For anyone that has been following crypto in 2017, hearing about the next hot ICOs has been par for the course. Having a phonetic similarity to IPO and only having 3 syllables when each character is sounded out, has definitely played to its “cool” factor. And, for folks that want to play up their hipness in the space, saying “īkō” as a 2-syllable word can sound even catchier.

Regardless of your stance on ICOs are, they are a novel fundraising phenomenon. Having largely been popularized by the founding of Ethereum in July 2015, ICOs standing for Initial Coin Offerings have taken the early stage technology market by storm.

What is an ICO?

But what exactly is an ICO? In short, ICOs are a global fundraising mechanism for blockchain-based technology companies. These companies issue a new cryptographic digital asset in exchange for more established cryptocurrencies such as Bitcoin and Ethereum. These companies typically use the raised funds for the launch of a brand-new company, and, in some cases, a new service or capability within an established company. The ICO mechanism has served as a launch point to make that possible. In return, ICO investors receive tokens at some predefined crypto exchange rate.

Generally, these tokens are expected to have platform utility and secondary market liquidity. This investment vehicle is highly speculative and risky. In a worst case scenario, any investor should be prepared to lose ALL of their investment.

The Speculative Why

Those unfamiliar with ICOs might be asking, “Why would anyone invest in such a thing?” Simply put, while the traditional investment world looks for ROI in terms of “%,” ICO investors are looking for returns in terms of “x.” Extreme ICO performance has yielded results in excess of 90x. Now, the possibility of a 9000% return in many cases is well worth the associated risk. While 90x is exceptional, a return of 200–400% in a matter of weeks or months has by no stretch of the imagination, been outside the realm of possibility.

Photo by Michał Parzuchowski

And while all of this may seem like high stakes gambling, keep in mind that the highest payout when playing roulette, a popular casino game, is 35-to-1. And the lowest roulette payout is a matching 1-to-1. For those investing in the stock market, “beating the market” tends to mean beating a 6–8% year over year yield. When looking at speculative investment, there are few steroid-like options such as these, short of trading with leverage and buying up derivatives, such as options and futures contracts.

Typically No Equity

With rare exception, most ICOs to date have not issued any equity in their respective companies. This essentially means that they have in many cases raised millions of dollars without giving up ownership in their respective companies. (Note that this primarily holds true at the retail investor level. There are likely to have been equity terms provided to institutional investors that make larger investments in these companies, similar to what you would expect from traditional early stage capital markets. Also, I expect crypto token equity offerings are due to increase in the years to come.)

The Regulated Security Predicament

To make the ICO even more vexing of a subject, many of these ICOs have been executed under the pretense that their token offering is not a regulated security. While the Securities and Exchange Commission (SEC) in the United States has begun voicing their stance and taking action against companies who are clearly in violation of the certain terms that would qualify any investment as a security, many technology companies pursuing this funding mechanism have gone to great lengths to protect their tokens from being considered a security.

To date the SEC has:

Now if you were a company and you could raise millions of dollars without giving up equity, why wouldn’t you take advantage of this opportunity? While most would not say “no” to this type of funding opportunity, ICOs are not easy to launch, nor are they guaranteed to be successful. And the consequences of launching a failed ICO can be devastating.

Early Stage Capital and the ICO Market

In the age of startups, the early stage capital market has consisted of Seed and Angels investors, Venture Capital Funds, accelerators and incubators, specialized banking services, and various crowdfunding platforms. The crown jewels of these investment methods has typically been access to equity, future revenues, and in some cases control over the direction of the candidate company.

While I am confident that the early stage capital market is still alive and well, a shot over the bow was fired this June 2017. June was the first month where ICO fundraising took in over $500 million in equivalent crypto capital priced in US Dollars, whereas Angel, & Seed VC Funding in the Internet/Tech space was approximately $300 million. To put it bluntly, ICO fundraising on a per dollar basis was more than early stage capital in its equivalent category.

While this June ICO fundraising compared with traditional Early Stage Capital could have been an anomaly, July reinforced this market phenomenon. July ICOs were just over $300 million, while angel and early VC funding was just over $200 million. If you are an internet-based early stage investor, this recent trend is a troubling turn of events and has most likely made you reconsider your investment strategy and terms for getting into blockchain-based internet tech deals.

Red Flags, Controversy, and Bubble Rhetoric

Since ICOs issue a cryptocurrency and cryptocurrency is largely attributed to Bitcoin in mainstream media, the word “Bubble” is frequently thrown around. And for those who have been following additional cryptocurrencies that have also appreciated substantially in value the Bubble argument becomes even stronger.

So are we in a Bubble? This is a complicated topic and my personal belief is that the answer is both Yes and No.