CoinDesk’s 10th Anniversary ICO Era – Success Factors?

During Consensus 2023, a panel of CoinDesk employees discussed major events in the history of cryptocurrency. When asked to vote on the most significant event, the majority chose the chaotic and fraudulent period of “ICO mania” that lasted from early 2017 to mid-2018. However, this choice may not seem obvious since initial coin offerings (ICOs) were not entirely positive. Many of the negative aspects and threats that ICOs brought to cryptocurrency, such as investment fraud and securities violations, continue to be significant problems. In fact, 80% of all ICOs during the boom were found to be outright scams in one retrospective study.

Despite the downsides, the ICO bubble was also a time of progress. Some of the most important projects in decentralized finance today, including Aave and 0x, launched during this period. Speculators who were well-informed, careful, and lucky could have made significant returns by investing in legitimate projects.

Moreover, the historical impact of the ICO boom goes beyond the few successful investments. It allowed investors from anywhere in the world to profit from their insights, regardless of their location or citizenship, fulfilling the promise of cryptocurrency to cut out financial middlemen.

One prominent speculator who first got involved in cryptocurrency during the ICO era and now works in crypto trading professionally said, “Looking back on that period, we were building infrastructure. You can’t build something and build the underlying infrastructure at the same time. I think of all that as trial runs.”

What was an ICO?

At the time, an ICO resembled an initial public offering in the equity market. However, from a buyer’s perspective, the main difference was that ICOs were accessible to any individual who could set up a digital wallet and fund it with a smart contract token like ETH, SOL, or ATOM.

However, there were significant differences between what investors in ICOs and IPOs were buying. An IPO buyer acquired a legal claim on a portion of a company, while an ICO buyer only received tokens that did not formally represent any ownership in a company. While IPO investment gains were premised on growing corporate revenues, ICO tokens only rose in value because people wanted to use them. This is the “utility token” thesis that some believed separated token sales from securities offerings.

The lack of regulation and transparency during the ICO craze made due diligence processes unreliable or impossible. Anonymous founders could easily steal investor funds, and hype often overshadowed any rational approach to evaluating proposed services.

This feature is part of our CoinDesk Turns 10 series, which looks back at seminal stories from the history of cryptocurrency.

Five years later, with an SEC crackdown ongoing, the ICO nomenclature indeed seems foolhardy

The era of Initial Coin Offerings (ICOs) was, by most objective measures, a disaster for investors and a huge waste of capital for the cryptocurrency industry. However, it remains endlessly fascinating – and perhaps not as much of a catastrophe as it might appear.

What started the ICO boom?

It’s hard to pinpoint a clear starting point for the “ICO era,” but one signpost may be the $60 million failure of The DAO in 2016. The decentralized organization was intended to act as a collectively managed investment fund for Ethereum-based projects, with a balance of power that privileged major holders.

The project’s investment model balanced the input of experienced large investors with that of less expert funders. As The DAO co-founder Cristoph Jentzch recently explained, that model could have bent the whole ecosystem towards deeper, more expert vetting of proposed projects. It might still be the right way to balance the expertise of traditional venture capitalists with the open nature of decentralized finance (DeFi).

However, The DAO was catastrophically hacked before it could launch, resulting in an extended state of emergency for Ethereum as a whole. Meanwhile, projects that had expected to receive funding from The DAO were left searching for an alternative model.

Also in this series: 2016 – How The DAO Hack Changed Ethereum and Crypto

For better or worse, that model was close at hand. Ethereum’s token presale, conducted in 2014, became a powerful vehicle (it raised $2.2 million in 12 hours). By the time Ethereum launched in 2016, it had proven not only that a token sale could fund the development of important projects, but that it could make early investors rich.

But the true madness of the ICO era wouldn’t be unleashed until the introduction of the ERC-20 token standard. The standard lays out specific features that ensure tokens operate uniformly across the Ethereum ecosystem, including external tools like wallets and exchange APIs. It was first introduced as early as 2015, though not fully formalized until September of 2017.

Whatever their galaxy-brain promise, the actual results of the ICO free-for-all are not easy to defend

Creating ERC-20s was and remains far less technically and socially challenging than launching a new “layer 1” blockchain. Instead of having to recruit its own miners or validators, a project could rely on the existing security of the Ethereum blockchain. On the other side of the market, ERC-20s were far less technically challenging than standalone blockchains to integrate into exchanges, wallets and other services. It was during the ICO boom that the benefits of smooth interoperability really became clear.

“People started to [adopt] the shipping container worldview,” says our anonymous trader. “Which is that, if these things fit in the same [ERC-20] container, it’s much more efficient.”

The good ICOs

There were unquestionably some huge successes to emerge from the ICO era. Near the top of that list are Aave (AAVE), Filecoin (FIL) and Cosmos (ATOM). Each is a substantial part of the blockchain ecosystem nearly six years after their initial fundraising push, and have generated huge returns for ICO investors.

Another project that emerged from an ICO to produce an actual successful product is Brendan Eich’s Brave Browser, which raised $35 million worth of ETH when it ICO’d in 2017, and has continued to build since. The BAT token that provides various services through the browser certainly hasn’t mooned, but it has largely held value against broader crypto indices.

“But those positive examples must be cherry-picked from a much bleaker big picture dominated by fraud, theft and failure. The takeaway seems to be that ICOs can be very effective fundraising tools in individual cases where founders are trustworthy and well-intentioned, but that overall they invite massive fraud.

Read more: CoinDesk Turns 10 – 2020: The Rise of the Meme Economy

The libertarian ideal of a completely unregulated financial market, in short, did not quite deliver on its promises, in what was arguably the biggest controlled economic test of the idea in modern history.

