Shaping the future of culture and technology through investment
Crowdfunding,” “tokenization,” “blockchain,” “cryptocurrency.”
In this article, I will explain …
Why I believe these new funding options are needed and why they are useful additions to the economy, the evolution of funding options from crowdfunding to offering security tokens, the key differences between these different funding options so that you as a consumer can make a better choice when deciding which companies or projects to support.
First, the terminology
ICO – Initial Coin Offering
IEO – Initial Exchange Offering
STO – Securities Token Offering
Why were these new funding opportunities needed in the first place?
From 1999 to 2009, I ran a cloud-based mutual fund analysis software platform with my brother. It was a great experience to build something new from scratch. It was great to see new customers’ eyes light up when they understood what our software could do for their business. It was great to see the checks start flowing. But trying to take my business from a small two-man operation to the next level was not so great.
Trying to raise money for a business in the “old days” was not much fun because you basically had few options:
- You could go to the bank and take out a business loan with the equity in your home. This is a nice and proven option, but it’s difficult to raise a large amount of money, and I’ve heard rumors that large loans secured by a family home generally put a strain on the marriage.
- You could ask friends and relatives to put their money into your business. This option spares your marriage, but if the project or business doesn’t go well, this option can strain the friendship and make Thanksgiving dinner much more difficult than it should be.
- You could try venture capital – an option chosen by many, many companies before they attempt an initial public offering (IPO). It would be nice if you got it, but your business idea had to be really amazing and potentially very, very profitable just to get your foot in the door to a meeting. Even if you were successful in getting a venture capital firm interested in your business, you would probably have to give up a majority stake in your company (i.e., you would go back to working for someone else).
The evolution of funding big ideas
Crowdfunding is actually a very old idea that has been around in various forms for many, many years. However, the modern version of crowdfunding was born with the internet. Think of Kickstarter, Gofundme, Indiegogo or Patreon.
Crowdfunding today requires three parties: a project initiator, a group of people who financially support the project, and an intermediary who provides project details on a website and matches donations with projects.
Crowdfunding has been used to fund fantastic projects of all kinds over the years, but crowdfunding has also been marred by quackery and charlatans.
ICOs – Initial Coin Offerings
ICOs, the next evolutionary stage of public financing options, was made possible by the invention of the blockchain.
According to Wikipedia, the first work on a cryptographically secured chain of blocks was described by Stuart Haber and W. Scott Stornetta in 1991.
In 2008, the first blockchain was proposed by the mysterious Satoshi Nakamoto and in 2009 Bitcoin was born.
In 2014, the development of Ethereum was crowdsale funded by raising 3700 Bitcoin in pre-sale.
I consider ICOs an evolutionary step forward in corporate finance, as they eliminated the need for an intermediary in the transaction. In the stratospheric days of 2017 and 2018, when ICOs really took off, companies raised millions and millions of dollars, often with just a whitepaper explaining the invention, project, or business strategy, and a wild dream of making money.
Blockchain allowed companies to create their own tokens and issue them for cash. The tokens were linked to a smart contract, eliminating the need for a central platform, which is still required for Internet-based crowdfunding. At least in theory, this means it could be cheaper to get more of your money for the project you want to support. Also, if the ICO is successful, the tokens could be accepted by a cryptocurrency exchange, allowing the tokens to be traded on a secondary market.
Unfortunately, ICOs also have their share of gangsters and scammers entering this formerly unregulated space. Of course, there have also been an amazing number of success stories, but I would argue that it was this secondary market trading and subsequent gambling by speculators in the crypto bull run that ultimately led to the collapse and further development of the crowdfunding space.
IEOs – Initial Exchange Offerings
One of the big problems with ICOs is that they have been very difficult for investors to value fairly. Crowdfunding platforms tried to help investors by ruling out or rejecting obvious fraud. Although mistakes still happen, having professionals properly vet a project before money is poured into it is a good protection for investors.
