Should You Launch an ICO to Raise Money for Your Startup?
In the past few months, you've likely heard about initial coin offering (ICO) fundraising,
as some startups have experienced a significant amount of funding this way. Could ICOs replace traditional venture capital? On the surface, ICOs appear to be the new, successful startup journey alternative. However, before making any hasty decisions, it is imperative that you understand how these two very different types of funding compare.
ICOs have seen immense growth, but there are challenges.
There's been a significant amount of media coverage in relation to ICOs, especially as the blockchain and cryptocurrency industry evolves. However, taking a closer look, it appears that there are some critical gaps in the available information, which for many is misleading. Of course, there are advantages to this model, including more rapid funding and fewer regulations — which may actually be a double-edged sword. Unlike the traditional model, which requires startups to first build a company, generate revenue, and then get funding from angel investors (before landing a venture capitalist), ICOs provide somewhat of a shortcut.
The growth of ICOs alone is enough to turn heads. In June of this year, ICOs surpassed $550 million in funding, which was more than what was raised through venture capital fundraising. However, these benefits are not enough to convince many partners and investors. Being an open, unregulated system, anything can happen, and when you’re dealing with millions of dollars, “anything” isn’t exactly what you want to hear. In fact, one of the primary concerns for investors is the ambiguity of utility tokens, resulting in varying rights. There are also a number of significant risks involved, including taxable proceeds.
ICOs simply are not ready to take over traditional venture capital. Here’s why.
Although many support ICOs and blockchain technology overall, it is the general consensus that the technology itself is still immature, leading to many risk factors. In some countries, such as China, ICOs have been banned due to a lack of regulation, as well as a high rate of fraudulent and illegal activity. If you are considering the ICO market to fund your startup, please consider the following in relation to traditional venture capital.
Although companies are raising real capital, without enough liquidity, the participation from buyers quickly outweighs the supports of market buyers. Strict regulations and the use of multiple currencies also contribute to poor liquidity.
Quality control and increased risk of scams.
One review, published by the Wall Street Journal, found that after analyzing 1,450 ICOs, 20 percent contained major red flags. This included plagiarized documents, fake executive teams and guaranteed returns.
Higher failure rate.
As of February 2018, 46 percent of the previous year’s ICOs had already failed — despite the fact that they had raised more than $104 million. This is resulting in what’s referred to as a “digital graveyard,” as many of these ICOs appear to have been doomed from the start.
At the end of the day, the majority of ICO-funded startups are poorly managed and lack the required cash flow. Since the cash raised by an ICO doesn’t technically have any legal leverage, as they are not currently regulated, this option is risky for investors, as well as your reputation. Token sales and the phenomenon surrounding ICOs certainly has potential, but it's still in its infancy. It’s the new “Wild West,” and until some of the major kinks are worked out, venture capital is still largely the most promising route, as you will attract loyal investors while building valuable connections.
Regardless, this is an industry that should be watched closely, as many industry leaders, including Bill Gates and John Donahoe, support the evolution of digital currency. Based on your current business model and business plan, are you unsure which option is best?
Rahul Varshneya is the co-founder of Arkenea, custom software development services for founder-led companies.