In that last few months, I’ve been very skeptical of the ICO market. It has been saturated to the point that it was hard to analyze which tokens were worth additional analysis and which should be avoided. Because of the risk, I took the stance of avoiding all ICO Investments until the situation changed.
Now that a lot of the craze behind ICO’s has started to die down (many have advertised themselves on popular social platforms and still failed to meet their funding goals), the market is becoming more focused and able to be analyzed. During this period, I’ve found a trend in projects that I (personally) find worth further investigation.
Because of this, I want to begin seriously investigating ICO Investments again. Specifically, I’ve invested in my first ICO since May of this year, largely because I felt the project deserved the funding. Here’s the criteria I’ve come up with on judging what makes a good ICO Investment.
Limited Pre-Sale Funding Rounds with Strict Terms
One of the more worrying aspects that have come out of the ICO Investment craze is how ‘token pre-sales’ are handled. A pre-sale is exactly as it sounds, a round of funding (often done with private groups) to raise funds for an ICO before it it’s offered to the public. There are a couple of genuine reasons to do this:
- Getting anchor backers (like a high visibility Venture Capital firm) to help validate a project and bring in additional funding, or…
- Rewarding early supporters of a project with beneficial terms, similar to how early employees at a startup would receive large equity shares for joining early.
In the stock market (with IPO’s), protections are put in place to make sure that the public investors don’t get hurt by generous private terms. This includes adding lock-out periods, where investors have to wait for their tokens to vest before selling.
However, more and more decentralized projects are abusing pre-sale funding and the public at large. Many ICO’s have launched where tokens were sold at significant discounts (up to 90%) with no lockout periods, allowing for insiders to sell tokens immediately, guaranteeing large profits. This has resulted in tokens trading for less than their ICO price, making the public investors bag-holders for the insiders.
Because of this trend, I’ve been attracted to projects that either have a very clear pre-sale round with terms that match what you would expect from stock/equity, or have no pre-sale at all. This is a signal that the ICO Investment is truly there to help fund a project, not to get a group of insiders rich.
Long Funding Rounds with Clear Investing Terms
Vitalik Buterin had an excellent article explaining the challenges of creating a ‘fair’ pre-sale.
In his article, he points out the conflict of having a cap on the number of tokens versus having an uncapped round. On the one hand, having a hard cap ensures that the team does not end up with more money that it needs (>$100 million), but it creates race conditions where only those that have the right technology and resources can invest. On the other hand, having an uncapped round can create it’s own host of problems, including unclear terms and absurd token caps. It’s a problem where you have to choose the best of two poor options.
After watching dozens of ICO rounds and consulting with teams, I believe that uncapped rounds create the best ICO funding terms for the community. When a round is uncapped, you can give users a reasonable amount of time to decide whether they want to invest. When you have this time, it alleviates the fear of missing out that is palpable during capped ICO’s (such as the BAT token, which closed it’s ICO round in less than 30 seconds). This creates the breathing room to make sure your investors can understand your project more fully before pulling the trigger.
Even with long investing rounds, it can still be a bad deal if you’re not sure what you’re investing in. Teams that don’t make it clear what amount of tokens you’ll have after an investment, or what the total supply of the tokens might be given the demand, create situations where it’s hard to figure out your return. This is not always created by sinister means, but any situation that can’t be understood and evaluated on it’s face generally means there’s something you’re not supposed to understand.
Obscurity in finances tends to be bad news for outsiders, which is why I always look for terms that are unambiguous. If I am investing, I am looking for terms that:
- Shows me what the exchange rate for BTC or ETH/your token (or the clear methodology)
- Shows me how much has been raised
- Shows me the exact address I need to send my funds to (with verification)
- Shows me how much time is left in the token sale (generally looking for more than a week for the total sale time)
- Shows me where the terms to the token sale are that I can review
Reasonable Token Allocation with Modest Token Retention
This is another area that teams have used to make deals extra lucrative for the internal team at the expense of the public market. Tokens are a new funding mechanism that has some unexpected downside for the organization. In this case, it’s the idea of ‘funding rounds’ and how they don’t translate well to token generation events.
If you’re a typical Silicon Valley company, looking to raise funds, there is an expectation that you will have multiple rounds of funding, where you will sell equity in your organization during two to five rounds, eventually ending in a public offering. This means that as your organization grows and scales, there is an expectation of having equity to sell to bring your ideas to fruition.
Token offerings, as they exist today today, don’t have easy options raising multiple rounds. A typical ICO will sell off >60% of their tokens to outside investors, only leaving a small part of the tokens for themselves. While this doesn’t leave much room for alternative rounds of funding, it does give the teams some ability to have another round, albeit much diminished.
However, even this reasonable assumption has been abused by teams looking to get rich quick. In addition to having loose terms for the investors and founding team (often without a lockout period for token sales), some teams have given themselves a majority of the tokens to sell off immediately.
Despite the risks mentioned above, I think it’s the responsibility of the token founders to distribute most, if not all, of the tokens when selling to the market. The room for abuse among insiders is too great, so any self-allocation that is too high (personally, my benchmark is no more than 20% to founding organizations) is not in the public’s best interest.
Highly Technical Projects Advancing the Industry
The first three points have all been focused on one common theme: Token organizations creating financial structures to overtly avoid abuse. The biggest threat we have in this unregulated industry is people taking advantage of the vying public to make a quick buck. I believe that the best projects should not just claim their belief in the common good, but should take steps to show the public that they will bind their own hands, in a sense. Without regulation, this is the only means offered.
However, this only answers the question of whether the team is morally in the right place. It does not answer the question of what kind of projects to invest in. For me, my answer is simple: the projects most worth investing in today are highly technical projects, building platforms and infrastructure to advance blockchain technology in it’s field. No other type of project in this industry’s short history has show to sustain returns besides those that on a technical level are moving the industry forward.
There have been a wave of new products attempting to create consumer facing applications utilizing blockchain technology. This includes applications like Steemit and Gamecredits, which aim to bring the blockchain to applications like Reddit and In-Game currency. The problem with these applications is that they only have marginal benefits on the outset and will end up being worse applications than the services they want to replace. Blockchain is an incredible technology, but it is very far from being accessible to most people.
The current crop of projects should not be focused on bringing the ‘final mile’ of blockchain to end users. The world was not ready for social media in 1996 because much of the internet’s infrastructure and adoption had not reached a critical mass, even though technically it was possible to create such as service. Instead, I think it’s more valuable to focus on infrastructure innovations that be adopted by current users or enable some new development features.
Conclusion and ICO Investment
There are a lot more details beside this that deserve attention. Dave Friedman has been writing article for Hivergent explaining how to evaluate teams and read into the details on white papers. However, these are some of my early qualifiers I use to evaluate organizations.
As for the project that made me want to invest, I decided to invest funds into the RAIDEN project. RAIDEN is Ethereum’s answer to the Lightning network for Bitcoin, which would allow for private, secure and instantaneous transactions on the Ethereum blockchain. While it’s doesn’t perfectly fit all my criteria (They’re holding 34% of their tokens, which seems a bit high to me), it hit enough criteria that it got me excited. The terms were very clear, and the token sale went on for multiple weeks, so I was able to spend a lot of time deciding if the investment was right for me.
I don’t plan on investing often, but now that the glamour of investing has died down, it’s a good time to start thinking seriously about why certain ICO’s are better than others. Hopefully more projects like RAIDEN can come along so a new crop of investors can be introduced to ICO’s that don’t scam them.