ICOs are experiencing a tremendous popularity boom right now, and many participants might think that the concept is a new one, when in fact it isn’t. Long before Ethereum-based ERC20 tokens began to be offered for sale, Ethereum itself was launched using an ICO. Many don’t realize that the history of ICOs goes even further back than this, though.

Mastercoin

Imagine that somebody tells you that a new cryptocurrency is about to be created that will enable the use of smart contracts and will allow people to create their own digital currencies. Sounds familiar? No, we’re not talking about Ethereum, but something called Mastercoin.

Mastercoin was launched, via ICO, on July 31, 2013. Investors could send Bitcoins to a certain address and would be rewarded with a proportional number of Mastercoins. The new protocol would do much of what Ethereum now does, but it would actually use the Bitcoin Blockchain rather than creating its own.

Much like Ethereum, Mastercoin would create an easy way for individuals or companies to create their own cryptocurrencies and offer them for sale via an ICO. One of the first projects to take advantage of this feature was Maidsafe, a distributed file storage platform. The crowdsale of Maidsafe tokens was supposed to last 30 days, but the entire allocation of tokens was sold in just five hours.

Maidsafecoin

Such huge demand sounds incredibly promising, right? Maidsafe nominally raised $7 mln from the sale, which may be small potatoes in this era of $100 m;n ICOs, but was a vast amount of money for such an untested fundraising method back in 2014. Maidsafe determined they would accept Bitcoins and Mastercoins as a source of funding. Unfortunately, that created a serious problem.

Maidsafe announced that a certain number of tokens would be awarded per Mastercoin and a certain number would be awarded per Bitcoin. However, what Maidsafe didn’t realize was that at the ratios they fixed, people could buy far more Maidsafecoin tokens if they paid with Mastercoin than if they paid with Bitcoin.

Because of this, the price of Mastercoin soared in the days leading up to the Maidsafe ICO. As soon as the ICO was over, a major source of demand for Mastercoin was suddenly gone, and the price of Mastercoin collapsed. Thus Maidsafe raised about $3 mln in Bitcoins and $4 mln in Mastercoins, but the value of the Mastercoins they received drop rapidly. Maidsafe couldn’t liquidate $4 mln in Mastercoins quickly without tanking the price, causing them to hold a currency (Mastercoin) which continued to diminish in value over time.

Once it was all said and done, Maidsafe raised only about half the money they had intended to raise, and the market was on fire with speculation about backroom deals and market manipulation. Part of the problem was that Maidsafe had worked out a terrifically complicated deal with a Bitcoin-based VC firm called BitAngels. The arrangement was so complex as to be nearly incomprehensible, involving Mastercoins changing hands multiple times between the entities.

Maidsafe is still around and still working on their project, but the critical lack of funding allowed them to be eclipsed by a number of competitors in the space.

From Maidsafe to Tezos

Tezos is a project begun by spouses Arthur and Kathleen Breitman to combine smart contract functionality with a formal on-chain governance structure. The ICO was based in Switzerland, and in accordance with Swiss law, is overseen by the Tezos Foundation. A total of $232 mln was raised during Tezos’ uncapped fundraiser in July. The ICO accepted both Bitcoin and Ether for contributions, and the proceeds are held in the custody of the Tezos Foundation. At today’s prices, the foundation controls nearly half a billion dollars.

According to Reuters, the Breitmans control Tezos’ source code, but the Foundation controls all the ICO funds. Now the Breitmans are seeking to oust the head of the Tezos Foundation, Johann Gevers. The Breitmans accused Gevers, in a blog post:

“In early September we became aware that the president of the Tezos Foundation, Johann Gevers, an attempt at self-dealing, misrepresenting to the council the value of a bonus he attempted to grant himself. We have been working with the Tezos foundation to resolve the matter and have advocated for his removal from the foundation council. We are confident in the council’s ability to handle this sensitive matter with care and diligence. In the meantime, Johann’s operational role in the foundation has been suspended, pending an investigation by the council’s auditor.”

