Cryptocurrencies, or new investment vehicles of startups using blockchain technology, have gotten a lot of publicity recently, especially with the rise and fall of Bitcoin, the first cryptocurrency. Just in 2018, $21.5B was raised via ICOs, or Initial Coin Offerings. If you want to learn what an ICO is all about, you can start by reading this.
In this article and the corresponding video, I would like to focus on the advantages and disadvantages of ICOs as investments, because sadly many investors still significantly underestimate ICO risks.
The Positives of ICO Investments:
1. You can raise more money at a faster rate.
This is incredible for early-stage startup founders. With this vehicle, you can raise all the money you need right away and focus on developing your product, without ever having to spend another minute on fundraising.
2. You have access to a global investor base.
ICOs make it possible to have investors from all over the world. This is great news for foreign entrepreneurs, especially from countries with poorly developed VC ecosystems.
3. Anyone can invest.
In the U.S. only accredited investors, or individuals with a certain income level and/or net worth, can invest in an early stage company via traditional means such as equity and convertible debt. ICOs democratize the investing landscape by allowing anyone to invest.
4. The investment is liquid after an exchange listing.
Your investment becomes liquid immediately after a token is listed on an exchange. This is attractive to investors as it affords them the much needed liquidity faster. With traditional vehicles, investors typically have to wait for 3 to 5 years before a company makes an exit (if they are so lucky) and they can get repaid.
The Negatives of ICO Investments:
1. Large capital raises for early-stage ventures result in overspending and misalignment of incentives.
It is not ideal that early-stage startup founders can raise so much money up front, often more than they need. As a result, the founder’s and investors’ incentives are misaligned.
Usually, a startup has to go through several rounds of financing, where each round signifies a milestone. Achieving these milestones shows investors that the startup team can execute, and they are a proxy for the company’s growth trajectory.
When you give a massive amount of money to a startup upfront, you eliminate any incentive for the startup to really try and you also encourage overspending.
2. White Papers are often not thought through.
Under the traditional model, when you raise money, you have to put together an investors deck and financial model and there are standards for what information must be included in each. Sadly, there are no such standards for White Papers.
However, just because there are no requirements to include certain information, does NOT mean this information is not needed. Poorly prepared White Papers simply indicate that the founders are NOT ready to launch their product. That is bad news for investors because most likely their investment will go south.
3. Lack of transparency and oversight.
It is wonderful that ICOs allow us to raise money from all around the world. However, it also implies that these companies are far away and difficult to monitor. There is also often no recourse for when things go wrong.
4. Fraud and cybersecurity risks.
Because of all the issues I’ve discussed thus far, it is no surprise that there has been a lot of fraud in the space. Further, due to the nature of ICOs, they are susceptible to cybersecurity and other risks.
ICOs investments are riskier than angel investments. Just because they are liquid DOES NOT MEAN they are less risky.
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