Op-Ed: Can ICOs Escape Economic Reality?

Initial coin offering



This article is provided for information and education purposes only and is not intended as investment advice. Readers are encouraged to do their own research and consult a professional before making any investment decisions.


There is a blockchain “solution” for everything these days — from value exchange to asset registration. There are even coins devoted to praising garlic bread or paying tribute to Vladimir Putin. Even the porn industry, where privacy and anonymity are at a premium, has produced a range of crypto tokens. An enormous diversity of blockchain businesses and startups have risen on the coattails of Bitcoin and Ethereum.

What is of concern, however, is just how many of these startups don’t seem to be solving any new problems. Most businesses that use blockchain don’t actually need to use it – and some of the biggest tech giants aren’t even bothering. Couple that with the fact that 59% of consumers in a 2017 worldwide poll didn’t even know what blockchain was and you have a recipe for chaos.

Veteran tech investors may be experiencing some déjà vu because we have seen something like this before. Recall the big dotcom rush of the 1990s where any start-up with the word “Internet” attached to it could raise millions of dollars without any evidence of a solid business plan. Do you know what happened to most of those companies? Where are they now?

Most ICO products are not offering any new advantages by adding blockchain to their business model. They’re merely entering industries that already have a glut of established, better-funded competitors, speculating wildly that the magic word “blockchain” somehow makes them different – yet the fact remains that they are typically offering services that are fundamentally the same as their more established competitors.

Just like those pre-2000 internet start-ups, today’s ICOs are finding ways to get blockchain into their business model to attract easy capital. Unfortunately, their goal is often to generate quick start-up liquidity rather than improve their products and services. Their executive teams are thinking about fast times and a handsome share of ‘dividend equivalent bearing’ tokens, not what will benefit their customers and equity investors in the long-term.

And make no mistake; the best thing for your customer is for your company to focus on developing a concrete long-term business model - not how the tech can get you a Lamborghini.

Startups that financialize from the beginning, could pay for it in the long term

Functionally, the best ICO tokens act essentially as a claim on profits with a higher priority on the capital structure than equity holders. The problem is that ICOs are treating them more like a magic discounted cash cow. For a crypto token to have any long-term staying power and continue to attract investors, an intrinsic value and utility must be built into them.

Many ICOs offer their contributors nothing in the way of fundamental value — no voting rights, and no equity. To make the token relevant and attractive to purchase before it’s issued, however, most blockchain startups force their users to purchase their ICO tokens to engage with the companies.

In the best-case scenario for ICO contributors, a small but still significant portion of the startup’s future operating profits are distributed to token owners. This gives the impression that the token is linked with some type of intrinsic value that would attract investors, of which the startups founders tend to be the largest owners from the initial distribution. Herein lies the unforeseen opportunity cost for most ICOs that plan to be around for the long term.

While ICOs are great for immediate cash flow, many of them structure their reward systems as a percentage of total income from fees (i.e. 10% of fees are returned to token holders) – and that could harm them in the longer term. In these instances, competitors that did not partake in the ICO process will not be hampered by the need to include additional fee structures to pay token holders that could put their platform and its income at a competitive disadvantage.

If we learned anything from last century’s internet bubble, it was that businesses like Amazon, Google, and Microsoft that focused on fundamentals and net-operating profits were about the only dotcom firms to survive. Nearly all others frivolously spent their IPO proceeds on intangible assets, like marketing for ‘growth’ and ‘brand recognition’, and they perished when the bubble popped.

The lack of fundamental quality among the majority of blockchain businesses paints a bleak picture for the survival of most of the current generation ICO-born companies. The problem is multi-pronged: if the central token fails because it doesn’t have any intrinsic value or valid realized purpose, contributors lose all their money and the startup will lose a lot of users and reputation (and likely die because its earnings were probably in that dead crypto token).

If it does have intrinsic value (from its fee structure), real equity investors in the ICO-born company will watch on as the ICO token proves a permanent drag on the company’s long-term prospects – which, given the general spending on intangible business activities, aren’t good to begin with. The token goes to zero.

While you can ignore economic reality for a time, economic reality will not ignore you forever. Many ICO projects are at a distinct long-term disadvantage. Most of their businesses will fail, and their tokens will go to zero. No amount of belief in a product’s ability to disrupt a 1 trillion-dollar industry or repeating the mantra “if we can capture just 1% of the market” can enable those projects to escape this reality.


Author: Timothy Goggin

Timothy Goggin is an economic analyst with an interest in the application of moral philosophy and decentralized systems. He studied economics at the Business School at Victoria University of Wellington, New Zealand. His area of research is the consequential and moral dimensions of implementing digital currencies and the resulting synergies for consumers in the trading environment.

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