Initial Coin Offerings: Neither Second Coming Nor Apocalypse


ICOs have leaped into prominence over the past few months. It seems a day doesn’t go by without some startup announcing a fat fund raise using this financial offspring of Bitcoin and the Blockchain.

As often happens with fundamental new ideas, voices have arisen across a broad spectrum, hailing ICOs as the New Finance and Death of Venture on the one side and the AntiChrist of business fundraising on the other.

We’ve been talking about ICOs a lot at Social Starts. Personally, I see ICOs as simply one more new tool for finance, with unique benefits and limitations, like any tool.

Here are my current thoughts on ICOs, which I’m sure will develop and change as we all get more familiar working with them.

Not a great tool for fundamental financing. Despite all the sizzling headlines, I don’t see ICOs as a great tool for core funding of startups, long term. Right now, ICO offerings pop because a huge universe exists of holders of bitcoin and other cryptocurrencies who have essentially nothing to spend it on. They pile onto the ICO offerings because they have few other options. If cryptos develop as true currencies, holders will have lots of choice about where to spend coin; if they don’t this initial overhang of unspent coins will soon be depleted and raising ICO rounds will get next to impossible.

Even more importantly, the current ICO fundraising craze seems rooted in some deeply flawed presumptions. One is that, if a company’s value rises, the value of its associated ICO pool will rise as well. This is critical for ICO success, since buyers of these instruments get no actual ownership in the company. But it is straightforward to imagine scenarios where a company can get valuable while its ICO pool does not. These crypto pools are open to manipulation in a host of ways. Just consider if a potential acquirer wants to pressure a company by driving the ICO pool down. Easy to do. Or consider a greedy executive, who finds ways to limit the ICO so that holders don’t reap all the benefits they presume they get.

And, when companies fail, as they inevitably will, ICO holders will suddenly realize that holding these instruments isn’t all balloons and birthday cake. When ICOs fall in value, holders will get surly. That becomes a huge distraction for the issuing company.

Finally, ICOs used for core fundraising can lead to management behaviors that actually hurt a company’s long term prospects. If management believes freshets of money appear at will with no dilution, it can lead to over-spending, lack of discipline, over-reaching, a host of sins. When that easy flow of capital vanishes, the company might well crash.

It seems like some hybrid has to emerge around ICOs that tie them to actual ownership and include some basic protections for their holders. This will come from SEC intervention or market innovation. But it feels like it has to come before ICOs can be taken seriously as a new central method for financing companies.

Even so, it is possible right now to see some strong practical uses for ICOs in business operations:

ICO as factoring. I don’t see why a company that has strong A/R and growing revenue might not choose to factor that revenue to its own community via an ICO. The terms are likely to be much better than available on the commercial market because of the supportive nature of the group. And, such an offering binds key constituents—customers, suppliers, backers—to the company in a way that a mercenary traditional transaction does not.

ICO instead of bank lines. Bank lines are great for growing companies. But the covenants they carry can be daunting. What about using ICOs instead of bank lines as, essentially, a credit pool the company can draw on as needed?  In this way, the company’s community can help facilitate its growth. As with factoring, the terms could be much better for the company. Imagine if virtually all of a credit line could be put to work with no covenants. It could be powerful.

ICO as marketing/merchandising. ICOs also have the potential to drive a level of loyalty programs never seen before. Far beyond current weak points offerings or threadbare discounts, ICO-based loyalty programs provide best customers with real meat: a piece of the action. This could generate extraordinary connections between an organization and its most valuable community members.

And, yes, at some point, private currency. While our fund, and I, are deep skeptics about Bitcoin, we recognize the potential for genuine local digital currencies to emerge within active communities. As key stakeholders and companies deepen their mutual ties via ICO-like arrangements, those webs of relationships are going to become ever more currency-like. I think we’ll see effective local digital currencies arise in such communities. They will be more like the recently announced Kik currency that only applies to members of that social platform. Back in the early days of money it was common for individual towns and manors to have their own currencies. They were widely liquid in that community and nearly valueless elsewhere. That is the kind of currency we can imagine beginning to appear in digital communities where ICOs have been applied to running the business better, rather than toward core fundraising.