Why did ICOs fail as an investment model?

A large amount of ICO investment proved unproductive because investors themselves didn’t understand the novel financial and technical theory that made tokens investable. The “fat protocols” thesis fundamentally only makes sense if a protocol or contract’s function is truly native to or tightly integrated with its token. Good examples include ether’s role as “gas” for Ethereum transactions, or filecoin’s use to pay for verifiable on-network storage. These use cases make sense because they leverage the three blockchain pillars of decentralization, open access and trustlessness.

But the further you get off-chain with any feature of a distributed ledger, the more this model breaks down, for at least two reasons. First, because there’s less and less on-chain verification that goods or services are actually being provided, inviting fraud. This was seen repeatedly in scam ICOs, where entrepreneurs claimed their tokens were “backed” by real estate or diamonds – claims that couldn’t even be verified, much less redeemed, on-chain.

Similarly, “fat protocols” can’t hold when there’s no exclusivity to the relationship between a token and a service. You can’t use anything but ETH to run smart contracts on Ethereum, so ETH has economic value. But you can take your pick of currencies to pay a dentist, so dentacoin (a “blockchain solution for the global dental industry”) doesn’t have economic value.

Investors missing these fundamentals enabled a huge amount of low-IQ mis-investment and fraud. And we’ve seen it continue into the present day, such as with various “exchange tokens.” There is no rational investment thesis for a nominally decentralized token attached to a fully centralized exchange, yet traders treat tokens like Binance Coin and FTX’s FTT as similar to equity.

But even for those with full comprehension and the best of intentions, ICOs had major downsides. The capital structure, which often led to startups getting huge blocks of cash up front, remains its most profound drawback. If you raise several hundred million dollars to start a project, you no longer have much incentive to actually build it.

Read more: CoinDesk at 10: 2019 – The Ghost of Libra Lives On

Further, the necessity of high-stakes treasury management was basically detrimental. Most ICOs raised in ETH, which crashed dramatically in dollar terms soon after the ICO bubble died down. So when it came time to actually operate, the U.S. dollars available to hire developers and pay for offices were far fewer than the initial headline fundraising number might have suggested.

At the same time, the temptation of speculating with ICO funds was too much for some founders. A project called Substratum was found in 2018 to be actively trading with its treasury, with a full-time trader on staff. (Substratum is no longer active, but it at least seems to have been a legitimate project. It was reportedly acquired in 2021 by Epik, a domain registrar, and the token now trades at basically zero.)

Even happy versions of this story conceal this shadowy underbelly: A successful startup called Monolith, for example, managed to turn a $16 million raise into $25 million using a DeFi-based hedging and leverage strategy. The problem here, even leaving aside hidden risks, is that this activity meant time-and-effort not spent developing the actual product pitched to investors.

Here we see just one way 2017 ICOs created a misalignment of interests. Because they exist outside of any real legal framework, ICO tokens didn’t give investors any direct exposure to the upside of treasury speculation. Holders benefit if a project is finished and finds real users (or if investors can find a “greater fool” to sell their tokens to in the meantime). Building is obviously easier with 50% more funds, but there’s no true, enforceable obligation to actually spend those funds on the project.”

However, if a project risks its own funds, major losses in the treasury are almost certain to hinder investors by slowing or halting development. This is significantly more likely to happen.

The end of the ICO era

It is impossible to identify a definitive “end” to the ICO era, as they still frequently occur, albeit less visibly, in the United States and similar jurisdictions. However, one type of end to the ICO era can be traced back to the moment when existing large companies attempted to participate and were met with resistance.

Telegram’s plan to tokenize the network and sell a TON token was a technically sound concept that could have been transformative, but significant pressure from the SEC in 2019 forced its abandonment. In 2019, the SEC also sued messaging platform Kik for its token sale in 2017, resulting in a $5 million settlement.

I would also argue that a less obvious event from 2019 marked the end of the ICO era: Facebook’s proposal of the Libra stablecoin. Libra was unlikely to have been issued or sold as an ICO. However, as the highest regulatory and legal bodies in the U.S. scrutinized it, their blunt hostility made it clear that they were horrified by Facebook’s adoption of norms and practices that had become standard in crypto. The regulatory backlash we are still facing five years later seems to be fueled by that incredulous outrage.

Can we do better?

Perhaps someday a regulatory system will successfully impose good transparency and controls on ICOs while retaining their accessibility advantages. However, that is likely many years, or even decades, away. In the meantime, is it possible to steer the moral arc of token launches towards rationality and honesty?

It can be difficult not to view those who lose money on ICOs cynically. Many ICOs were and are so blatantly fraudulent that it can be challenging to sympathize with those who fall for them. This is particularly true since so many token traders describe themselves as degenerates and gamblers.

However, free market economic theory sees a long-term upside. A genuine Wild West like the ICO scene can be viewed as a process of education and toughening, with each loss serving as a lesson. It’s the exact opposite of the infinite bailout mentality that people dread in the current mainstream banking environment. In theory, over time, it should make participating individuals much smarter investors, ultimately resulting in a “safer” market than any regulation could impose–at least after a sufficient period of tough lessons.

That, at least, is the theory. ICOs are the financial equivalent of Darwinian evolution, gradually weeding out fraudulent founders and uninformed speculators. Perhaps the carnage of the ICO era made traders smarter. Perhaps over time, this radically free transnational investment market will become a global positive for humanity.

On the other hand, five years after its inception, the persistence of degeneracy and ignorance among crypto speculators can override that optimism. Regardless of the theory, real-world outcomes are difficult to dismiss–and as of right now, whatever their galaxy-brain promise, the actual results of the ICO free-for-all are not easy to defend.

Edited by Ben Schiller.