ICO, which raised $232 million. In a bout of recent high-profile troubles, Tezos has been hit with three class-action lawsuits from three separate US-based law firms. The lawsuits are seeking compensation for participants in the Tezos ICO.

Following a highly publicized spat between the couple that founded Tezos and the head of the Swiss-based Tezos Foundation, it was revealed that the tokens purchased during the Tezos ICO were never legally registered as securities, although the language of the ICO sold them as such. There have also been accusations on both sides of the schism that the opposing side attempted to pocket some of the ICO funds for personal use.

However, Tezos is attempting to carry on business as usual; the plan to distribute the tokens purchased during the ICO this coming February is still in place.

Governments Worldwide are Hurrying to Regulate ICOs and Crypto in General

As ICOs become increasingly popular, governments hoping to both protect their citizens from illicit activities and capitalize on the taxation of funds raised by ICOs have begun to push and pass regulations around the practice.

In the United States, no specific action has been taken to regulate ICOs, although the SEC issued a warning to startups that tokens sold in ICOs may need to be legally registered as securities in order to be legitimate. Additionally, the IRS has publicly stated that virtual currencies are indeed taxable if they can be converted into a dollar amount.

Countries across Asia and Africa, including India, China, Malaysia, Kazakhstan, Zimbabwe, South Africa, the Philippines, and others, have been creating legal frameworks of their own to deal with cryptocurrencies. Some of the world’s smallest states, like Gibraltar, are treating the emerging cryptocurrency market opportunistically, purposefully leaving laws a bit lax to attract more business.

Others have cracked down hard on the practice of holding ICOs, making the practice completely illegal. China, Russia, South Korea, and Morocco are among the countries who have banned ICOs outright, although it’s certainly possible that their decisions could one day be reversed.

To Be Continued…

At only eight years old, cryptocurrency is still in the beginning stages of its life (especially considering that it only started receiving any sort of real attention within the last two to three years). The world is still learning how to deal with it.

While some may argue that the cooling of the ICO market is a bad sign for cryptocurrency, perhaps proof that the whole thing is a fraud or some other sort of disaster waiting to happen, a more balanced view seems to be that the new market is enduring some simple growing pains as consumers become more educated and governments tighten the reins.

Undoubtedly, it will be some years before 1) cryptocurrency and blockchain are adopted for any sort of widespread use and 2) the world’s legal and financial institutions have the proper frameworks to regulate and transact with cryptocurrencies themselves. For now, the best thing that we can do is continue to educate ourselves, and to enjoy the ride; it certainly will be a ride.

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