Just a few short years ago, ICOs promised to change the way investment was done.
A new crop of startups built their hopes on widely-distributed, crowdfunded investment, often without handing over equity in return. And investors saw a way to diversify portfolios, grow their investments at startup speed, and access direct business investment opportunities as retail investors, without the red tape.
So what happened? Where did all the ICOs go, and what happened to the ones that made the news in 2017, 2018 and 2019?
Let’s start with some clarity on what an ICO is.
What does ICO stand for?
An ICO is an Initial Coin Offering. It was the first major digital-asset alternative to an IPO, an Initial Public Offering. ICOs are a vehicle to attract investment from a wide range of investors for projects that don’t yet have fully working products. They let retail investors back projects without going through the regulatory hurdles that bar them from most traditional investment opportunities, and they let new projects seek funding outside the VC circuit.
How does an ICO work?
A project publishes a document laying out how its product or service will operate, including technical and business details. Usually this is a white paper, with a website to support it and facilitate signup, and a GitHub to show the code for the project. Often the project was a new digital asset or a new digital asset platform; a DEX, a new coin, or a new blockchain-based business with its own coin.
Investors assess the likelihood that the nascent project will one day become successful and generate a profit. Then, they buy tokens. The money they spend on tokens goes to the project to help it grow; what about the tokens themselves?
The tokens aren’t coins; they’re usually ERC 20 tokens, smart contracts built on the Ethereum blockchain, though others were and are used. If you’re an investor, you buy these tokens, then later exchange them at a pre-agreed rate for the project’s own coin. This is called buyback. The value to the investor depends on the expectation that the project’s own coin will be worth something, which is where the SEC enters the picture.
Is an ICO illegal in the US?
The SEC — the Securities and Exchange Commission — regulates the sale of securities in the USA. Securities are any agreement in which investors exchange money or money’s worth of goods now, for an expected profit from a third party later. Many ICOs regarded themselves as carrying out essentially unlicensed activities beyond the purview of the traditional financial structure: in 2018, Investopedia told its readers:
“Currently, there’s very little regulation on ICOs in America, meaning as long as you can get the tech set up you’re free to try and get your currency funded”.
But by 2018, the SEC had already begun the work that would lead to its firmly establishing its right to regulate ICOs.
ICOs are not illegal, per se. But, and it’s an important but, they are more often than not selling securities. And that means they have to abide by a stringent set of requirements imposed by the SEC, or face regulatory action that could put them out of business.
ICO scams and fraud: the full story
ICOs developed a reputation for scams and fraud, and by 2018 the largest ICO scams had accounted for over $680 million in fraud, mostly by simple-yet-effective methods like “exit scams”. In exit scams, bad actors created fake ICO materials for a project that was never planned to really exist, took investors’ money and simply closed the ICO and held the cash. In other cases, fraud was more sophisticated. But it nearly always relied on the naivety of new investors.
There’s another side to the ICO fraud story, though. The majority of fraudulent ICOs didn’t get away with much money. The majority of money stolen by fraudulent ICOs was accounted for by just a few audacious thefts. And while there were a lot of fake ICOs, the majority of investment in ICOs went to real projects. And in 2018, when Forbes looked into the top 10 ICOs worldwide, three had more liquid assets than their market capitalization; how many businesses can say that, let alone startups?
ICOs aren’t inherently fraudulent or inherently unregulatable. And many were legitimate fundraising exercises by businesses that went on to build real products. Stratis, for instance, now has a cryptocurrency that trades at 13.4¢ — not BTC, true, but a significant raise on its 1¢ initial token price.
So what happened during the ICO boom?
The ICO boom: Both sides of the coin
The golden year of ICOs was 2017. That was the year that ICOs became a common feature of the digital assets industry. Investment exploded, projects proliferated, and exchanges flooded with new coins and tokens.
Yes, some projects failed — and yes, some were fraudulent. But others fundamentally changed the way the digital asset ecosystem worked.
The most successful ICOs were carried out by companies with a real product, and often took place very fast after a lengthy buildup period. Web browser Brave’s ICO generated over $35 million in just 30 seconds; Block.one’s EOSIO took a little longer, but raised over $4 billion — the largest ICO ever.
Where are these projects now? Brave is growing as a business, with 25 million users as of February 2021 and a successful token, the Basic Attention Token, allowing users to earn micropayments for consuming ad content. It’s also the most private browser available as well as one of the fastest. So while its ICO was conducted well, there was already a working product — Brave launched its 1.0 browser in 2016 — and a plan to build a business.
EOSIO is a more complex proposition. Currently it’s a popular environment for blockchain developers, running well-attended hackathons and allowing developers to build blockchain-based applications using non-blockchain languages. The company owns 10% of EOS, the EOSIO coin, and builds decentralized applications of its own.
But Block.one was one of the companies pursued by the SEC for unregistered securities sales; sale of its tokens was banned in 2019. While it’s settled with the SEC for $24 million, that’s just 0.6% of the $4 billion its ICO raised. Some investors, unsatisfied with the regulator’s actions and feeling they’ve been left with a virtually-worthless asset, have brought a class action against Block.one. One, hedge fund CEO James Koutoulas, said:
“Institutional funds that were lied to by Block.one have a duty to all their investors – large and small – to take action against fraudsters and con artists”.
These very different cases point to the ways ICOs can play out differently. Brave brought investors on board very quickly, selling mainly to a smallish number of investors — the top 100 BAT holders owned 94% of the entire supply at the end of the ICO and the largest holder was the Brave foundation itself.
When BAT was listed on exchanges a week later, its value leapt — from a sale price of 3.5¢ per BAT (or rather, the equivalent in ETH) to 24.5¢ per BAT; a 600% jump in six days. For investors who wanted to turn a buck into two and cash out, the Brave ICO was a big win. It was a big win for Brave too; they gained access to a large, liquid pool of capital (and got a ton of positive publicity) without having to relinquish any equity. And for investors who intended to profit from Brave’s business growth long term rather than from immediate post-ICO price bumps, the news is even better. BAT was 79¢ at the time of writing — more than triple its initial listing price and over 1,800% up on ICO price.
What next for ICOs?
ICOs were replaced by ITOs — Initial Token Offerings — and other ways to crowdfund businesses with digital assets. But with the joint pressure of the SEC and the growing reputation for fraud and mismanagement, ICOs became much less numerous. That doesn’t mean there are no ways for businesses to make money using digital assets — just look at the exploding DeFi scene. And there are still plenty of ICOs in the works: Layer 2 Bitcoin solutions, loans and finance, yield farming and chain-agnostic smart contract tools are all running ICOs now or soon. But the ICO has become just one way for some businesses to raise some money, not the replacement for traditional VC and institutional investment it once appeared to be.