Gevers responded that the Breitmans are essentially trying to sidestep Swiss law and exercise direct control over the Foundation “as if it were their own private entity.” Gevers points out that the dispute between the Breitmans and himself is causing significant delays in the project. The Breitmans acknowledge that, saying:

“The momentum we had prior to the fundraiser has slowed despite the resources now available for supporting the project. Some development has continued and we have personally been working to create strong relationships with successful entrepreneurs looking to build with Tezos. Unfortunately, other aspects have fallen behind, such as:

Creating online resources for contributors and developers to learn more about Tezos.

Scaling up the development team.

Articulating our vision for the project more clearly through a series of explanatory blog posts, as we used to produce.

Engaging with the community of Tezos contributors and makers, and helping them in their endeavors.”

ICO structure and remedies

The ICO was designed in such a way that the Breitmans’ company, which owns the right to the Tezos code, would be purchased by the Tezos Foundation. In light of the current dispute, that hasn’t happened yet. If it never happens, then investors may end up owning a fractional interest in a worthless foundation. In the meantime, without funds from the foundation, the Breitmans’ may find themselves owning the source code to something whose development may never be completed due to lack of funding. In other words, everybody loses.

At least one law firm is considering filing a class action lawsuit against either the Breitmans, or the Tezos Foundation, or both, in order to ensure a full return of all funds back to investors. Such an action, called full rescission, could be ordered if the SEC determines that the Tezos ICO was in fact an unregistered securities sale.

The Draper connection

Cointelegraph’s London Correspondent Nick Ayton recently published a thorough accounting of the Tezos debacle, and pointed to another source of controversy. Billionaire venture capitalist Tim Draper publically invested in Tezos in a special pre-ICO deal, and the Breitmans unquestionably used his support to promote the ICO. After all, if billionaire Draper thinks Tezos is promising, surely the project could be a good deal, right?

However, Ayton pointed out that Draper actually received a special deal; in return for his early support, Draper would apparently receive the option to cash out at double his initial investment, regardless of how the project was doing. Not long after Ayton’s piece was published, Cointelegraph received a demand from Draper that the story be retracted.

Draper wrote:

“Please get your facts straight. My fund is a long-term investor and holder of tokens. I back promising entrepreneurs with the prospect of transforming society for the good of the customer. There was nothing secretive about our purchase of Tezos. Most ICO founders earn tokens over time. All tokens we hope to receive that we didn’t buy in the Pre-sale (alongside with all the other investors who participated) will vest over time with the founders’ tokens. I have no intention of selling these tokens because I am a true believer in the Tezos mission. Arthur and Cathleen [sic] are dedicated, honest and brilliant founders. They made it clear to me and the other purchasers that the token would require time to develop. If they are successful, they might just transform society, and we will all be better off as a result, and then, maybe five or ten years down the road, my investors and I might get rich. I expect a full retraction. And I think you should send Arthur and Cathleen [sic] some flowers and an apology.”

How not to conduct an ICO

Based on lessons from Maidsafe and Tezos, there are some obvious things that should be avoided by future ICOs:

Don’t accept illiquid currencies. Accepting funds in illiquid currencies, and especially setting the token price in such currencies, should be avoided at any cost. It hamstrung Maidsafe’s development.

Avoid complicated deals. Maidsafe’s deal with BitAngels and Tezos’ deal with Tim Draper caused a great deal of complexity and controversy. At best, such deals look bad. At worst, they could represent actual corruption.

Avoid complicated structures. A foundation promising to buy a company’s intellectual property upon completion of an ICO is simply too complex of a structure to really work. By creating two power centers--the owner of the IP and the holder of the ICO funds--too much complexity (and room for dispute) was injected into the post-ICO period.

Dispute management. The structure of the Tezos ICO created two essentially equal entities: the Breitmans who controlled the actual source code, and the Foundation that controlled all the funds which would be necessary to further software development. There was no protocol for dispute management, however, and the Foundation’s promised purchase of the company that owns Tezos source code never came to pass.

An uncertain future

How will this all end up? Much remains to be seen. At the very least, the Tezos project has been significantly delayed, with its scheduled Q4 2017 release now being pushed to early 2018. At worse, the project may never be finished and investors could end up with nothing. It’s likely that the legal battle will grow more complex (and expensive) and that regulators could even get involved in the dispute. Investors could see a full return of all their funds, or they could lose everything.

There’s also a third option: a delayed but ultimately successful Tezos could end up being launched, possibly generating significant profit for ICO participants. At this point it doesn’t look likely, but stranger things have happened.