Initial Coin Offerings are Laced with Fraud, Give Cryptocurrencies a Tainted Reputation
Since 2017, ICOs have been the hottest topics in the crypto industry. But this decentralized way of fundraising has been tainted with frauds and scams, as evident by the fact that 81 percent of ICOs in 2017 were fraud or just straight up bad investments. However, the 19% that were honest managed to raise $7 billion in the year.
Let us take an example of an honest girl who is a promoter at a music festival and wants to host an ICO to finance the event. She needs $8 million to sign bands, rent venues, advertise and pay other expenses. She could, for example, create 100,000 shares and sell 80,000 at $100 each for expenses and keep 20,000 as her compensation. Another strategy is to presale the product, perhaps 200,000 tickets at $40 each. Instead of owning 20 percent of the equity, her compensation consists of any additional ticket sales and other revenue that are generated after the presale.
The promoter creates 50,000 tokens and sells 40,000 for $200 each, keeping 10,000 tokens as her compensation. She pledges that festival tickets will only be sold for tokens. If the festival doesn’t click and total demand is for only 50,000 tickets, then one token buys one ticket and the ICO investors paid $200 for a ticket. But suppose total demand is 500,000 tickets and people are willing to pay $50 each for them. Now one token buys 10 tickets and can be sold for $500.
Investor, customer and manager interests are exactly aligned. All of them only care about the total quality delivered; total revenue, not profit. This changes the fundamental purpose of the enterprise. If bands and other vendors accept token payment, there is even more alignment. There is less risk as well. An ICO buyer who paid $200 for a ticket gets to see a festival he desired, and in more intimate setting with only fellow fans rather than a gigantic venue with a general audience
All ICO's Are Not Created Equal But Negativity Attracts Press
This is just the best case scenario of the idea. The promoter could implement token financing with a centralized database or physical tokens. Nobel laureate Friedrich Hayek suggested this in 1976, but pointed out token users would have to maintain separate accounts at every company using token financing, making the tokens illiquid and inconvenient.
A good analogy is stocks. Many companies allow direct stock purchases, where investors can buy stock directly from the issuer without fees or market impact, and in any dollar amount. But these are not popular because the investor must set up an account at each portfolio company; and selling one stock to buy another requires a series of transactions. Almost all investors prefer to maintain a single brokerage account to hold all their shares, and to execute transactions on public exchanges rather than dealing with the issuers directly. While in theory we could set up brokerages and public exchanges for company tokens, that’s hugely expensive. Crypto does the same thing better, faster and cheaper.
Legal, financial, technical and regulatory infrastructure will need to be created, and expensive lessons learned by trial and error, before ICOs for non-crypto projects are ready for prime time. But ICOs have the potential to create a new type of economic entity that could be as transformative as the for-profit public corporation.