There are hundreds of startups globally developing blockchain-based applications and attempting to pioneer disruption across various markets. The deployment of blockchain technology initially focused on the financial services industry; however, other use cases in supply chain management, identity and contract management, data storage, and IoT, among others, are being studied to determine blockchain's viability to enable new efficiencies and ways of doing business. Several are making their way into production. A growing number of these startups are raising funds via 'initial coin offerings' (ICOs). According to data from CoinDesk's ICO Tracker, more than $1.6bn has been raised through ICOs from 2014-2017. However, ICOs operate in unregulated territory, and participation should be considered with caution.

The 451 Take

A new financial instrument has come out of the blockchain community, with its own benefits and risks. ICOs live and operate in a gray zone that is outside of traditional legal and financial frameworks. Nothing is guaranteed and funds can be lost. Blockchain itself has potential as a foundational technology to underpin a variety of different intraparty transactions. Coin or token offerings, though, represent an unregulated and overheated market that seems to be growing well ahead of blockchain's business applications, and there is a lot of experimentation in business models, as well as product development in a background of market volatility. ICOs are an innovative method of fundraising, but offer investors little protection from losses due to naïve management teams, poorly conceived products and outright fraud.

What an ICO is and how it works

ICOs (aka token sale) are being used as a way to crowdsource the purchase and use of digital tokens. Digital tokens in an ICO enable owners to participate in an element of an emerging company's service. These tokens represent some kind of value or right of use, and confirm the investor's stake in the project (they do not represent shares in the company). These tokens can typically be purchased with cryptocurrencies like Bitcoin and Ether. In contrast to IPOs, ICOs operate in unregulated territory – there is no involvement of any financial institution, regulatory body or a trusted third party.

Early supporters want to use or experiment with the company's product or service, or are motivated by a prospective return on their investment – hoping that the ICO operation is successful and that the value of their purchased tokens will go up. If the money raised does not meet the minimum funds required by the company within the established timeframe (token sale event), the money is supposed to be returned to the investors and the ICO is declared unsuccessful.

When a startup intends to raise money through an ICO, it typically publishes a whitepaper on its website, where it describes the project and token sale (these can be separate documents) – for example, the product, the team, the token economics, the business plan, where and how to purchase tokens, the duration of the ICO, etc. There is no standard structure or best practice for the ICO documentation, and the published information is often very sparse. Also, the token-sale model varies among projects. In the next section, we provide examples of ICOs for illustrative purpose.

Examples of ICOs

Ethereum carried out an ICO in 2014 and raised about $18.4m in Bitcoin (BTC) ($0.40 per Ether [ETH]) in 42 days. The initial price of Ether was set to 2,000 ETH per BTC, which linearly dropped to 1,337 ETH per BTC at the end of the ICO. The project went live in 2015, and in 2016 had a market cap of $1bn, with one Ether valued at $14. However, the price of ETH has experienced sharp fluctuations since its launch, and its future (and that of cryptocurrencies in general) is uncertain. Ether could be a big bubble, but if the platform is properly managed and implemented across a range of use cases, it could stand the test of time, since it has a purpose beyond just speculation (e.g., the paying of smart contract transaction fees).

Blockchain-based storage network Filecoin (Protocol Labs) completed its ICO in early September and raised $257.8m over a month, which includes $52m collected in a presale ahead of the ICO, with the participation of Sequoia Capital, Andreessen Horowitz and Union Square Ventures, among other accredited investors. This is the largest completed ICO to date. Filecoin offers a decentralized network for storage where participants can rent out their spare capacity, and in return receive Filecoins (FIL) as payment.

The presale was priced at $0.75 per FIL. During the public sale, the price increased as more investors joined in, and the sale cap was set to 200,000,000 FIL. Since the Filecoin network was in development and not yet live at the time of the ICO, it created a fundraising instrument called Simple Agreement for Future Tokens (SAFT), which is a legal agreement between the buyer (who buys tokens to be delivered at a future date) and the seller (who delivers those tokens at a future date). According to Protocol Labs, the token sale was limited to accredited investors, which could take part in the ICO via CoinList (a platform the company developed) and startup investment platform AngelList.

Dragonchain, an open source blockchain platform originally developed at Disney, is now in the process of an ICO to back up its commercial venture of the same name. Fifty-five percent (55%) of its tokens (called Dragons) are offered for public sale from October 2 to November 2, and can be purchased using BTC and ETH. The Dragonchain team describes Dragons as tokenized micro-licenses that will be used to interact with Dragonchain's commercial platform services. In total, a fixed quantity of 433,494,437 Dragons will be issued. The value of a Dragon has not been arbitrarily determined by the startup team, and will depend on the funds raised during the ICO – the more funds, the higher the value. According to the company, Dragons will be tradeable after the ICO, given that not all Dragon holders will necessarily want to use Dragonchain services, and some may see this exclusively as an investment that could generate gains in the future.

ICOs are risky business

Early investors in a project may think about converting their coin/token profits (if the value of the token goes up) into Bitcoin or Ether, and then into a fiat. However, the value of cryptocurrencies is still volatile, and their future is uncertain at this point.

Opening the opportunity to take part in an exciting project to a broader community appeals to those who would like to see early users, rather than venture capitalists, benefit from the growth of next-generation technologies. ICOs, however, operate in unregulated territory filled with speculative investors basing few of their decisions on business fundamentals. The loose regulation of this market increases the odds of losses due to fraud, managerial incompetence and inadequate cybersecurity, along with the risks faced by any early-stage company in an emerging market.

Hundreds of ICOs have launched in the last three years. Many of those seem to meet the criteria to be classified as securities, although they don't typically register with the SEC. According to the SEC, any investment contract made with expectation of a profit tied to the performance of an entrepreneurial venture or management team is a security and should be registered with the SEC (and subject to all the disclosure requirements that entails).

The SEC has recently warned that fraud is likely abundant in this market. For example, Josh Garza, the Paycoin CEO behind the Hashlets ICO, has already pleaded guilty to fraud. At the end of September, the SEC charged two related businesses with fraud for running ICOs for nonexistent businesses. Many ICOs may not have the proper security controls in place to protect their investors. For example, investors in's Decentralized Autonomous Organization (DAO) ICO faced a near disaster when one-third of its underlying cryptocurrency syphoned away, necessitating a reset in the ledger to salvage investor money. (The SEC found that the DAO should have registered as a security, although no charges have been brought.)
Csilla Zsigri
Senior Analyst, Cloud Transformation & Blockchain

Csilla Zsigri is a Senior Analyst for 451 Research’s Cloud Transformation channel. Csilla also works on custom research, providing strategic guidance, as well as market and competitive intelligence, to technology vendors, service providers and enterprises.

Scott Denne
Analyst, Mergers & Acquisitions

Scott Denne is an Analyst with 451 Research, where he helps direct the firm's coverage of technology mergers and acquisitions. He also contributes to 451 Research's Customer Experience & Commerce Channel with coverage of the advertising technology industry.

Keith Dawson
Principal Analyst

Keith Dawson is a principal analyst in 451 Research's Customer Experience & Commerce practice, primarily covering marketing technology. Keith has been covering the intersection of communications and enterprise software for 25 years, mainly looking at how to influence and optimize the customer experience.

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