August 7 is a red letter day for Sumukh Shetty. He launched his Ether trading marketplace EZ Ether that day. Five weeks into the platform, it is clear that he needs to scale up operations. That requires funding.
How does a startup scale up? Traditionally, it has been through VC or angel funding. But, today, entrepreneurs such as Shetty have a new option: ICOs, short for initial coin offers.
“We are yet to decide whether to opt for traditional funding or go for a token sale via an ICO to raise money. The whitepaper for the ICO is almost ready but we are yet to decide on what path to choose,” says Shetty, who founded EZ Ether with two friends – Quijano Flores and Arseniy Klempner – he met at Jaaga Study, an open learning center in Bengaluru. Think of the whitepaper as an information memorandum given out to potential investors in an angel or VC round or an initial public offer (IPO).
Shetty feels that unlike traditional investors in the case of IPOs, every ICO investor is incentivised to help market it and improve the value of the ICO tokens they hold. He says, “With an ICO it’s just not funding but you also the token holders become evangelists for the platform or product. The ICO also creates a shared structure wherein not just one stakeholder makes all the money.”
Guess what? Shetty is not a lone rider. There are dozens of entrepreneurs in the world raising capital in cryptocurrencies.
ICOs, ICOs everywhere
ICOs seems to have come of age in 2017 with around $665 million raised from token sales in the month of July alone, according to data from Token Data. The amount for the year is expected to exceed $3 billion.
New coin offers — besides ICOs, they are also called token sale, crowd sale etc. — are still a tiny fraction of the capital raised by IPOs globally, to be sure. In 2016, counted as a tepid year for new share sales, IPOs raised some $132.5 billion worldwide.
Not only are ICOs booming all over the world, there is a strong surge for appetite among Indian investors and, lately, issuers from this country.
For easy understanding, an ICO can the thought of as an IPO with minimal regulation and frictionless crowdfunding. A company doing an ICO usually raises money by selling its crypto token in exchange for cryptocurrency — BTC or ETH in most cases. But unlike an IPO, the ICO may not entitle the holder to shares or a stake in the company. Instead, the value of the token issued during the ICO increases based on how well the company is doing.
The now famous cryptocurrency Ether was actually the result of the Ethereum ICO that ran between July 20 and September 2 of 2014. During this period the Ethereum ICO raised 31.5k BTC (worth $18.4 million at the time) in return for 60 million Ether distributed to investors.
Indians on the ICO path
Mohit Mamoria, a cryptocurrency enthusiast from Gurgaon, is prepping to launch a crypto hedge fund, the first of its kind targeted at India. How can an investor buy into it? By buying what Mamoria is calling a GOD Token. For investors, a GOD Token will represent a proportionate equivalent, based on the investment amount, of a pool of various other cryptocurrencies the crypto hedge fund will manage.
The money from the token sale is what will power the pool.
“We have already started issuing tokens in a presale beta by invite only. We have only 100 slots in the beta presale and around 60% of it has been completed,” says Mamoria, well known in crypto investing circles and the author of Blockchain for noobs: A definitive guide for FactorDaily.
For now the minimum investment amount has been set to 3.5ETH, which is the only cryptocurrency the company will accept, worth nearly $1,000. For every $1,000 invested, the investor will receive 1,000 GOD Tokens, valuing each token at $1.
Depending on how the cryptocurrency pool is managed by the company and its value increases, the value of the GOD Token will rise. Alternatively, it will fall.
GOD Token plans to open token sale for public in another six weeks.
The company’s revenue will be in form of a fee for managing the fund and a percentage of the total profits made by the portfolio — much like a portfolio manager betting on share, bond or currency prices.
India investors love ICOs
Chandan Choudhury is a day trader in cryptocurrencies we wrote about earlier. A former derivatives trader and analyst, Choudhury ventured into cryptocurrency trading earlier this year via a couple of investments in ICOs.
“I started with investing in ICOs. Humaniq and TaaS were the first and they gave me around 6x to 8x growth in a couple of months time. But nowadays I’m very picky and choosy about the ICO investments I make,” says Choudhury, who feels that until about six months ago investors had an early mover advantage in the ICO space but today that does not exist.
“This is because in an unproven market which tends to resemble a bearish market, the investor sentiment is down, an ICO trying to raise money is more likely to quote themselves low, else the ICO becomes unsuccessful. The scenario changes when the market is bullish, where there is an investment frenzy… ICOs tend to make more money because investors have surplus money and are on an investing frenzy. ICOs can also tend to over quote themselves at this time,” says Choudhury.
