How Will The Rise of ICOs (Initial Coin Offerings) Affect The Traditional Venture Capital (VC) Industry
The amount of funds raised by Blockchain and Cryptocurrency has been rising in recent years. The level of capital raised by Initial Coin Offerings(ICO) has surpassed the amount raised by Venture Capital.
Initial Coin Offering(ICO) has emerged as a new way to gather money from the investors by allowing them to buy a stake. The users receive tokens or digital currency that are similar to shares of a firm. It has become very popular among cryptocurrency and blockchain startups. These startups can go online, create digital tokens and raise an unlimited amount of money from anyone. This enables them to raise funds without giving up their decision making power.
Mastercoin, the first ever ICO was offered to the public in 2013 and in just a few years, this market exploded in popularity. Bitcoin and Ethereum emerged as the two most common cryptocurrency. In 2017, $6 billion was raised by ICO and earned another $2 billion in the first quarter of 2018. There were around 200 ICOs in 2017. With exponential growth among investors, many ICOs have been used to financial scams and fraudulent activities.
Venture Capital Functioning
As an integral part of funding chain, VC funds function as connectors and distributors. Venture Capital creates large ownership chunks of a company that are then sold to few investors through a limited partnership. They create a pool of enterprises that allow startups to raise large amount of funds from the centralised bodies that invest relatively larger amount of money. It is easier to get funds from large investors than individuals.
Regulations make it very hectic for the entrepreneurs to raise funds by limiting the participation in startup equity. Venture Capitalists can raise only a limited amount of capital. It can be understood as the gatekeeper of capital. Startups need to find investors who are willing to invest, negotiate terms and draft proper conditions.
ICO is capable of removing all the roadblocks. Startups can raise enormous amount of capital by ICO with no legal terms. Digital currency can be distributed to the investors seamlessly over the web. ICOs have therefore reduced the need for venture capital.
Certain Assumptions on the ICO vs VC
The assertion that ICO will replace VC makes various assumptions. It assumes that the current trajectory of ICO will continue to grow without fail. The premise that ICO will replace VC relies on three main assumptions.
1. It is assumed that token based model of ICO is relevant for all the companies, which might not be true. The digital tokens should be somewhere related to the core products of the company. These tokens may not be relevant to various businesses especially to the ones that sell to the other businesses. Firms that are not engaged with blockchains at their core might not find it feasible to issue tokens. It is expected that a lot of companies will adopt the token model in the near future. Presence of both blockchain and non blockchain firms is necessary to maintain business harmony and a conducive environment.
2. Regulators have hindered the growth of venture capitalists by capping the equity at $1 million every year. On the contrary, ICOs face little such regulations. These regulations are important to ensure that there are no unscrupulous activities. Lack of monitoring makes ICOs more vulnerable to scams and fraudulent activities.
3. It is assumed that ICO will continue to raise exorbitant amount of funds seamlessly. As market moves towards better organisation and better understands the lifecycle of blockchain and associated risks, ICO will move towards better sums and requirements.
It is believed that ICOs will replace VC industry in future. However, a combination of two would create a more robust funding environment.
Also read: Difference Between IPO and ICO
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