‘Crowdfunding’, ‘tokenization’, ‘blockchain’, ‘cryptocurrency.
In this article I will explain …
- why I think these new financing options are needed and why they are useful additions for the economy,
- the evolution of financing options from crowdfunding to security token offering,
- the major differences between these different funding options so as a consumer, you can make better choices when deciding what businesses or projects you’d like to support.
First, the terminology
Why were these new funding options needed in the first place?
I owned and operated a cloud-based mutual fund analysis software platform with my brother from around 1999 to 2009. It was an awesome experience to build something new from scratch. It was awesome to watch new customers’ eyes light up when they understood what our software could do for their business. It was awesome to see the cheques start rolling in. However, trying to get my business from a small two-man operation to the next level was not awesome.
Trying to raise money for a business venture in the ‘old days’, was not a lot of fun because basically, you had only a few options:
- You could go to the bank and secure a business loan with your home equity. This is a nice, time-tested option but it’s hard to raise a serious amount of cash and I’ve heard rumors that large loans secured by a family home are generally hard on one’s marriage.
- You could ask friends and family to risk their money in your business. This option is a lot easier on your marriage but if the project or business doesn’t go well, this option can strain friendships and make Thanksgiving dinner a lot tougher than it really should be.
- You could try venture capital — an option chosen by many, many businesses before attempting an IPO (Initial Public Offering). Nice, if you could get it but your business idea had to be really amazing and potentially, really, really profitable just to get your foot in the door for a meeting. Even if you managed to get a venture capital firm interested in your business, you’d likely have to give up majority ownership of your company (meaning you’d just be working for someone else again).
Crowdfunding changed all of that.
The evolution of funding great ideas
Crowdfunding actually is a very old idea and has been around in various forms for many, many years. However, the modern version of crowdfunding was born with the internet. Think Kickstarter, Gofundme, Indiegogo, or Patreon.
Crowdfunding today requires three separate parties — a project initiator, a group of individuals who support the project financially and a mediator that hosts the project details on a website and matches donations with projects.
Crowdfunding has funded fantastic projects of all kinds over the years but crowdfunding has also been marred by quackery and charlatans.
ICOs — Initial Coin Offerings
ICO’s, the next evolutionary step in public funding options was made possible by the invention of blockchain.
- According to Wikipedia — The first work on a cryptographically secured chain of blocks was described in 1991 by Stuart Haber and W. Scott Stornetta.
- By 2008, the first blockchain was proposed by the mysterious Satoshi Nakamoto and by 2009, Bitcoin was born.
- By 2014, the development of Ethereum was funded by crowdsale by raising 3700 bitcoin in presale.
I consider ICOs an evolutionary step forward in business funding because it removed the need for a mediator in the transaction. In the stratospheric days of 2017 and 2018 when ICOs were really hitting their stride, companies were raising millions and millions of dollars, often with only a white-paper explaining the invention, project or business strategy and a wild dream of making money.
Blockchain allowed companies to create and issue their own tokens in return for cash. The tokens were connected to a smart contract which eliminated the need for a centralized platform that still remains necessary for internet-based crowdfunding. At least, in theory, this means it might be cheaper to get more of your money for the project you want to support. Additionally, if an ICO was successful, the tokens could be accepted by a cryptocurrency exchange allowing tokens to be traded in a secondary market.
Unfortunately, ICOs have also had their share of gangsters and con people enter the formerly unregulated space. Of course, there have been an amazing number of success stories as well but I would argue it was this secondary market trading and subsequent gambling by speculators in the crypto bull-run that ultimately led to the collapse and further evolution of the crowdfunding space.
IEOs — Initial Exchange Offerings
One of the big problems with ICOs is they were very hard to fairly assess by investors. Crowdfunding platforms tried to help investors by removing or rejecting obvious fraud. Although mistakes still occurred, having business professionals properly vet a project before money is allowed to flow into it, is a nice level of protection for investors.
