ICOs burst onto the global finance scene last year with revolutionary gusto -the new fundraising mechanism was slated to invite a swathe of new investors into the startup scene and to provide some companies with unprecedented amounts of capital.
And so it was, for a while. The ICO market boomed, and with it, thousands of retail investors joined the cryptocurrency space for the first time. However, just as quickly as the ‘revolution’ had come, it began to wane. Clampdowns by regulators, an increase in self-regulation, and the revelation of many fraudulent or botched products changed the ICO market forever.
Indeed, the ICO market has made a major shift away from small retail investors and toward large institutional investors. According to a Bloomberg report, the majority of more than $18 billion that has been raised this year “is increasingly due to blockbuster sales that targeted accredited (read: wealthy) investors instead of just anyone with an internet connection.”
Research from Token Data suggests that roughly 58 percent of all ICOs had raised their full funding amount through private presale rounds.
Regulation is Largely Responsible for the Shift
Perhaps the most glaring example of this is the Telegram ICO that closed in May. The token sale raked in a record-breaking $1.7 billion, a sum second only to EOS’ $4.2 billion ICO.
The original plan was to raise no more than $1.2 billion. However, when the company easily reached this goal during the pre-sale that was open exclusively to resale investors, it upped its goal to $1.7 billion. When that figure was reached, Telegram cancelled the public portion of the ICO altogether, blocking access from small retail investors altogether.
At the time, TechCrunch reported that the move happened “almost certainly because it had already raised enough money to develop TON without the risk of running into the SEC’s ongoing ICO probe by soliciting money from the public.”
Indeed, SEC Chairman Jay Clayton began to crack down more seriously on the ICO space near the end of 2017, when the Commission started to target companies who were selling their tokens as utilities rather than securities. The first company that the Commission went after was Munchee, a Blockchain -based restaurant review app that was shut down in December for this very reason; the company was forced to return funds to investors. The SEC (as well as other regulatory bodies) have come down on a growing number of companies since then.
The ICO Market is Either Over-Regulated or Under-Regulated, Depending on Who You Ask
Killian McGrath, the founder of Unhashed.com, told Finance Magnates that this trend contributed to the ICO market’s shift from retail to institutional investors. “As 2018 approached, it started becoming clear that simply labeling a cryptocurrency a ‘utility token’ would not keep regulators from designating it as a security. This led to the majority of top projects in the space limiting investment to private institutional investors.”
Killian McGrath, Unhashed.
Global director of fintech strategy at Autonomous Research Lex Sokolin explained to Bloomberg that regulatory scrutiny has caused companies holding an ICO to be much more cautious. “The space went from three things to think about to 30 things to think about, and those 30 things are very analogous to traditional finance,” he said.
Despite the increase in legal concerns for companies holding ICOs, regulations in the US are still somewhat unclear around the matter. Rather than creating new regulations specifically for the blockchain and cryptocurrency industries, the SEC and other regulatory bodies have chosen to apply existing laws to the industry. This has led to some contradictory statements from various government bodies and a general sense of caution and wariness within the industry.
What a nightmare this is. SEC says "all ICOs" its seen are sales of securities, but FinCEN says they are "generally" money transmission.
But by law, they can't be both. As an industry, we must do a better job of educating our governments.https://t.co/KUaX6uoehs … @coincenter — Marco Santori (@msantoriESQ) March 6, 2018
Kyle Asman, Partner at BX3 Capital, explained to Finance Magnates that essentially, “the market hasn’t seen any regulation from the US, which is typically the leading regulatory body in the world. This has caused a ton of uncertainty in the marketplace, and a lot of people to remain on the sidelines” both in terms of investors and companies.
Kyle Asman, BX3 Capital.
To Reach Retail Investors, Some Companies Have Gone Off-Shore
Some companies have chosen an alternate route to avoid regulatory troubles. Rather than excluding most retail investors from their sales, Jeff Stollman, Principal Consultant at Rocky Mountain Technical Marketing, told Finance Magnates that some companies are simply choosing to avoid highly-regulated markets altogether.
“Because startups don't typically have an extra $100K available to hire expensive attorneys to navigate issues such as securities regulations, the technologies are seeking alternative jurisdictions that don't impose these costs,” he said. “To do this, they give up major markets (such as the US). But they just can't afford compliance with US laws pre-ICO, because they don't have the initial capital. Accordingly, many are opting to issue ICOs in countries that either don't have regulations or are promulgating ICO-specific regulations that are ICO-friendly.”
Jeff Stollman, RMTM.
Bharath Rao, Founder and CEO of Leverj, echoed similar sentiments in an interview with Finance Magnates earlier this year. He argued that establish a company in an unregulated market was the only way to stay ahead of the game: “the competitor who goes toward the unregulated market will make more profit and be able to capture what is currently feasible.”
“The person who goes through the regulated market–two years later, when he gets approval, his product will be obsolete,” Bharath explained.
A More Educated Consumer Base Has Raised the Bar for ICO Standards
However, a company based in a market that’s known to be unregulated presents a different problem: skepticism from investors.
Indeed, retail and institutional investors alike have seen the dark side of the cryptocurrency markets. Companies who hopped onto the ICO train during the crypto boom at the end of 2017 are now having to build their plans into realities. Some have squandered their money; others have proven themselves to be completely fraudulent. The future of most ICO-funded platforms is (at best) unclear.
As such, investors have developed a bit of healthy skepticism--the consumer base is generally more educated and less likely to buy into platforms that lack technical substance. Asman explained that a more ‘sophisticated’ consumer base is coming in tandem with more institutional cash. “The ICO consumer based has changed dramatically, it has become far more sophisticated. We see every day more and more venture capital firms flooding the marketplace.”
Put more bluntly, “In 2017 you could put ICO in front of anything and raise capital. In 2018 you need a project with a real product or real revenues. The bar has been set much higher.”
A number of self-regulatory initiatives have also emerged from within the cryptocurrency industry to raise accountability and to educate consumers. These organizations have also directly contributed to this maturation of the market.
Security Tokens and Asset-Backed Tokens--The Future of the ICO Market?
Killian McGrath explained that the increased skepticism and more intense regulation has made it difficult for ICO investors to be profitable, and as such, some of them have chosen to exit the space. “Numerous investors I've spoken to, who made a fortune investing in ICOs, are now transitioning to more traditional investments,” McGrath said.
“Today, the combination of increased regulation and lack of fulfilled promises by past ICOs has led to a decrease in investor confidence.” Additionally, Killian said that an over-full ICO market has caused “ICO investors [to] struggle to find buyers for their tokens once they hit exchanges.”
But there is hope yet. Asman pointed out that as ICOs for low-quality products and unregistered securities are dwindling in popularity - and as they do so, the popularity of asset-backed and securitized tokens continues to rise. “I believe the Security and Asset backed token market is heading much higher...Much of the tokens on the marketplace now will go extinct because the companies have no revenue, and the tokens have no real use cases."
Similarly, when Finance Magnates asked Todd Mitchem, CEO of BUILD1x Inc., about the future of the ICO markets, he said simply: “STO, STO, STO.”
Todd Mitchem, Build1X.
Mitchem explained that his own company has chosen to run an STO “instead of ‘begging forgiveness’ from the US regulators.”
“It creates collaboration with regulators,” he said. “As [a] CEO, I need that collaboration rather than opposition. The days of renegades and outlaws in the wild west of ICOs will crash to make way for the STO.”
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