New Thinking

With ICOs, Blockchain Goes Big Despite Big Setbacks

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It’s impossible to escape certain buzzwords in business and tech media, and last year’s “bitcoin” has given way to “blockchain,” the technology that undergirds the cryptocurrency which promises to change how we think about everything.

The summer of 2017 could be dubbed the Summer of the ICO, or Initial Coin Offering. Blockchain startups sell “tokens,” which behave like digital stock certificates, appreciating (or depreciating) in value along with the value of the startup. Several startups have raised record-breaking sums over the last few months, relying on large numbers of everyday bitcoin geeks, as opposed to institutional investors, to fund their budding companies. Filecoin raised $250 million, Block.one raised $185 million, and Tezos raised $232 million. AllI told, Blockchain projects have raised over $1.2 billion via ICOs as of early August, and the trend shows no sign of slowing down.

VC Max Mersch of Open Ocean wrote in a Medium post in May that “the past four years have produced more innovation in technology funding mechanisms than the previous 4 decades.” He suggests that the astronomic rise in the valuation of bitcoin and other cryptocurrencies is less significant than the ascendance of this new fundraising mechanism, which incentivizes early adopters to “build, grow, distribute, and love the product.”

The blockchain is a public, cryptographically secure record of transactions. If you believe the media hype, it’s already in the process of infiltrating every possible industry. Take music, for example. Spotify provides a platform where people listen to music, and then they pay artists a tiny fraction of whatever money they take in from advertising. But what if there was an open, distributed platform that could keep track of who’s listening to what? Artists who previously needed to rely on wealthy private or institutional patrons can now crowdsource their patronage across those who purchase their art. Artisans who might have relied on eBay or Etsy to provide a showcase for their wares might one day be able to sell directly to consumers because the blockchain will provide the trust mechanism that enables safe transactions for both parties. Even writers and journalists could create a market for their output with blockchain-enabled microtransactions, reducing their reliance on big corporate publishers. Why should Netflix or YouTube take such a large slice of the ad revenue that their creators generate?

Social networks are only free because their owners make money by surveilling you and selling your personal data to advertisers which then target you based on that data. Blockchain technology hints at a future where networks that aren’t owned by any company provide safe and secure social sharing and messaging for free. Or, the network could pay you to produce content by allowing you to voluntarily accept ads.

Why do Uber or Airbnb need to exist? They maintain the technology underlying their networks, facilitate secure payments, and contribute a customer service layer so that everyone in the network plays nice. These are all functions that blockchain could provide without any centralized party making sure everything’s running smoothly. Could such networks become open-source, built and maintained collectively by volunteers similarly to how Wikipedians have created a sprawling collaborative compendium of knowledge, or how Linux developers maintain technology that powers most of the servers in the world?

Supply chain management, investment, inventory, marketing—all of these business functions are vulnerable to major disruptions from blockchain tech. Smart contracts and peer-to-peer messaging are poised to eliminate massive inefficiencies in the way that businesses talk to each other and fund one another. The coming ubiquity of the blockchain will also revolutionize how companies are managed. Today, private companies are protected from poor management decisions and short-term thinking because their value is set arbitrarily. Blockchain investing will allow private investors to sell their shares seamlessly, incentivizing management to protect the interests of the company above all else to avoid catastrophe.

I’ve painted a picture of a decentralized future, free of middlemen and managers who have been rendered obsolete by the perfect trust network of the blockchain. However, technological development never quite works this way. Advances in blockchain adoption are not likely to cause an immediate reduction in the size or complexity of any of these markets, nor are they likely to completely oust incumbents. In fact the opposite is expected—disruptions often create opportunities for more businesses to thrive in a marketplace, just as the introduction of Bitcoin has created a blossoming of startups and new ventures from existing players in the banking and transaction spaces. The rise of the Web didn’t kill AT&T or Time Warner. Instead companies like these were able to adapt, in some cases painfully, but they managed to stick around thirty years on because they reenvisioned their businesses for a new world. Today’s large companies have much to gain by embracing the uncertainty of the blockchain. The efficiencies that distributed trust networks promise to create will more likely expand every economy it touches in both size and complexity. More startups, more jobs, more pie for everyone!

