A 78-page “Token Mania” document from Autonomous NEXT summarizes ICOs and explores many of the issues that have surrounded them, including similarities to the dotcom bubble, the impact of “bitcoin whales,” regulation and other topics. The analysis provides takeaways for startups, financials incumbents and investors.
Until 2017, all token launches were less than 1% of global crowdfunding activity. In 2017, more than $1.2 billion was raised in more than 50 projects. The report lists all 56 2017 token sales.
While the current ICO market has features of a bubble, there is an underlying innovation with the attributes of a massive platform shift in the digital world, the report notes. While most ICOs fail, some will redefine their industries in a winner-take-all dynamic over a 10-plus year holding period.
Financial incumbents should consider using crypto tokens as an operating strategy, such as tokenizing internal currencies and workflows, or catalyzing developer communities around open APIs.
ICOs Are Unique
ICO offerings are akin to the sale of a future money supply or a platform utility enabler, rather than a sale of securities. But unlike the sale of equities in a private venture investment or in IPO, the object sold in an ICO is a digital token that is both scarce and validated based on advanced cryptography techniques.
ICO offerings are issued by groups that may or may not be formally organized as a legal entity. Hence, regulation has not come to an agreement about these offerings. Some jurisdictions treat them as assets, commodities or currencies.
Some ICOs launch with developed products and roadmaps for utilizing proceeds, while others are raising money without a developed product but aiming to leverage speculation.
Crypto Evades Traditional Venues
The crypto economy is growing outside of traditional venues, the report notes, which has happened before with video game gold farming and virtual economies, but not on such a global scale.
Speculation and volatility across the crypto economy are rampant, and many participants are aware of both fraudulent practices and a growing bubble fueled by bitcoin whales. There are many fraudulent ICOs intended to take advantage of excitement in the ecosystem. They do this by leveraging social media for promotion and a lack of enforceable consumer protection, raising legitimate regulatory concerns and attempts by select market participants to self-regulate.
But beneath the turbulent waters are seeds for a massive transformation of the real world.
While many companies of the first tech bubble in the late 1990s have disappeared, winners like Amazon and Netflix have experienced large capital gains and monopolization of their sectors.
Most cryptocurrencies have not been successful, but bitcoin and Ethereum have experienced large capital gains and growing adoption, signaling an underlying structural shift.
Token Benefits
Investment in tokens allows economic participation at the protocol layer of a next-generation Internet.
Token value is derived from two primary sources: functional and speculative. The functional value is that derived from the use of the token itself. The speculative value is the value a trader of the token derives from trading it on an exchange, relative to others. This can be a positive development for the ecosystem as it draws validating capital, which can be invested in real projects. But if tokens are issued primarily for speculation, it raises regulatory issues.
ICO Challenges
While the type of risk in ICOs is similar to other early stage projects, judging quality is different from venture capital, and best practices are only beginning to be defined.
Offerings are shifting from core technology to use cases like markets, investment products, media and identity.
The report goes into detail about large ICOs such as the DAO, SONM, Storj, Status and Gnosis.
Institutional Investors Emerge
Institutional investors are in the early adoption phase of investing in the crypto asset class, but they are becoming as important as high-net-worth early adopters. The impact of these “whales” is to distort prices and market mechanics on new offerings.
Cryptocurrency market volatility likely created very large capital gains for early adopters. Large market participants are able to dominate the new assets coming up through ICOs. There are several possible sources for these whales, ranging from crypto players to traditional capital.
The venture capital community has been most engaged with the space, with the earliest investments in the space targeting bitcoin infrastructure.
There is a current realization that ICOs have a similar risk profile to venture investments, and that participating in them within a new structure is worthwhile. As a result, venture funds have invested into either hedge funds or operating companies like Digital Currency Group that are indexed to the rise of the sector.
Like crowdfunding, public participation in ICOs may compete with venture capital as an asset class.
The “high finance” communities like hedge funds and private equity, meanwhile, are just learning the basics. While some firms like Fortress have seeded strategies targeting crypto, it is not yet a broadly accepted asset class given the lack of institutional structuring.
The Bitcoin Investment Trust provides a stark example of bridging the gap between investors/institutions and an acceptable legal structure.
There are also ICOs like ICONOMI that package cryptocurrency indexes into an investable product.
While retail demand is increasing, it has not been able to access the asset class easily.
The Winklevoss twins have been advocates for creating a Bitcoin ETF, but the SEC has stalled the project for years and not allowed it to market; similar efforts are happening for Ethereum.
Opportunities For Financial Firms
Despite the challenges, there are many opportunities for financial services incumbents to incorporate ICOs as an asset class into a business model.
Closed banking networks must become more open through regulation like PSD2, the report noted. Many private blockchain projects– from Hyperledger, Enterprise Ethereum, Ripple, R3 and others –are already putting in place the technical foundation for tokenizing
The report also summarizes the roles of miners and exchanges in the crypto ecosystem.
Miners in proof-of-work blockchains are gold diggers that annualize to hundreds of millions of in proceeds. The report includes a chart listing annual proceeds as of June 16 to 20, 2017. The highest proceed went to AntPool, which mined 93 blocks, each representing 12.5 BTC valued at around $2,600 per coin, annualizing to $282 million per year.
The report also lists the largest exchanges by BTC volume.