Many startups across the world are skipping venture capital dollars to raise funds through ICOs. Despite the regulatory ambiguity, startups are looking to skip traditional VCs for the ease and democracy associated with the ICO world. The year 2017 was a tipping point with ICOs generating at least 3.5 times more capital than VCs for blockchain related projects.
Such a massive change in the dynamics of a market long dominated by venture capital firms requires all stakeholders to evaluate what is the future role of VCs and will they remain relevant in the new era of ICO fundraising.
Token 2049: Cryptocurrencies and VC Funding
A panel discussion at Token 2049 featured a discussion on the future of venture capital in the post-ICO world. The participants were Jehan Chu, co-founder and managing partner at Kenetic Capital; David Chang, a partner at Hong Kong-based Mindworks Ventures; Darren Camas, a senior advisor at Emurgo; Jason Fang, a managing partner at Sora Ventures, who also worked in open-ended funds and six months ago joined the crypto company mif.io, started by Jeffery Wong; Peter Vessenes, a managing director at New Alchemy, who has experience at the Bitcoin Foundation; and Paul Veradittakit, who is a partner at Pantera Capital, a hedge fund investing in cryptocurrencies since 2012.
The panel had a go at a wide range of topics. They started off with how startup deals were structured in the recent past and how the existing frameworks limit traditional VCs. They also discussed that, though the mechanism might be different, there are many underlying similarities in finding the right deal in cryptocurrency or VC investing. An interesting point was the difference between the US and the Chinese crypto markets. The panelists believe the US market is more buy-and-hold with a 12-month lockup or a minimum 6-month lockup as the norm whereas Fang, with his insight into the Chinese market, shared that China-based ICOs typically do not have any vesting, which allows for selling tokens as soon as they are listed. He also claimed founders of companies he invested in would choose him as a backer again despite him selling all their tokens.
An In depth Analysis Of Crypto Deal Flow
Traditional venture capitalists were the gatekeepers of capital across the startup universe. Being funded by a VC, or becoming a “venture-backed” startup, was believed to be the surest way to success. But the startup world is full of anecdotes where VCs conspired against the founders to either take away the company or install a “mature” CEO to ensure the company is IPO ready. VC money comes with some strings attached and also dilutes the founders’ stake in the company. But venture capitalists are focused on helping the company grow its value as they are on the same side of the fence.
ICOs bring value to the stakeholders, not through equity participation, but through the tokenization process that leads to the creation of coins or tokens that increase in value as the companies’ ecosystem grows. As a majority of ICOs look to list their coins on cryptocurrency exchanges, it ensures instant liquidity for investors (providing they receive their tokens). By comparison, venture capital firms are generally illiquid, and typical money is locked-in until an exit through a sale or IPO. These investors need a wait, hold, and grow approach before they can monetize their investment.
Though the current corporate governance associated with VCs is of a much higher level as compared to some of the ICOs, the future will see only startups with the highest levels of compliance being able to raise ICO funding from the market. Even recently, the ICO bar has been raised substantially. We saw a lot of fly-by-night operators, whose businesses were based entirely on a whitepaper and a website, entering the market in the initial phase.
Though ICOs have democratized funding so that anyone can invest in the next Google, this democracy is not stupid. Potential investors have started asking some very tough questions to founding teams, and a whole ecosystem has sprung up which evaluates and dissects an ICO and the company/team behind it. This is a sign that the crypto economy is maturing, and a higher threshold is setting in for players looking to raise funding.
Another reason that is forcing startups to look at ICOs as the primary source of funding is the in-built incentivization structure. VCs are great partners at supporting founders on strategic, administration, and legal issues. They have solid networks that can help founders find the right supplier, candidate, or client. But they are usually not the end user or the target market of the startup’s products or services. ICOs allow new blockchain startups to engage with their prospective customer base in a way that was not possible before. Now, the contributors in an ICO are emotionally and financially invested in the startup’s success. Also, clever structuring through smart contracts and tokenomics has allowed startups to onboard long-term contributors who are vested in growing the fundamental business of the company.
Steemit, with its STEEM Dollars and STEEM Power, is heralding a new era where long-term holders engaged with the platform are rewarded. This process of building a community of users and rewarding them is one of the most powerful tools in the repertoire of ICOs. It creates a strong feedback loop where the user is rewarded, leading him or her to use the platform more.
Is There a ‘But’?
An ICO is not meant for every startup. If your business does not have an inherent token requirement, it is better off sticking with venture capitalists or other appropriate financing. Even if you are incorporating blockchains or smart contracts into your business, it does not necessarily mean that you should use an ICO for investment. Many companies will fall on the ICO sword when they will not be able to generate value for their tokens. This is because their business never needed a coin in the first place. Integrating tokens just for the sake of it is a surefire way to destruct your company and pull down the entire crypto universe along with it.
So, it is sure that ICOs are the the future, and they will redraw how startups raise funding and engage with multiple stakeholders. VCs need to rethink their value proposition and innovate to ensure they remain relevant in an era where they no longer hold the keys to capital.
Stephanie Vaughan is vice president at Block X Ventures. She is an experienced capital markets professional with a background encompassing crowdfunding, venture capital, and investment banking. She served as director of capital markets and development at StreetShares, a marketplace lender focused on providing small business loans to veteran-owned companies funded by Institutional, Regulation A and Regulation D investors. At StreetShares, she led all strategic initiatives for investor products. She also played a key role in raising the company’s $23 million Series B financing. Previously, she was a senior associate executing venture debt transactions for LunaCap Ventures and was an investment banking associate with Houlihan Lokey. A former captain in the United States Marine Corps, she served as communications and operations officer and held strategic roles assisting in re-designing the USMC Force and overseeing anti-terrorism efforts for U.S. Central Command in Afghanistan. She holds an MBA in Finance from Columbia Business School and a BA in Quantitative Economics from the United States Naval Academy.