For decades, the general path for startups has been: (1) raise investment money, so that you can (2) build something valuable, in order to (3) capture some of that value as profit. It’s not quite so simple: you raise a little (angel/seed) to prove value (MVP) and raise more (series A) to validate further, to raise more, on and on until you hit a profitable path or exit. This cycle involves the exchange of equity and currency, as builders and investors invest what they have now (fundraising) in an effort to grow both for the future (monetizing). This batched, progressive fundraising model gives teams runway between rounds to focus on building, lets investors manage risk, and allocates capital ‘efficiently’ towards companies that have proved more value.

From Chris Dixon’s ‘breakthrough in open network design’

Blockchain tech has ushered in the rise of ICOs as a fundraising mechanism. Native tokens, which enable anybody to spin up incentivized networks to coordinate towards a goal, serve as both equity and currency in the system at once. This has led to celebration of tokens as a way to ‘beat the bootstrapping problem’ faced by new networks, which may prove true.

Why doesn’t this make sense?

I’d expect the nature of tokens to have another impact to investment models: the link between (1) investment, (2) value creation, and (3) monetization should be tighter than ever before. Tokens are code, and their creation/allocation can be tied to activity within the network. This should mean that the effort to gauge value potential and negotiate terms (currency for equity) should be far smaller, and the ability to gauge both risk and value potential far more predictable.

Tokens should enable tighter feedback loops in the entrepreneurial cycle, with investment capital allocated more effectively to projects as they demonstrate value. The trend should be towards frequent small rounds, or even a nearly continuous-raise model that funds (and rewards) builders as they show more value potential.

However, ICOs to date are mostly the exact opposite: a single massive raise early on, when minimal value or viability has been proven yet, that is meant to fund the entire project (and in some cases even serve as the long term business model — monetization — of it for the founders).

Of course we haven’t yet developed the tools to completely change our investment and valuation models and mindsets, so a complete shift isn’t expected immediately. And investors today are acting in an attempt to capitalize on huge network inflation potential. But thinking through how system-wide funding and reward of projects should work, it seems foolish to expect the current model of ICO to continue once we have built better models.

What should we expect?

Taken to the extreme (as a thought experiment), smart contracts and tokens could enable a ‘continuous-raise’ model, where projects are funded with investors’ capital according to their needs and the valuation (rate of token allocation) dependent on how much value the project is demonstrating.

Taken just past that extreme, not only do the (1) investment and (2) value creation phases of the cycle condense, but so does (3) value capture. This would involve creators not just being funded for demonstrating value potential, but actually being rewarded in real-time for value creation. Remember that native network tokens function as both equity and currency in a network, and that both the investment and value capture stages in traditional cycles involve trading equity for currency. We should be able to combine them. My hope is that we begin to see token models that rely less on initial sale as fundraising and inflation as value capture, and more token models that combine the two: token generation happening continuously over time (a la bonding curves) in line with value creation, with that value being allocated directly to the creator.

This is an idealistic model, and in some ways unrealistic. Measuring value creation of course will be difficult in many cases. And in many cases there will still be the need for initial (or later) coin sales to raise the capital needed to fund early stages — though this can likely look more like traditional security investment and does not need to drive the long-term token model. But I do think it’s likely the relationship and cycles between investors and creators will change significantly as we adapt to tokens as the native asset class.