Why ICOs are Not an Investment or an Asset Class
You won’t have to look very hard to find people who think initial coin offerings (ICOs) are all scams and people who think they’re the greatest thing since sliced bread. With a fierce debate raging on, we want to try and understand this whole “ICO/cryptocurrency/blockchain” thing from the perspective of investors who can see that the underlying blockchain technology has disruptive potential but at the same time wonder if the same holds true for ICOs. We’re going to clear that up right now.
There are ICOs popping up left and right, everywhere you look. This excellent market map from the insightful lads and lasses at CB Insights shows just how pervasive ICOs are across all industries:
While there is merit to finding picks-and-shovels plays for blockchain technology, and there may even be merit in speculating on some of the more popular cryptocurrencies, ICOs are broken and will never be able to act as an investment or an asset class in their current shape and form. In order to explain why, we’re going to examine the ICO from the perspective of the various stakeholders involved.
ICOs from a Founder’s Perspective
From a founder’s perspective, the ICO is something that seems too good to be true. Imagine a situation where you can get your future customers to pay for your product in advance of you actually building the product. No pesky VC will question the viability of your brilliant idea or hold you to certain milestones that ensure you’re getting to market as quickly as possible. If you fail to build the product, or if you fail to even write a single line of code, you still get to keep all the money you raised. If the product you build is isht and nobody wants to use it, you still get to keep all the money. You will have 100% equity in your business and every bit of future profit will go directly into your pocket. You also have a pile of tokens that you get to keep which will be magically transformed into something of value for no reason whatsoever. With an ICO, you take on zero risk and get to reap all the rewards. It’s perfect.
ICOs from the Customer’s Perspective
People talk about ICOs not representing equity in a business as if that were a good thing, then in the same breath go on to talk about how ICOs stand to replace the “broken” venture capital model. It takes a certain kind of dumb not to see the contradiction there. People who buy ICO tokens are not investors, they are future customers of software that doesn’t even exist yet. The tokens the customers hold can be used to buy product from a single provider who they have now committed to buy from in the future. It’s like crowdfunding except ten times worse because delivering a software product to market is far more difficult a task than delivering a physical product. It’s not even as good as equity crowdfunding because there is no equity involved. In short, it has the word sucker written all over it.
ICOs from the Media’s Perspective
Some of the articles we’ve been coming across are seriously dangerous, but they serve an important function. They stand to validate the ignorance which is rife among those who are promoting these schemes. We’ll give you some examples from an article titled “Is EOS a Scam or a Fraud? 5 Points of Contention” which was published a site called Cryptovest a few days ago.
Apparently there is an ICO called EOS which people seem to think is a scam and this article is going to examine that. Here are some gems of wisdom contained within:
- If there are too many tokens in circulation, the upside potential is limited. No investor wants a price ceiling on their returns – This statement is simply ludicrous. It shows a complete lack of fundamental understanding as to how capital markets operate. It’s equivalent to saying Google’s stock price is expensive because it’s $1,000 a share. EOS plans to circulate 1 billion tokens, a number which is completely irrelevant because we’ve thrown the notion of valuation out the window a long time ago. Then there’s the “price ceiling” comment which puts even our most talkative MBA at a loss for words.
- EOS tokens have no utility and serve no purpose. At least with most ICOs, they tell you the purpose of the token on the platform. – All tokens have no utility and serve no purpose until there is an actual product that is solid and that people want to use at the time it is made available when compared to competing solutions on offer. The fact that other ICOs tell you what they think you might use your worthless tokens on in the distant future is hardly a vote of confidence.
- All proceeds from EOS are revenue for a private company – Here we see the author actually coming to grips with what ICOs are all about. Every single ICO out there is selling tokens in exchange for future revenues for a private company in which the founders hold all equity.
Hopefully nobody actually reads that drivel because it does nothing to teach people about the basic principles of investing and why ICOs are not investments. While this is a small media outlet, even mainstream tech news outlets appear to be doing very little to rein in the madness that we’re seeing in ICOs. Instead, they propose that ICOs are somehow the panacea to unequal wealth distribution and you can stick it to the man by buying all these worthless tokens. Unfortunately it’s exactly the opposite. You are simply spending money now on a service that may be provided later with absolutely no assurance about the quality of said service. The provider of the service gets to keep all the equity and (extremely unlikely) profits from the venture.
ICOs from Our Perspective
Let’s say that this trend continues, and we have 1000 startups offering services in a decade’s time, each with their own set of tokens that are traded on token exchanges. This is where things become a bit fuzzy in our minds. Let’s use a single ICO as an example, CarTaxi, the world’s first operating car towing platform on blockchain.
CarTaxi is starting to radically change this outdated set-up in the towing services industry around the world. CarTaxi’s goal is to encompass the global market and establish a decentralized system of Client Contractor transactions based on blockchain.
If you think that’s ridiculous, just check out how much they raised for this “investment” that they cite as having “low risk” and “high potential”:
Low risk? Again, we’re at a loss for words. So let’s say you bought $1,000 worth of these tokens and decide to keep them until the platform goes live. Then what? Apparently you wait until your car breaks down then you open up your virtual wallet with 1,000 different types of tokens in it, you choose the CarTaxi token, and you give some to the tow truck driver. How many tokens? Well, that will be a function of what price ethereum trades at the time. Cryptocurrencies are extremely volatile, so prices will be constantly changing. Since you are locked into their tokens you’ll need to go trade them for some other tokens if you want to use someone else’s service. The whole thing is just one big embarrassing mess, in fact, we’re embarrassed just writing about it.
We cover 12 primary categories of disruptive technologies here at Nanalyze, and we see blockchain as one that will fundamentally transform all industries in much the same way that artificial intelligence is doing at the moment. There are ways for retail investors to participate in addition to buying cryptocurrencies. Some ETFs are popping up and there are some stocks that may provide some exposure to the picks-and-shovels that will be used to create distributed ledgers across all industries. There are opportunities for retail investors to make some money here, but ICOs are not one of them.