Why the ICO Model's Success Could Be Its Downfall

Last week, CoinDesk released the results of its first Spotlight Survey of 2017: Blockchain ICOs. While the whole thing is worth a look, here I want to highlight a couple of slides that point to this new financing method’s rise and, at the same time, its potential fall.

But first, let me tell you a joke. (Bear with me, this is leading somewhere…)

It was late autumn and the Indians on a remote reservation in South Dakota asked their new chief if the coming winter was going to be harsh. He hadn’t yet learned how to read the skies, so he said they should gather firewood just to be safe.

After several days, he managed to get through to the National Weather Service. “Yes,” the meteorologist replied, “it looks like this winter is going to be quite cold.” So the chief told his people to collect even more firewood. A week later, he called the National Weather Service again. “Yes,” he was told, “it’s going to be very cold.” So the tribe gathered more.

A week later, the chief called again. The weatherman was certain: “It looks like it’s going to be one of the coldest winters we’ve ever seen.”

“How can you be so sure?” the chief asked. The weatherman replied: “Because the Indians are collecting a sh*tload of firewood.”

From weather concerns, we move to slide 13 of the report, where we see another beautiful circularity and a different type of deforestation:

The vast majority of respondents who invested in an ICO did so for the potential price increase, rather than the token’s utility.

Slide 21 shows that almost half of respondents believe that institutions will come to dominate the ICO investment space.

There’s the circularity: if some institutional investors treat blockchain tokens as an asset class, then they become an asset class attractive to other funds.

Institutional investors are competitive. Therefore, success in an ICO bet encourages others to take a similar risk, and before you know it, hedge fund managers are competing to grab tranches of interesting projects. The success of some recent issuances could be an indication that we are already seeing the effects of competing funds chasing relatively illiquid investment opportunities.

While the notion of institutions muscling in on a financing method originally aimed at involving the community of developers and users is disquieting to some, that’s not the part that will weaken the system.

It’s this: if investors are buying tokens for investment or as a speculation, as our survey showed, then they are a security. And if they are a security, the SEC (or its equivalent in other jurisdictions) will take an interest.

And if the SEC takes an interest, it’s generally to (at best) increase the reporting requirements and compliance hurdles, which significantly raises the cost of financing through this method. In fact, it could end up pricing this path out of the reach of the small startups that had hoped to crowdfund their initial operations.

If this trend progresses, we could see an intentional dial-back of the investment appeal. Allocations could be limited, the utility of the token could be emphasized and institutional investors may end up deciding that there are more interesting high-risk opportunities elsewhere.

Without a shift in direction, the future of ICOs looks rocky. Just like a tribe’s reputation as weather diviners ends up killing a lot of trees, the success of token sales as an investment could end up being the nail in their coffin.