William Mougayar is the author of “The Business Blockchain”, a board advisor to the Ethereum Foundation and a venture investor.
In this opinion piece, Mougayar offers his thoughts on a new blockchain use case being evaluated – and used – by entrepreneurs as an alternative to traditional venture capital.
Initial cryptocurrency offerings, or initial coin offerings, (ICOs) are the flavor du jour in the sprawling crypto-tech market.
As I’ve described in previous writings, ICOs represent a fundamental shift in how companies get funded, at least when compared to the traditional venture capital driven methods.
What I inferred from that post is that the way forward is a clever combination of both worlds, the old and the new, a point that Zenel Batagelj from ICONOMI picked-up in “ICO 2.0 – what is the ideal ICO?” – a good post that I strongly recommend.
For background, I’ve already described the “best practices for ICOs” in a lengthy post two years ago. Its lessons still apply, but for a new reason: there are several more ICOs today than in early 2015.
I’d like to expand my own thoughts on how to evaluate an ICO by categorizing the criteria along four dimensions:
- Startup characteristics
- Operational transparency
- Crypto-sale resiliency
- Business model relationships
Arguably, the bar is higher now because if you want to comprehensively evaluate an ICO, you need to look at some new dimensions.
But at the same time, the bar can appear to be much lower because no one is forcing new investors to examine these four areas with the same required rigor that venture capitalists typically exercise, and specific ICO regulation appears to be lax or non-existent.
That’s where all the traditional VC stuff goes in. In a non crypto-tech world, VCs would continue their jobs as they always have, by making investment decisions based on evaluating startups, one at a time.
This is where the traditional “team-product-market” trifecta evaluation comes in, and I’m not going to rehash what happens in that dimension.
It often takes a career lifetime to perfect how to invest based on pattern recognition and drawing your own guideposts for making decisions. You can’t replace that, and you can’t fake it either. In here, you can add such topics as competition, go-to-market approach, product roadmap and implied valuation.
A warning signal emerges when newcomers start offering broad brush evaluations without having had the benefit of direct investment experience that includes lessons learned from having made good and bad decisions.
An additional requirement here is that someone evaluating the markets or solutions being targeted by these new companies needs to know something about the emerging crypto-tech space.
Many of these companies are not targeting traditional bricks-and-mortar or existing online markets.
Rather, they could be basing their models on the assumptions of a new ecosystem of blockchain-based users, applications and novel types of marketplaces, with new types of services that didn’t exist before (eg: identities, verifications, rights, smart assets, smart contracts logic, etc.)
Here, we enter crypto-tech territory. This part covers the sheer mechanics of the cryptocurrency sale, including its legal and regulatory aspects.
Some questions to ponder include:
- In what jurisdiction is the company incorporated?
- What legal structures are being disclosed?
- What is the token distribution structure?
- How is security handled?
- What are the apparent, perceived or real regulatory risks?
- Are there plans for external or internal audits?
- If there is a DAO-like component, is its articulation realistic and well grounded?
- Who has written up the token issuance contracts and actual token issuance software?
- Which blockchain infrastructure is backing up their sale?
- Have they published the terms and conditions of the sale in clear language?
- Have you talked to at least three other entities who have successfully done a token sale before?
The non-profit advocacy group Coin Center has published a very good analysis that is worth reading. It mentions two important points to keep in mind: 1) tokens must be a utility to the operations of the business, and 2) they should only become available after your operations, not prior.
I wrote this in February 2015:
With public money comes greater responsibility. Doing a public crowdfunding campaign is a two-way street. It’s almost like being a public company from day one. It’s not easy being in the public eye. If you can’t deliver the transparency, don’t take that path. And if we don’t self-govern to higher standards, the regulators will come and put a damper on this journey.
This is all still true, and it relates to how you plan on communicating progress visibility.
Some questions to ask:
- Is the company providing public dashboards?
- Does the company have independent auditors?
- Are their delivery promises well articulated so that they could be later measured?
- Does GitHub or another public repository reflect their progress, and has a given track record?
- How will they continue to communicate their progress?
- Are they blogging regularly about their work?
- Are the team members well identified with links to their LinkedIn profiles?
- Do they have external advisors?
- Do you have plans to list your cryptocurrency on public exchanges, and which ones have you talked to?
Business model relationship
This is a critical part that should not be taken lightly, and it should be figured out early on.
It pertains to building a case for why a cryptocurrency model is the right path for this company. The basic premise is about how tokens are related to the business model of the company.
The token is supposed to tie everything together.
For example, in the case of the bitcoin blockchain, bitcoin as a currency is totally ingrained in that blockchain’s operations, and it is at the center of a variety of actions: transaction validation, value exchange, miners rewards, store of value, transaction fee, currency for services, etc.
In the case of ethereum, ETH is used to reward miners, as “fuel” that funds smart contracts, and it is also a proxy to other tokens that can be created and managed on the ethereum infrastructure.
Fundamentally, some questions must be answered:
- What is the purpose of the token?
- What function or utility does it perform?
- Is it absolutely necessary?
- Can you describe a viable economic model behind it?
Here’s another important question that deserves its own dive:
How does value flow from the outside of the ecosystem to the inside, and vice versa (not counting speculatory trading on public exchanges)?
There are two types of segments for generating value:
- Inside your own market
- Outside of your market and into the cryptocurrency markets in general or the real world.
For example, can your users just spend and earn their coins inside or can they also spend them outside of your application?
If you are using a currency that has available liquidity (such as BTC or ETH), you benefit from the broader network effects of these currencies, but if you are creating have your own proprietary currency, your interdependency liquidity may take a little longer to materialize.
For example, steem has done a good job crossing boundaries between their cryptocurrency-governed site Steemit, and the real world, and demonstrated it at their recent Steemfest in Amsterdam.
Here are four examples I describe in a recent article, “Steemit’s First ‘Fest’ Reveals the Power of Blockchain Community” that showcase this cross-pollination of transactions between the crypto-world and the non-crypto spaces.
To quote from the piece:
“Many of the attendees paid for their travel using steem dollars they had earned on the platform, As a bonus, each attendee received a number of Steem Power as a reward for attending. Furthermore, a fund was made available to reimburse attendees in financial need. One small exhibit area featured Maurice Mikkers, a “tear catcher” who photographs your tear via a special microscope in high resolution for 25 SBD (Steem-backed dollars).”
Do you really need an ICO?
Amidst all the excitement generated by ICOs and the prospects of freedom from the strings of venture capital money, there is a fundamental question that must be asked:
Do you really need an ICO with its own currency or perhaps you may just want to use an existing cryptocurrency that attaches to your model, in which case the ICO might be burdensome and risky?
Of course, you can spin your own coin and hope the economics of the business model will natively support it for the long term, but you could also decouple the token from your model and treat it like a currency that is pegged to an existing popular one (eg BTC, ETH or STEEM).
On the positive side, despite the current Wild West appearances of the ICO market, some known best practices are emerging to create and evaluate ICOs.
Whether you are an entrepreneur planning for an ICO, an investor trying to decipher how to evaluate them, or a regulator pondering their future, do not ignore the guidelines proposed in this article.
This article was previously published on the Startup Management website and has been republished here with permission. This article is not intended to provide, and should not be taken as, investment advice.
Puzzle image via Shutterstock
Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.
ICOInitial Cryptocurrency Offering
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