In one way, IEOs are a step back and in another way, they are an evolutionary step forward. IEOs bring back ‘centralization’ that blockchain purists hate. Unfortunately (at least for now) this is a necessary step in my opinion. Involving cryptocurrency exchanges means tokens are now guaranteed to be tradable in a secondary market on the sponsoring crypto-exchange. This means vetting of projects should be better because the exchange (at least in theory) has its reputation on the line. I would also argue, IEOs will allow regulators to more easily monitor that KYC and anti-money laundering rules are being followed. Again, blockchain purists might hate this but I firmly believe regulation is necessary if we expect the masses to adopt this technology.
I would argue, added protection for investors combined with a guaranteed secondary market for tokens on a token exchange are a positive evolutionary step forward for funding great ideas and I look forward to seeing all of the interesting IEOs sure to come out in the near future.
STOs — Security Token Offerings
One of the side-effects of the ICO bull-bear cycle was deepening scrutiny from financial regulators, worldwide. What regulators taught us was that calling your ICO a ‘utility token’ did not make it exempt from securities laws if your token couldn’t pass the Howey test. Like crowdfunding before it, if your ICO offered future profit or fractional ownership of a business, then it really wasn’t a ‘utility token’, it was a security, meaning an issuer had to follow all of the rules and regulations a regular IPO had to deal with.
STOs will be the next evolutionary step in the world of finance. Also based on blockchain technology, STOs will allow anyone to tokenize any business or asset and offer it fractionally to investors around the world. STOs will come with more regulation and therefore more cost. However, I believe the benefits to investors will be staggering.
Imagine owning a small percentage of a business building in Tokyo through the purchase of a security token. Through the use of smart contracts connected to the security token on your phone, profits generated from the rental of the business building could be paid automatically to your hot wallet without ever having seen the building and never having met any of the other token holders. Regardless of where you live, you could share income, vote on major decisions concerning the property, and you could offer your token for sale on a token exchange if you ever decided you wanted to re-allocate the money somewhere else.
What are your investment options now?
Crowdfunding, ICO’s, and IEO’s are all possibilities, but as of the writing of this article, STOs are still in their infancy due to a current lack of standardization for trading purposes and a lack of understanding from the investing public. However STOs are evolving quickly and I believe likely to become popular 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 is widely released to the general public or if you are looking for a discount on a future product or if you’d like a T-shirt as a thank you for offering your money toward the completion of a project, or if you’d like to support a YouTube channel, than this option might be perfect for you.
Crowdfunding tends to be limited to residents of first-world countries and legal rights seem to revolve around the idea of investors coming to some kind of a consensus in the case of legal trouble.
ICOs and IEOs
If you are looking for an ‘electronic coupon’ that will offer you access to special products or access to a token economy where you can purchase products only with a utility token, or if you’d like to offer a financial contribution to a medical or technology problem (with no expectation of participating in the growth of the company), this might be an option for you. Remember, the advantage with ICOs and IEOs is that if the project succeeds 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 confers on the token holder.
ICOs and IEOs are generally available for purchase by anyone worldwide but regulations are changing quickly, particularly in the United States. If an ICO is a con, you’re probably out of luck. I think it would be much more difficult 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 token issue quality and if projects go well, the smart contract attached to 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, to fractional ownership of iconic buildings, collections of art, businesses of all kinds, and perhaps even fractional ownership of sports teams, with all rights of every owner permanently secured on the blockchain. Similar to ICOs and IEOs, security tokens will be tradable in a secondary market on a token exchange.
Of course, there will be serious additional regulatory issues to deal with when investing in STOs but those regulations will also confer rights to token holders, perhaps ultimately producing unparalleled legal protection to token holders through automatic execution of the attached smart contract. I’m really looking forward to seeing what inventive STO creators come up with.
Next time you’re at a cocktail party or in an office meeting and the issue of crowdfunding comes up, excuse yourself, re-read this article, then go back and wow your friends and colleagues with your insightful opinions about crowdfunding options.
Better yet, start educating yourself about this new wave of investment options. This is the first time in history that average people, and not only insiders, are able to invest in projects on the ‘ground level’. The beauty of crowdfunding in its various forms, allows the average person an opportunity, at least in a small way, to shape the future of culture and technology through investment.