Source: iStock/mrdoomits

Juan Villaverde is an econometrician and mathematician devoted to the analysis of cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created Weiss cryptocurrency ratings.

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One of the positive consequences of the crypto bear market is that it forces projects to either adapt or die. It separates the real companies from the passing fads.

That’s especially true for the teams behind the plethora of Initial Coin Offerings (ICOs).

They’ve endured a painful year of plunging prices. They’ve had to confront the harsh reality that there’s little or no demand for the crypto tokens they’ve offered to investors. Most face abject failure.

But some are beginning to discover a critical distinction between two kinds of ICOs. And therein lies a practical solution to their dilemma.

The old kind is utility tokens. These are cryptocurrencies designed to pay for fees inside a distributed application (dApp). Gambling casinos provide a good metaphor. Before you can hit the roulette or blackjack tables, you have to exchange your currency for chips that can be used strictly on premises. In the virtual world of crypto, these chips would be the equivalent of utility tokens.

A newer kind is security tokens. These are not just used as an exchange medium. They also represent an ownership share in some asset — the startup company itself, real estate, a work of art, maybe even intellectual property.

Here’s the key:

We’ve long held the view that utility tokens are a doomed anomaly; a complete mismatch to what investors need or want. And from the outset, we have predicted that they will ultimately be replaced with security tokens.

Now, that’s what’s starting to happen!

Recently, for example, one ICO project in particular has decided to take steps to move their token away from its utility function and transform it into a security token. And in the months ahead, you can confidently expect much more of the same!

More about that project in a moment. First, let me explain …

The 3 Reasons Why Most Utility Tokens Have Been a Disaster

ICOs were all the rage in 2017.

A whopping $5.3 billion was raised, more than all the money raised from traditional venture capital!

In 2018, however, the crypto bear market has been devastating to ICO tokens. Most have lost more than 90% of their value since last year. Some have become virtually worthless.

Given their deficiencies, that should come as no surprise.

What IS surprising is that the market is still quite active with new projects appearing on a weekly basis. This tells us the party is far from over. But the dance has got to change.

Here are the three reasons utility tokens have been a disaster …

Reason 1. Virtually no link between the success of the company and the benefit to investors.

Let’s say you go in with your eyes wide open and invest in a high-risk startup with fiat currency, as a traditional investment. The company fails, and you lose your money.

Not fun! But at least you had a winning chance.

Utility tokens are much worse: Even if the company succeeds, you don’t get any upside. You’re left out.

Reason #2. Investors were duped.

You may ask: Since when do companies raise money from investors and then give them only the downside?

Answer: Ever since utility tokens became the rage, giving investors the distinct impression that they were buying some kind of investment asset.

That’s right. Investors were duped, plain and simple. The overwhelming majority actually thought the tokens were like proxy shares for the startup. In reality, nothing could be further from the truth.

I repeat: The typical utility ICO revolves around the idea of creating a token that will be required to pay for services that will be offered by the company. It does not give investors any participation whatsoever in the future success of the company.

Most ICO issuers may have thought the utility alone would be enough to drive up the token’s value. But it isn’t. In fact, precisely the opposite can happen, which leads me to …

Reason #3. The more each utility token costs, the greater the likely barrier to adoption.

This doesn’t happen all the time. But it’s far too commonplace to ignore: Companies tout their tokens and drive you to an exchange to buy them. Almost invariably, they are highly speculative, illiquid assets.

Then the companies twist your arm again to use the tokens — for the purchase of goods or services the company offers. That process, in itself, can be a real obstacle for adoption, especially if there’s little demand for the company’s services.

What’s worse is this: The more the tokens cost, the less likely you will be to buy and spend them … and the less adoption the tokens will enjoy.

Higher token values mean higher fees, and higher fees turn potential customers away. Sure, the more they charge, the more money they could make. But in practice, the more they charge, the less usage they get for their tokens.

Result: The tokens themselves can be a factor in the ultimate failure of the companies!

My Message to ICO Issuers

You can’t have it both ways, guys!

If you insist on issuing utility tokens to pay for goods or services, OK. But never confuse investors that they are investing in the company. Make it clear.

Or, if you want to raise money from investors and speculators, that’s fine too. Just be sure to give them a share in your business. Again, full disclosure.

Blending these two functions into one sloppy milkshake is a recipe for disaster. You must embrace a more sound, time-tested fundraising model: security tokens that represent equity shares in your business. And you can still do so via a distributed ledger platform. Do that, and …

• You will establish a clear link between the price of your tokens and the success of your business.

• You will no longer need to bend over backward to fit a cryptocurrency token into your business.

• You will break down key barriers to adoption. And …

• You will begin to solve the single-biggest obstacle that the overwhelming majority of ICOs face today.

This is what we’ve been saying all along. Now, fast forward to the present.

The First Interesting Test Case: Iconomi

Iconomi first launched its ICO in August 2016, making it one of the first projects to embrace this new technology of issuing tokens to fund a startup business.

Until now, however, the value proposition of Iconomi’s ICN token was strictly that it could be used to pay for certain premium services on the Iconomi platform. (As I pointed out earlier, this is standard in the world of utility tokens.)

Real-world demand for their token was disappointing. But the team continued to believe in the long-term value proposition of their business. So they decided to do something other projects are also bound to try in the near future:

First, they’re swapping the old ICN token for a new eICN token that’s backed by shares in the Iconomi AG company.

Second, they will be registered in Liechtenstein. Investors from most places in the world will be able to participate in the swap, provided their credentials pass muster with the company.

Third, fees originally slated for payment in ICN will be paid, instead, with Ether (which can even be bought on Yahoo! Finance) or fiat money, such as dollars and euros. Most customers have easy access to these, and their prices are more stable.

These changes make a lot of sense. They will make it easier for potential customers to pay for products and services. At the same time, they will provide investors an asset that’s tied to the growth and prosperity of the business.

The security tokens are cheap and easy to manage. They’re an obvious choice for smaller companies and startups that want to tap into capital markets’ lower barriers to entry.

And they could revolutionize the world of finance …

Our ICO Market Forecast

As the ICO space matures, Iconomi will be just the first of many projects that walks down this new path. And, as more join the club, a new kind of financial marketplace will emerge.

Buying company shares will be almost as easy as shopping on Amazon.

There will be no brokers or intermediaries.

We will see a new era of corporate governance with greatly improved accountability to individual shareholders.

And it could all happen a lot sooner than most people think!