Can ICOs Disrupt Venture Capital in Asia? Or is it just another bubble waiting to burst?
It was only inevitable that the finance and banking industries would be disrupted by fintech companies. We have seen this happen with “unbanks” that addressed the needs of the underbanked population in Asia. However, with the rise of blockchain-powered companies, there is a new trend that fintech aims to disrupt, and that is venture capital.
Initial coin offerings, or ICOs, are somewhat like their regulated counterparts, the initial public offering (IPO), in that shares are sold to the public at a predetermined (usually discounted) price, and which are then allowed to float based on supply and demand. Only with coins or cryptocurrencies, the “shares” sold are not shares of equity, per se, but rather tokens that can represent ownership of cryptocurrency or other asset backing the token.
The region has no shortage of startups dealing in fintech and other areas where high-technology has introduced a lot of innovations. However, with companies launching their businesses backed by ICO funding, there is concern whether this new crowdfunding type is edging out traditional venture capital.
Being a fundraising activity, an ICO lets companies fund the development of their blockchain-powered services, and the ownership of tokens will guarantee the ICO buyers the right to participate in the company’s activities and benefit from the blockchain once the product is launched.
A venture capitalist would bank on the success of a company, in the hopes that the VC firm’s stake in the startup would significantly increase. Meanwhile, a token owner would also be hopeful of the company’s success, since the value of coins or tokens would also be dependent on the demand thereof (which is, in turn, dependent on how successful the product is).
Coins vs Shares
However, the main difference is that venture funding is dilutive, meaning that startup founders and other holders of equity (employees with ESOPs, for instance), will find their stakes in the company diluted after every funding round with traditional venture capital. With an ICO, meanwhile, it’s simply fund-raising, without having to give up equity in return.
This means that startups can simply start raising millions of dollars all without losing a single share of their companies. The question and the challenge for the region is whether this will edge out venture capitalists as the preferred means of fundraising for startups.
Mentorship and Network
While equity dilution is, of course, one of the downsides of venture capital, there are also intangible benefits that can prove to be very advantageous to startups. For one, there is mentorship. Most venture capital firms are composed of seasoned entrepreneurs and investors who have had successful exits and multiple ventures. This means years of experience and knowledge in their respective industries. With these VCs on a startup’s board, inexperienced founders can gain important insights and wisdom, which can help one’s company in its goals and milestones.
In addition, VCs would usually have their own network of portfolio companies, as well as other companies that can potentially work with a startup for better synergies. For example, a company wanting to break into the payments industry might benefit from partnering with an established e-commerce company. Simply raising money through a coinsale might not come with these side benefits.
Validation and Investor Benefits
Aside from the equity vis-à-vis token ownership debate, there is also the argument about continuity and longevity. 90 percent of startups fail, there is no question about that. For venture capital firms that have invested in failed startups, most would simply write these off as losses, as the failed investments would inevitably be offset by successful endeavors elsewhere. Also, the VC might still be able to count on the founding team to start other ventures or pivot their existing startups, which might see success.
In the case of an ICO, the risk of failure comes with possibly unfinished or unsuccessful products, as well as untested teams of founders who may not be able to manage all that money raised properly.
Notable ICOs in Asia and Beyond
Just this year, Thailand-based Omise raised around $25 million through its tokensale. The company aims to create a cross-platform payment gateway system that does away with the multiple gateways currently in place in Thailand and other Southeast Asian countries.
Interestingly, the company has been VC-backed having previously raised $20.1 million in Series A and B+ funding, as well as another round with undisclosed amount from institutional investors like Singapore’s Golden Gate Ventures, Japan’s SBI Investment, and Indonesia’s Sinar Mas Digital Ventures.
Justin Hall, principal at Golden Gate Ventures, wrote that Omise’s coinsale was more like an IPO, in that the company chose a pre-sale model wherein its coin manager, Bitcoin Suisse, screened investors prior to accepting their payments. In addition, the company chose a modest fund-raise.
“Omise determined that it simply didn’t need that much funding to develop and launch its Omise Go network, opting instead for a relatively modest raise of US$25 million.”
What Industries Can ICOs Disrupt?
Blockchain-backed startups have no limit in terms of the industries they are disrupting. Beyond fintech, for instance, startups involved in social media, communications, and even entertainment, are benefiting from this new crowdfunding phenomenon.
In the area of social networking, Obsidian, which has developed its messaging platform on top of the Stratis blockchain, wants to reinvent chat by ensuring a private and secure way for users to communicate, all done through the distributed ledger.
The company addresses the fundamental weakness of other encrypted messengers, which involves the fact that meta-data can be easily intercepted by the platform. Thus, even if the contents of messages are encrypted, other entities – such as law enforcement agencies or hackers – can potentially determine who the two correspondents are.
The Obsidian Messenger will also have other features that can be easily implemented through blockchain technology, particularly an integrated payment system that lets users send and receive cryptocurrency.
Obsidian uses a decentralized approach, thus also removing any financial incentive for the platform to utilize user data for advertising or other purposes. What is necessary, though, is to pay the host nodes, so that they have a financial incentive to run the decentralized nodes.
The company is not yet considering venture funding, as the team’s product is still relatively small in scale.
“We are probably used to working and developing our product in a relatively small scale and that’s what our current fundraisers already enables us to do,” says Peter McClory, chief executive officer at Obsidian. “Nevertheless we know funding is what makes things possible, especially when you have large competitors like WhatsApp and SnapChat. So, we will be exploring venture capital and strategic partnerships, but we are hardly at the beginning there.”
Entertainment is also ripe for disruption by blockchain-powered startups, particularly the film, TV and music industries. As it stands, the studios hold most of the power in these industries, leaving creators and artists to slim pickings, in terms of the revenues from their works. With a blockchain-based approach to distribution and monetization, creators and artists can reap more of the benefits, whilst being able to directly reach their fans and patrons.
For example, in 2015, Ujo Music collaborated with artist Imojen Heap in distributing music through the Ethereum blockchain, in a project that was said to “help musicians make money again.” In 2016, SingularDTV started building on the rights-management technology developed by Ujo Music in distributing video content using the blockchain.
“Our rights management platform will empower creators by giving them back control over their creative output,” said SingularDTV CEO Zach LaBeau, adding that its blockchain technology “will address today’s lack of transparency and fundamentally change the prominence of creative accounting in the entertainment industry, with a particular focus on benefiting independent productions.”
In October 2016, the startup’s ICO reached its $7.5 million ICO funding goal within 15 minutes of opening.
Are ICOs a Bubble, or is it the Future of Investment?
ICOs are truly disrupting the industry. With venture capital, the power to decide on which companies to fund often lies in the hands of a few. An ICO democratizes this through crowdfunding – enabling potential investors and users to support the business that they feel offers value to them.
However, there is still some question as to whether ICOs will be sustainable in the long run, or if we are experiencing yet another bubble, similar to the dotcom rush of the 1990s and the VC funding rush of the late 2000s. What is different today is that technology – particularly the blockchain – is becoming an enabler of something even bigger than the individual companies combined. Distributed architectures, decentralized infrastructures, and distributed consensus mechanisms, are adding interesting dimensions to the companies and industries being disrupted.
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About the Author: Pini is a software engineer and front-end team leader for an Israel-based startup. When he’s not coding, this Bitcoin aficionado spends his time researching altcoins, mining Ethereum and blogging about blockchain