Looking to raise startup funding? You need to pitch to venture capitalists like me, right? Well no: not anymore.
Initial Coin Offerings, or ICOs, have rapidly emerged onto the startup scene as an alternative way for founders to raise capital directly from the community without suffering any dilution.
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By ‘tokenising’ their organisations – that is, designing a ‘token’, which acts as a unit of exchange in that technology’s ecosystem and is often available for secondary trading – founders can now raise funds quickly, in a crowdfunded model, with incredible network effects. Communities of people that hold a startup’s tokens are incredibly motivated not only to adopt its products but also to extol the product’s benefits to others.
This new innovation is only possible today because of the underlying blockchain protocols themselves. In fact if you ask anyone in the field what is the killer app of blockchain technology, most will tell you ‘token sales’. They have become so popular on the Ethereum public blockchain they are ‘bloating’ one of the world’s largest and most widely used blockchain networks, damaging its utility for almost any other form of activity.
The token offering craze has pushed the hype around the blockchain to new heights, as recent ICOs such as Bancor ($150m) and Tezos ($200m) show. But we are already seeing the trend go mainstream, breaking out into the wider startup space where network effects are a fundamental requirement.
Take, for example, messaging platform Kik, which is planning to issue tokens for digital rewards within its messaging app ecosystem. Kik isn’t a blockchain company, yet issuing a token could help it build a micro-economy.
Now it’s important to stress at this point that most of the startups are raising ridiculous sums of money without any sign of viable products and no real utility to the underlying token. In large part they do so to get around securities laws and tap into what is seen as less sophisticated retail money. Take the ‘Useless Ethereum Token’, whose token sale website openly declares: ‘You're literally giving your money to someone on the internet and getting completely useless tokens in return.’ This parody of the ICO craze still raised more than $70,000.
However, as a venture capitalist I look past today and focus on tomorrow. In fact, so much so, my firm Outlier Ventures will now focus solely on startups that issue tokens rather than those that pursue a traditional funding for equity model. What interests me more than the sums raised are the new economic models being created.
At first glance an $100 million raise for an early stage startup may sound insane. But consider that the tokens are not equity but a unit of exchange in a newly conceived economy.
When we recently made an investment in IOTA, a new take on the distributed ledger for the internet of things, we made our investment not on the basis of a traditional valuation. Rather, we staked a claim that one day machines will frictionlessly exchange value with one another and in our view the IOTA protocol has a good chance of providing that value exchange mechanism. Imagine an electric car autonomously paying a charging point for its electricity or a domestic solar panel system selling its energy back to the grid using micro transactions.
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In this scenario, the utility of IOTA’s token to facilitate such transactions means demand will be high and its value will rise. At the time of writing IOTA’s secondary market is trading at $1bn, reflecting the expected future value of the machine-to-machine economy.
In fact this turns my own profession of venture capital on its head. For the first time ever capital raised through ICOs eclipsed VC money in Q1 2017, according to CoinDesk’s state of Blockchain report, and this gap will only continue to increase. As the model matures and established VC norms are adopted I believe this new funding model will become the most efficient use of capital we’ve ever seen for innovation.
Why? To hold an ICO the startup must open source its code-base and create a foundation much like Linux. If things go wrong and the founding team fails to execute then the community of developers can actually fork the code, take it in a fresh direction and value is still retained – including the holdings of any investors.
Previously, 90 per cent of traditional startups simply went bust and took their ideas with them. In 2015, for example, we saw roughly $100bn of VC investment wasted. With the ICO approach those startups wouldn’t 'go bust'. If the founding team weren’t delivering others could pick-up the open code and take it in a fresh direction.
But it doesn’t stop there. With a token sale you can actually hardcode incentives into the system, creating individual micro-economies in the process. For example, Bitcoin is hardcoded to be deflationary, because only a certain number will ever be created. This is a basic example, but now imagine a future where machines control more core processes, being able to code in economic incentives for fairness and functionality into your own micro-economy becomes more important.
This might all sound expansive, but at Outlier Ventures we’re already working with Imperial College’s Cryptocurrency and economics departments to model, test and apply game-theory techniques to design tokens with the right incentives. Imagine a socially-focused, blockchain-based credit union where the value of its tokens rise based on how often they are loaned out. You’d soon see incentives for social loans that can help small firms and the unbanked access money.
I can honestly say my industry is being disrupted beyond belief right now. The funny thing is, I like it.
Jamie Burke is founder and CEO of Outlier Ventures
This article was originally published by WIRED UK