Sales of tokens (as opposed to equity) in an ICO allow companies to grow side by side with their communities, proving their worth naturally. They won’t have to worry as much about reporting hockey stick revenue growth, which is not always a useful universal value metric. “This effectively solves the strategic chicken and egg problem of needing adoption to grow network value, but also needing value in the network to grow adoption,” writes Mersch. Blockchain startups, or any kind of startup, can raise money faster than working with traditional VCs, even when they only have a promising white paper or pitch deck to show for their company.

Plus, ICOs open investing up to a wider pool with unregulated, open offerings. On top of that, tokens are liquid compared to equity. Want to bail on an investment? Just sell your tokens at market rate within minutes of making that decision.

That’s not to say there haven’t been hiccups. Just this week, digital financial services developer Enigma was hacked leading up to their ICO scheduled for September. Scammers were able to manipulate the company website, mailing lists, and Slack accounts due to Enigma’s weak security. They then told potential investors that they would be providing advance access to their ICO, and pointed them to a cryptocurrency wallet that the hackers controlled. They were able to make off with almost half a million in stolen Ethereum before Enigma was able to regain control. Investors were understandably not thrilled. In July, as much as $7 million was stolen during the CoinDash ICO in similar fashion. Parity reported a loss of approximately $32 million in Ethereum. Aside from hacks, investors should be wary of startups that don’t consist of much more than a big idea, as there’s much more to running a successful business than an exciting white paper.

ICO Hacks and scams represent yet another ding for the reputation of the blockchain community at large, which has suffered from a number of high profile scams and security breaches. And there are certainly more to come. According to many voices in the field, ICO fever is often fueled by irrational behavior, namely FOMO (Fear Of Missing Out).

I spoke with Lamine Zarrad and Cory Flanigan, the CEO and CTO of Tokken, a blockchain banking startup based in Denver, Colorado. They’re generally optimistic:

We don’t think a few bad ICOs will be a setback for the adoption of blockchain… Rather we think it will create awareness and an ability to participate in unique investment opportunities for those who wouldn’t be exposed to blockchain otherwise. ICOs, if done ethically, could be the beginning of a democratization trend in venture capital.

Zarrad and Flanigan believe that large established companies will need to look beyond incremental improvement toward implementing new technologies that “create new paradigms.” Acquisition of scrappy startups that have overcome the risk but don’t yet have the muscle to scale seem to be a natural fit for large institutions looking to integrate blockchain. Say Zarrad and Flanigan:

…large companies can create many opportunities for talented, experienced people in the space. Especially if they’re mobilized effectively to bring products to market that create platforms for innovation and collaboration. We believe we’ll see similar positive effects for blockchains as we’ve seen when large organizations adopted various cloud offerings.

Timothy Ruff, CEO of Evernym, which is developing a blockchain-powered distributed identity platform, finds analogies to the current landscape in previous boom-bust cycles.

“It’s a little like the Wild West days of the beginning of the Internet where the people involved could tell there was a major breakthrough, and a lot of power, but there was also a lot of irrational exuberance and irrational behavior.” But, he argues, had the dotcom bubble of the late-90s not brought a dramatic boom and subsequent bust to Silicon Valley, transformative Web 2.0 companies like Google and Facebook would not have been able to rise from the ashes.

Ruff advises larger incumbents to consider approaching disruptive technologies such as the blockchain with an internal team that is given enough freedom to truly challenge the status quo. “Companies have to be willing to disrupt themselves. You have to have a skunkworks type of group that is not beholden to the company value chain, and is actually attacking the company’s sacred cows as any competitor would.”

Risk is baked into a disruptive boom. It’s likely that 2018 will bring larger, more conservative institutional players into these markets. They will find the gold rush too irresistible to ignore, and provide confidence for investors who are looking for reputational consistency proven by experience in a market that, as yet, has precious little.

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