There are no absolutes when it comes to investing, but “don’t buy an IPO” is a well-known axiom. That’s why I was skeptical when I first heard about ICOs or Initial Coin Offerings.

What’s an ICO to a Non-Believer?

The aforementioned run-in was through a podcast — Unchained, hosted by Laura Shin. The episode’s guest was Olaf Carlson-Wee, Coinbase’s first employee. Olaf was on to talk about his recent $15M fundraising from investors such as Andreessen-Horowitz and Union Square Ventures for his blockchain focused hedge fund Polychain Capital. By extension, the conversation touched upon the red-hot market for ICOs in 2016.

Even before the episode was over, my suspicions ran deep. However, the weight of the names backing Olaf ran deeper. I needed to know more. The potential was clear to me: if the idealistic vision of ICOs came to pass, then it could disrupt venture capital.

Crowd Funding vs. Crowd Selling

Let’s back up and level-set on what an ICO is. To simplify there are 4 steps in an ICO:

  1. An offering company generates a fixed amount of cryptocoins
  2. A set % of these coins are offered to the community
  3. The market exchanges cryptocurrencies or $ for a stake in the ICO
  4. Funding goal reached = transaction executed; else = money is returned

There are a few other interesting characteristics of an ICO, such as scaling of offering price, but I’ll skip those for now.

As you might have noticed, the structure of an ICO is similar to crowd funding platforms like Kickstarter; however, unlike Kickstarter, where your money is effectively a donation, an ICO is an investment.

In fact, the financial returns for backing a successful company during their ICO can be monstrous. As an example, here is Ethereum’s price chart:

Source: World Coin Index

From $2 to $50 in less than 2 years. I think every VC’s mouth just started salivating at the thought of a 24x return on a relatively liquid (compared to startup equity) asset.

However, much like the venture world, explosive returns are rare to find. In fact, only a few other coins have experienced massive growth on the scale of Ethereum — Maidsafe (11x), Augur (8x), and Golem (5x) to name a few.

Considering that ICOs are like Seed/Series A funding for early-stage startups, it makes sense. Failure is the rule; success the exception.

Unicorn Hunting Without a Permit

Let’s get back to Polychain Capital — the hedge fund backed by VCs. That’s right, professional investors have started investing in professional investors. A clear indicator that something is afoot. In the context of what’s at stake (a la 10x+ returns), it makes sense.

In fact, the data supports the move by Andreessen-Horowitz and USV. ICOs are becoming an increasingly popular form of raising capital by blockchain-tech startups. According to Smith+Crown, the ICO market raised roughly $225M in 2016, up from ~$15M in 2015. Even after adjusting for the DAO, which accounted for roughly $130M in 2016 ICO fundraising, we’re still left with $95M in total ICO funding— an increase of 500% Y/Y.

Was 2016 an outlier? Well, as of March 31, 2017, there has been $35M raised year-to-date and a $7M pipeline of in-process ICOs. So to answer the original question: no.

Concluding with the Fine Print

Although ICOs are an intriguing development in crowd selling, it is a young and unregulated market. ICOs represent an unprecedented opportunity for individuals to get involved in startup investing, but the risk/return profile simply does not make sense for most people at this point.

In addition, many of the companies that have raised funds through an ICO have yet to start delivering on their promises. It’s also unlikely that we will get truly meaningful data points on their sustainability until initial funding runs out. Considering that the majority of ICOs happened in 2016, chances are we won’t be able to gauge the durability of the market until ~2020.

However, once there is a bit more data and structure to work with — all bets are off.

In the meantime, VCs should bone up on their Godfather knowledge:

Keep your friends close, and your enemies closer.

I’m onto you a16z and USV.



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