In some ways, IEOs are a step backward, but in other ways they are an evolutionary step forward. IEOs bring back the “centralization” that blockchain purists hate. Unfortunately, this is (at least for now) a necessary step in my opinion. The inclusion of cryptocurrency exchanges means that tokens are now guaranteed to trade on a secondary market on the sponsoring crypto exchange. This means that vetting of projects should be better, as the exchange (at least in theory) has its reputation on the line. I would also argue that IEOs allow regulators to more easily monitor that KYC and anti-money laundering regulations are being met. Again, blockchain purists may hate this, but I firmly believe that regulation is necessary if we expect the masses to embrace this technology.
I would argue that the added protection for investors combined with a guaranteed secondary market for tokens on a token exchange is a positive evolutionary step forward for funding great ideas, and I look forward to all the interesting IEOs that will come to market in the near future.
STOs – Security Token Offerings.
One of the side effects of the ICO bull cycle has been increased scrutiny by financial regulators around the world. Regulators have taught us that just because an ICO is called a “utility token” doesn’t mean it’s exempt from securities laws if the token cannot pass the Howey test. If your ICO, like crowdfunding before it, promised future profits or fractional ownership in a company, it wasn’t a “utility token” but a security, meaning an issuer had to follow all the rules and regulations that apply to a regular IPO.
STOs will be the next evolutionary step in the financial world. STOs, also based on blockchain technology, will allow anyone to tokenize any business or asset and offer it to investors around the world at a fraction. STOs will come with more regulation and therefore more costs. However, I believe the benefits to investors will be staggering.
Imagine owning a small stake in a commercial building in Tokyo through the purchase of a security token. Using smart contracts linked to the security token on your phone, profits from leasing the commercial building could be automatically paid to your hot wallet without you ever seeing the building and without you meeting any of the other token holders. Regardless of where you live, you could share your income, vote on important decisions regarding the property, and put your token up for sale on a token exchange if you ever decide to invest the money elsewhere.
What are your investment options now?
Crowdfunding, ICOs, and IEOs are all possibilities, but at the time of writing, STOs are still in their infancy due to the current lack of standardization for trading purposes and understanding by the investment community. However, STOs are evolving rapidly and I believe they will become mainstream as a funding strategy and as an investment in the near future.
If you are looking for an early model of a product before it’s released to the general public, or if you want to get a discount on a future product, or if you want a t-shirt as a thank you for putting your money towards the completion of a project, or if you want to support a YouTube channel, then this option might be perfect for you.
Crowdfunding is usually limited to residents of first-world countries, and the legal rights seem to revolve around the idea of investors coming to some sort of consensus in case of legal problems.
ICOs and IEOs
If you are looking for an “electronic voucher” that gives you access to special products or to a token economy where you can purchase products using only a utility token, or if you want to make a financial contribution to a medical or technological problem (without the expectation of sharing in the growth of the company), this could be an option for you. Remember that the advantage of ICOs and IEOs is that if the project is successful, you have the option to sell your tokens on a secondary market, or you can choose to use the token for the special rights it gives to the token holder.
ICOs and IEOs can generally be purchased by anyone around the world, but regulations are changing rapidly, especially in the United States. If an ICO is a scam, you are probably out of luck. I think it would be much harder to coordinate investors to take legal action, and the anonymity of such projects can make it harder to find project insiders. On the other hand, IEOs should improve the quality of token issuances, and if the projects do well, the smart contract associated with your token should make rights and obligations immutable.
I believe this is the future of crowdfunding. STOs will give investors access to venture capital-like projects, fractional ownership of iconic buildings, art collections, businesses of all kinds, and perhaps even fractional ownership of sports teams, with all rights of each owner permanently secured on the blockchain. Similar to ICOs and IEOs, the security tokens will be tradable on a secondary market on a token exchange.
Of course, there will be serious additional regulatory issues with investing in STOs, but these regulations will also create rights for token holders, perhaps ultimately leading to unprecedented legal protection for token holders through the automatic execution of the associated smart contract. I’m really excited to see what the inventors of STOs come up with.
The next time you’re at a cocktail party or in a meeting at the office and the topic of crowdfunding comes up, excuse yourself, re-read this article, go back and impress your friends and colleagues with your insightful opinions on crowdfunding options.
Or better yet, start learning about this new wave of investment opportunities. It’s the first time in history that average people, not just insiders, are able to invest in “ground level” projects. The beauty of crowdfunding in its various forms is that it gives average people the opportunity to help shape the future of culture and technology, at least to some extent, through investment.