The Rise and Fall of the ICO

An Analysis of the ICO Phenomenon’s Short Lifespan

This post was written by Herwig Konings, Founding Partner and CEO of Security Token Group. Previously, Herwig also served as the CEO of InvestReady and the Managing Director of the Miami Venture Capital Association.

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Some will look back and say all of this was obvious. Others may have shock from the wake up call they receive. Many will continue to deny and believe.

Below I am going to dissect the rise and fall of ICOs and give you the institutional investor’s answer to the rise and subsequent fall of ICOs.

A New Technology

Blockchain was already a new VC investment sector since 2013. The concept was pitched with its first native use case, Bitcoin. Up until the end of 2016, blockchain companies would receive almost $1.5 Billion dollars in investments.

Then came 2017 and with it, the rise of the ICO. It’s purpose? Removing ourselves from an existing financing industry. Let’s disrupt Venture Capitalists or Let the average joe/sally finance the future innovations most would say. Some would even go as far as to say the goal was to circumvent securities law altogether.

ICOs would go on to raise over $6 Billion USD in 2017, four times what the last four years were combined. Many would call this time period the wild west and in many cases it resembled exactly that as the SEC was forced to intervene and play sheriff numerous times.

The Rise of the ICO

The ICO did exactly what everyone had hoped it would. Anyone in the world was now able to essentially finance the future innovations of blockchain, and, more importantly, profit from it.

And many, many people profited. The success stories were left and right from all sides. Entrepreneurs avoided onerous terms from traditional financing options and the average person was able to suddenly play venture capitalist, and make money like one too!

As common in all success stories, the true reality has revealed itself to be far more malicious towards the majority than the individual success beneficiaries.

The Fall of the ICO

The year 2017 took a ~$20 Billion Market Size that exploded into almost an $800 Billion Market Size (40x growth) in what was little more than a year. Come 2018, the SEC was actively aware of this new market, and despite still being tiny compared to the markets they were supposed to monitor — Apple and Amazon’s market capitalization were by themselves still bigger than this entire market — the fact that any American, regardless of their age, sophistication, accreditation, or bad actor history, could participate in this market was a scary thought.

And that is exactly what was going on. Let’s compare the traditional markets that the SEC polices with the ICO market. Keep in mind that the SEC’s role is not to create financial innovation but to protect investors who participate in US financial markets.

To clarify, we are comparing an individual investor participating in the traditional market, most typically though a broker or agent. Instead of this, the investor is now simply holding and purchasing a digital token powered by a blockchain ledger and smart contract like Ethereum.

The issue that arose with the ICO is that the token mirrors the use of a share in a company or as a debt obligation to a business where the investor is anticipating a return on their investment. So for all intensive purposes of this comparison, we are going to consider the token as the instrument of participation for the investor, just like a company share. Additionally, the SEC is forced to look at it this way, legally.

By understanding the new risks that investors have compared to their traditional options, we have a much better perspective about why investors are reluctant to pick this market up again.

Token Risks

1. Lack of Investor Legal Protections — Tokens have no legal protections. At best, investors had a SAFT which were designed to be pretty much unenforceable by lawyers to cover the a** of their clients. The space is rampant with lawsuits right now.
2. Scam Risks — Too many examples have arisen of fake ICOs raising millions of dollars only to vanish entirely. The hype and excitement made it all to easy for bad actors to abuse this and swindle investors out of their money in a digital and anonymous fashion.
3. Technology Risks — Hackers, exchange shutdowns, and plain old stupidity are the main reasons that leave us with stories of people throwing away $60M or exchanges disappearing with almost half a billion dollars worth of tokens. These risks were all the same for ICOs and costed investors heavily throughout the last two years.
4. Lack of Investor Rights — Going off of point #1, investors also did not have any rights with their tokens. Rights are things that helps investors participate and protect their investment via voting rights, blocking rights, and all kinds of other mechanisms that institutional investors require because otherwise they cannot justify investing.
5. Liquidity Risks — Despite the allure of success and liquidity, many of these markets did not in fact have the liquidity they needed. After the peak in 2018 and on many smaller exchanges where ICOs lived, there was no real liquidity when the markets crashed and for those who did want to exit during a high note, many times their liquidation would force the token price the other way. This is a significant issue not because their is a lack of liquidity but because there is an illusion of liquidity that made investors more comfortable with this type of investment.
6. Market Manipulation Risks — Last but not least, these markets and shitcoins (as some became dubbed) were massively manipulated by large players. The average investor was at the complete mercy of pump-and-dump schemes of all kinds. This is yet another major reason that the SEC has had to step in and ensure markets are fair for investors, whether for institutional investors or the average consumer.

The End of the ICO

Since the phenomenon started, the SEC has made it very clear that the US markets will not allow this type of flagrant abuse of existing securities laws. Lawsuits, subpoenas, shutdowns, and fines have been issued to pretty much every player in the space, from exchanges to issuers to advisors, lawyers, and promoters.

Instead, we have seen a natural movement towards adoption of securities law. ICOs in the US have stared to file for Reg D and limit themselves to accredited investors. Other utility token projects have skipped the ICO altogether to focus on a public release of the actual utility token, as they should have all along. And now, all the good that came from the ICO has formed its way into Security Tokens to let investors know from the very beginning that this is going to be an instrument designed for institutional investors and existing securities law.

Looking Ahead at 2019

As a result of this phenomenon, a spotlight has been put on Security Tokens because their is real value in blockchain-based digital securities. While many look towards other rules such as Reg CF or Reg A+ to reach the average consumer, a real monster has awoken within the world of securities. From Wall St. to VCs to real-estate developers, Security Tokens have a real use case that has the potential to unlock the new way they finance, just as ICOs had intended.

The difference is, this time, the tokens will be US market ready.