I’m sure you have heard a lot about ICOs (initial coin offerings) recently. Startups are raising millions with them. Bancor raised over $153 million. TenX raised $80 million. Our portfolio company, Omise, recently raised $25m.
Many more startups have theirs on the way. So, in midst of all this excitement, I wanted to take a step back to think about how ICOs could profoundly impact venture capital.
First, what is an ICO?
An ICO is when a company funds itself through cryptocurrency. People can invest in an ICO by contributing cryptocurrencies through what is essentially a crowdfunding campaign. The Ethereum platform’s smart contracts allow people to exchange other cryptocurrencies for newly issued company coins.
The coins can later be sold and purchased on cryptocurrency exchanges, or held long term. Most of the time, these coins themselves represent a piece of whatever product or service the company provides. You can think of ICOs as IPOs, but instead of selling equity, you are selling a currency for whatever you are providing. For example, if Twilio did an ICO, you could exchange their coins for API calls. If Uber did one, you could exchange coins for rides. If McDonald’s did one, you could exchange coins for Big Macs.
What does this mean?
What this essentially means is that ICOs democratize fundraising for both fundraisers and investors. That innovation itself could have an important effect on virtually every industry that requires financing. When it comes to venture capital, I think ICOs could impact the industry in the following ways.
1). Venture capitalists may be able to fundraise through ICOs. So, anyone, anywhere, could invest in our funds. This could make fundraising a lot easier for us VCs.
2). On the other hand, startups will also be able to ICO, meaning that fundraising may be a lot easier for them too. Some think that startups will no longer need venture capitalists. I’d say that is somewhat true, but more complicated than that. What it will do is pressure investors to provide more than just money. They’ll need to provide additional value in the form of knowledge, network, or brand.
3). We VCs might invest in the coins before the ICO. Think of how investment banks like Nomura 0r J.P. Morgan reach out to investors and provide access to a company’s equity right before going public. VCs might find and source startups, and offer to invest in their coins before their ICO. That would drastically lower the time to exit for venture capital because we could get liquidity at the ICO.
4). Startups may be able to buy out their investors with proceeds from their ICO. Again, for VCs, this could reduce the time to exit significantly.
All that said, many of the benefits of ICOs are derived from the lack of regulation. Access to equity in startups is largely limited by regulations that are meant to protect unsophisticated investors. Right now, ICOs are basically a wild west. Unaccredited investors could pour their life savings into a business they don’t understand, and lose it all. Unfortunately, like most unregulated frontiers, a lot of people will be eventually get scammed. And when they do, regulators will get to work. It is funny how this cryptocurrency boom is helping us rediscover why we have regulations in the first place.
In any case, it would be naïve of venture capitalists to not watch this space carefully. ICOs have the potential to completely change our industry. There is a long way to go before ICOs become mainstream, and regulators will likely catch up before then. But this breakthrough should also force us to think about how we’d adapt to this new world. So we are watching and learning as it evolves.