Token sales come with no guarantee on returns and can underperform. The DAO token sale, launched in 2016, had raised over $168 million in funds. After the token was listed in the markets and trading started, a hacker found and exploited a vulnerability in the DAO smart contract which resulted in losses amounting over $50 million. As an aftereffect of this hack, investors started dumping the DAO token and its prices crashed.
Tokens such MCAP, which are still being sold by the parent company BitcoinGrowthFund for over $9 per token, trade for around $1.7 — nearly one-fifth its sale price. (We had written about BitcoinGrowthFund and GainBitcoin founder Amit Bhardwaj and his dodgy multi-level marketing schemes here.)
Still, Choudhury is taking part in the Kik ICO that started on September 12. But there are times when he feels that he has missed out on some good investment opportunities like the Kyber Network ICO that he recollects missing out on because he had not registered during its whitelisting.
Whitelisting in ICOs is very similar to registering for a flash sale for a phone sale on Amazon or Flipkart. If you don’t register on time, then you can’t take part in the sale.
Also, the amount of funds ICOs raised has increased dramatically in the last few months — from around $10 million to top the $200 million mark. Just recently, FileCoin raised $257 million from its ICO and Tezos $232 million.
ERC20, ICO whitepapers
Launching an ICO has become a much easier proposition today with improvements in protocol standards and services that let you issue tokens even without deep coding skills.
For example, the ERC20 protocol that lays down the specifications an Ethereum-based token needs to adhere to. “Developing a token based on the ERC20 standard requires very less amount less amount of programming. Also, an ERC20 standard can be transferred to a future compatible blockchain,” says Sunil Aggarwal, director at Theory Frames Knowledge Networks and author of ‘Bitcoin Magnet’.
He has authored a whitepaper for a soon to be launched ICO and is working on three more, he says.
What does it take to put together an ICO whitepaper? The whitepaper lays out a roadmap on how the issuer will develop the business and execute the project.
“All whitepapers should have three major components. The first one being the technology model being used. The second one is the business model and the third component is the community model,” says Aggarwal.
Several ICOs have failed for the lack of community support. “Currently, because of the huge interest in ICOs space by the venture capital players, some of them are getting funded by a couple of dozen investors and the community is absent,” says Aggarwal. “The success of a project is quite dependent on the community appreciation of the project.”
A high degree of VC involvement in an ICO can bring about a false hype about the project, Aggarwal says.
A high degree of VC involvement in an ICO can bring about a false hype about the project, Aggarwal says. This is one reason that some projects that initially got a very good response are now back at the issue price, he adds.
There are also several scams and MLM schemes operating under the guise of token launches. In a situation like this, where the market is booming, users have to be very careful when understanding and vetting an ICO project and the team behind it. There are many websites, like ICO Tracker and Smith + Crown, that list old and upcoming ICOs with details regarding their business model, team and token details
Turbid regulatory outlook
Most ICOs, even the ones specially targeting the Indian market, are registered not in India but in countries such as Switzerland and Singapore where cryptocurrency regulations are more friendly.
“With the ICO market maturing a lot of new changes are also being introduced. Earlier there was no need for a KYC compliance to invest in an ICO, but now with big players entering the field, a lot of the projects ask for KYC details as they do not want any regulatory problems in the future,” says Choudhury who has invested in over 15 ICOs including Storj, Tezos and Aeternity.
Also, most of the ICO take payments in the form of BTC and ETH and by not handling real currency are playing it safe from regulators. India’s markets regulator Securities and Exchange Board of India, or SEBI, for instance, has stringent rules on collective investment schemes. Add to this the regulatory caution expressed by the central bank on cryptocurrencies in India.
The recent ban on ICOs by China, one of the largest markets for cryptocurrencies and a stronghold of Bitcoin miners, has left a cloud of uncertainty over the future of ICOs, though it was a temporary ban. The ban also lead to some ICO projects like the Health Mutual Society to refund its ICO investors. Add to this the statement by the US Securities and Exchange Commission that it has found ICOs at times to resemble securities and, hence, needs to be regulated.
The outlook for ICOs is clearly cloudy, then.
On the other hand, Bitcoin, the most popular cryptocurrency in the world, has grown four times in value between April 1 and August 31, and altcoins, as all non-Bitcoin cryptocurrencies are grouped under, a spectacular 11 times.
Investment decisions, it is said, are dictated by greed and fear. In the case of ICOs, greed seems to be the stronger sentiment than fear. For now.
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Disclosure: FactorDaily is owned by SourceCode Media, which counts Accel Partners, Blume Ventures and Vijay Shekhar Sharma among its investors. Accel Partners is an early investor in Flipkart. Vijay Shekhar Sharma is the founder of Paytm. None of FactorDaily’s investors have any influence on its reporting about India’s technology and startup ecosystem.