June 1, 2017
A rose by any other name would smell as sweet – the quintessential Shakespearean analogy seems to be losing relevance in today’s rapidly evolving technology investment scene, accentuated by multi-million-dollar raises within minutes. Internet companies have been traditionally seen as lucrative, high-growth investments – so much so that we went into a bubble a decade back, investing in anything internet. Interestingly, few select internet companies who leveraged the network effects in the right way have enjoyed unprecedented growth and monopoly. Among the abundant promises of the Distributed Ledger Technologies – including taking us to the Sun someday, walking on water and what not – a less magical one is the inherent network effects of DLT protocols. Some of these networks such as Bitcoin and Ethereum have indeed seen substantial adoption and value appreciation (>100x). However, interesting enough is the fact that barring few exceptions, there aren’t any companies operating these DLT networks, unlike traditional networks such as Facebook. So the natural follow-on question would be: "How do I get a piece of this network’s value appreciation?"
Well, there exists an option to invest in these protocols, some call it "ICO" while others prefer "token sale" and we have seen quite a few of those over the past two years:
Source: coinmarketcap.com, inclusive of token sales and pre-sales data (numbers might fluctuate because of the averaging done by CoinMarketCap)
Initial coin offerings immediately draw a parallel with IPOs in the reader’s mind; however, coins, under existing legal boundaries, in no way represent a stake in the company. Consequently, coin holders do not have any right to company’s profits. Some companies clearly specify the aforementioned fact in their prospectus while others simply bypass this confusion by calling the fundraising as token sale. Protocol Tokens or coins are merely digital goods with some speculative value tied with the adoption of the network which uses it as a unit of exchange. Let’s try to understand this with the help of an example:
Case in point: Aragon Network Token (ANT)
The Aragon network enables users to establish and operate companies or decentralized organizations with the help of a network of third-party service providers (legal, accounting etc.) within the network, anyone who seeks to run a company on Aragon would need ANTs to transact with other companies and pay third parties. On May 17, 2017, Aragon sold 27.5 million tokens (70% of total ANTs) pricing each ANT at $0.9. ANT holders bought into the sale because they believe the network would attain the scale that organizations would need ANTs to operate, which in turn would increase the demand of the token and eventually its market capitalization in USD. Aragon currently runs on the ethereum testnet with 700+ organizations while the mainnet deployment is scheduled later this year. Having said that, there is a chance of the network not being able to see any substantial adoption and eventually disappear among the abyss of fallen tokens.
Let’s try to look at the accounting entries of such fundraising arrangements: Aragon gets $24.5M in ether but owes absolutely nothing; in case the network goes bust, there’s no redemption for ANT holders. Never have we seen a sweeter deal for companies to raise funds. The company may choose to account these funds in either assets or other comprehensive income while there is absolutely no complementing entry in liabilities or equity. So it’s definitely a win for founders.
Now, let’s look into what token holders get out of the deal, well for starters – liquidity. ANT is an ERC20 token sitting on the ethereum blockchain; all ANTs are immediately transferable and have been listed on a couple of exchanges. Essentially, a token holder may exit the investment right away. Obviously, if everyone chooses to do the same or if the founders choose to dump their stake, the price crashes.
In order to get a context on the post-sale performance of some of the tokens in the past, we dug up some data:
Or the more pricey tokens:
The data suggests that a majority of the tokens (>90%) have sold above ICO price on exchanges as of May, with tokens such as Augur and Golem giving exceptional returns in the range of 2000%. The rampant speculation in crypto-markets can also be seen as a major barrier, keeping traditional investors from considering tokens as an asset class. Therefore, we think that going forward, the effective regulation of this mode of investing is extremely vital for the overall growth of the ecosystem – be it via stringent investor protection for token holders or strict capital controls on companies choosing to raise money this way.
That being said, we are always open to hearing ideas and perspectives on this potentially revolutionary trend in supporting companies/networks/technologies one believes in. I can be reached via LinkedIn, Twitter or mail.
Disclaimer: This post is a generic commentary on token sales and in no way should be seen as investment advice; the author holds positions in some of the aforementioned tokens.