Interpreting ICO and altcoins from the perspective of blockchain venture capital

Baozou Commentary : We say that altcoins, tokens, and ICOs are all about blockchain digital currencies. With the development of blockchain technology, various digital currencies continue to emerge. Various industries and companies are flocking to them, which has led to various financing projects appearing in the form of ICOs. However, this type of financing cannot guarantee its own legitimacy and fairness. Therefore, when participating in such projects, you must pay attention and guard against possible risks.

Translation: Annie_Xu

ICO (Initial coin offerings) is a new term in the field of digital currency. It has become a hot topic in the blockchain field along with altcoins.

Visionary investors are beginning to support this business activity, thought leaders say ICOs are changing the traditional venture capital model, and Bitcoin veterans are also investing in blockchain tokens with hedge funds.

I expect there will be more ICO discussion and activity in 2017, but I'm not sure.

As the most active investor in blockchain startups, Digital Currency Group is uniquely positioned to profit from ICO growth, so we have been closely watching the market in 2016.

I’ve discussed ICOs with dozens of entrepreneurs who have considered or participated in them, and I’ve also had in-depth discussions with major ICO investors.

Although I am very interested in the promise of blockchain, I still believe that ICOs and altcoins are unlikely to be good investment options.

background

People who are not familiar with it may think that ICO is the crowdfunding of blockchain cryptocurrency, which is used for the development and operation of three types of blockchain projects.

1. Platform blockchain (such as Ethereum or Lisk).

2. Blockchain-based organizations DAO (decentralized autonomous organization) or distributed entities with a centralized architecture (CODE, centrally organized distributed entity).

3. Decentralized applications based on platform blockchain.

Tokens that power decentralized applications are sometimes called application coins, while tokens for DAOs and platform blockchains are called tokens or cryptocurrencies.

A typical ICO is to issue tokens through crowdfunding, which can be exchanged for Bitcoin or Ethereum. Then, as long as there is a large demand, the altcoin exchange will provide trading services for this token.

This new financing method is not yet mature. It is only called decentralized and disintermediated venture capital. It is a new opportunity for individuals to participate in investment and a new financing channel for enterprises.

Some blockchain entrepreneurs have raised a lot of money through ICO, which is more difficult in the venture capital market. Moreover, the large circulation of tokens can encourage early investors to support blockchain platforms and become users and developers. There is no doubt that many companies we communicate with are considering obtaining corporate operating funds through ICO.

This is an exciting development and ICOs and decentralized organizations may be able to transform the industry.

However, I believe we must understand the current situation. I have also encountered four problems in the process of token investment. Compared with traditional venture capital, there are many pain points.

1. Regulatory uncertainty

2. Overvaluation or overcapitalization

3. Lack of control

4. Lack of business use cases

I will read them one by one.

Immature regulation

First, issuers of new tokens generally underestimate the regulatory risks of ICOs.

They just talk about regulatory compliance over and over again, saying that they have communicated with lawyers and will ensure product compliance. But the fact is that most of them do not pay attention to legal risks.

Few entrepreneurs who launch ICOs understand the Howey Test, which determines whether a transaction meets the security requirements of the U.S. Securities and Exchange Commission (SEC). For example, many people mistakenly believe that companies established outside the United States are not subject to U.S. law. Few people understand why new tokens are so important to the operation of the project and why tokens are more than just crypto shares.

No one I spoke with was aware of or downplayed the risks, but unregistered ICOs are also likely to be illegal. I appreciate that the Ethereum developers chose to ask for forgiveness rather than apply for permission, but that doesn’t mean investors should turn a blind eye.

Although we don’t yet know the pitfalls of unregistered ICOs, financial regulators are often eager to expand their oversight, and the secrecy of many projects may attract regulatory attention. Recently, regulations have been enacted to target unregistered equity crowdfunding, and projects suspected of violating regulations may soon become their targets.

Of course, if these blockchain projects can bring huge benefits to non-professional investors without any risks, the law needs to be amended. Anyone familiar with financial regulation knows that these laws and regulations often ignore real needs and refuse to adjust.

Therefore, investors in these tokens should understand that if regulators intervene, they may lose most or all of their funds.

Make quick money

Secondly, I think the valuation expectations of these DAO crowdsales were unfair, and the amounts raised for the token crowdsales were staggering. Even the fundraisers did not expect sophisticated investors to participate so actively in the seed rounds, and to raise such high amounts.

While some may see this as a good thing, allowing entrepreneurs to circumvent the gatekeepers of elite venture capital and gain support from knowledgeable investors, I see this as a sign of a dysfunctional market.

Buyers in ICOs appear to be active early holders of Bitcoin and Ethereum who feel they are just spending the money of the bookmakers and are unable to determine the value of these projects or how much money is needed to invest.

This situation may stabilize over time, but I would not want to enter this market yet. Even the most promising projects have overvalued valuations.

Lack of control

Third, I am shocked by the way decentralized organizations use ICO proceeds. There is also a lack of control over how token holders distribute project proceeds.

In many cases, token holders have no idea what rights they have.

Token sale backers also have no legal rights to use the ICO proceeds, and are often not informed in advance of how those rights will be used. I have seen many companies unilaterally control millions of dollars in ICO proceeds.

In most cases, no one monitors how funds are used. It is possible to store funds in private bank fiat accounts or multi-signature cryptocurrency wallets. Scams are inevitable. Even well-intentioned supporters can be swayed by their own selfish motives.

Some people comfort themselves by saying that the rights of investors are encrypted into the project. But in fact, those who originally supported the ICO can unilaterally modify the code according to their personal wishes.

The corporate model has its own weaknesses, but it has also evolved over hundreds of years as the market changes. The Basic Law also balances the interests of shareholders and management agency issues.

I agree that the DAO is not a viable governance structure in theory, but how it will work in practice is uncertain. The DAO is a smart contract, but is it legally binding and can it protect investors? I don’t think it can be done at this time.

Lack of business use cases

The fourth point is perhaps the most fundamental. I have yet to come across a blockchain-based decentralized application that can truly solve a large-scale problem. Does the market really need a decentralized Uber or some other risky approach?

In theory, decentralized applications can achieve low cost, high privacy, high security, and disintermediation. However, privacy and security are not the key factors for large-scale applications.

I think the only way to popularize decentralization is to provide truly low costs without sacrificing user experience. However, without responsible employees, it is difficult to have a first-class customer experience. Although this is possible, it will increase the complexity of the blockchain system.

Even decentralized applications that have a strong value proposition come with overly complex rules because those rules are inherent to the decentralized nature of the project.

Of course, this does not mean that decentralized applications cannot succeed. There are many failures, learnings, and repetitions before success. However, the current situation is that decentralized applications cannot respond well to consumer needs. The basic factors that make blockchain disruptive also pose a great obstacle to its popularization.

in conclusion

Although I have been talking about risks above, if I were a blockchain entrepreneur, I would still seriously consider ICO because it is a good way to raise funds, and the wide circulation of tokens can increase the market for products.

And I believe that open source blockchain protocols will eventually realize their potential, and I hope to see it come to fruition.

However, we will not see this moment until regulatory issues, value proposition, monitoring, and blockchain entrepreneurs fail to solve real problems with these protocols in line with user needs. The fact is, the issuance of these tokens is highly flawed, and investors interested in ICOs and altcoins need to proceed with caution.