A nice write-up by Mr Arthur Hayes of Bitmex:
In Defence of ICOs
The ICO mania elicits strong emotions from many market participants. Digital currency industry insiders and outsiders heap a constant stream of invective upon the ICO industry. While I believe the majority of ICO issues are worth close to zero, I do not dismiss the importance of this new mode of financing. In fact, I like many, believe the ICO phenomenon is part and parcel of the move to democratise financial services.
Professional Money Managers
The asset management industry comprised of hedge and venture capital (VC) funds began in earnest in the late 1960’s and early 1970’s. Labor’s victory over capital produced high union membership and demands for pension schemes in the public and private sector. That produced huge pools of investible capital worldwide, and especially in America.
In 1971 Nixon untethered the greenback from gold, and began the government issued fiat money bonanza that is still with us today. Alongside that, advances in technology produced the first commercial mainframes, which transformed financial markets and birthed many of the technology companies still in existence today.
Professional money managers were needed to allocate the vast amount of capital now available. Due to the large amount of dry powder available, VC investors could invest in companies with unproven technology and no operating experience. Traditional banks would never loan to such outfits.
Proliferation of VC funds helped provide funding for most of the technology that we enjoy today. VC funds take an extreme amount of risk, and the successful shops are rewarded with amazing returns on investment.
The vast majority of the world cannot invest in a technology firm before the company goes public. VC funds only take investments from large public or private pension funds, and or very wealthy individuals. The public markets previously were the only place regular individuals could invest. Once a company is public, the risk is lower and so is the return.
A large percentage of the world is financially repressed due to low interest rates. The scramble for yield has pushed valuations to extreme levels for private and public companies. Many small and medium investors want to get in on the VC game, but cannot due to regulations and access. ICOs will change that.
ICO or VC Funding?
Why would a talented team choose to ICO their product over selling equity in their company to a VC?
Speaking from experience, raising money is a full time job that distracts key members of a team from producing a good product. Most VC investors are sheep, which is why most firms lose money. They will only commit capital to fashionable sectors or business models. Career risk prevents most managers from taking bold risks. If you lose money with everyone else, you keep your job. If you lose money alone, you’re out on the street. If your product idea or business model is not sexy, you will not receive funding.
The ICO process is much simpler and generates more publicity for a product. Instead of selling equity in the company producing a piece of technology, the ICO sells an interest in the usage of the product itself.
Your intended user base can now own a piece of the product. That not only incentivises them to use it, but to tell others about it as well. Contrast this to VC funding, which generates a nice blurb on DealBook, but your target consumer is no more incentivised to use or talk about your product.
Because subscription for the ICO and distribution of the tokens is completely automated, it removes the investment banks from the capital raising picture. Investment banks typically charge between 3% to 7% of a traditional IPO’s deal size as a fee. That does not include payments to the hordes of lawyers needed to launch a deal.
Security or Token?
Breaking securities laws in many jurisdictions will land you in pound-me-in-the-ass prison. That is why teams issuing ICOs structure their tokens so they will not be construed as a security.
It is a token because it derives its value strictly from usage natively in an application(s) or protocol. Without properly functioning technology, the token is fairy dust. There is no ownership in the company producing the token, nor any income stream.
By lowering the barriers to obtaining funding, the masses can now participate in early stage and risky technology projects without the need for traditional gatekeepers. No gatekeepers means no fees to underperforming asset managers, banks, and most importantly regulators. Some governments will embrace ICOs, many will staunchly oppose them.
Swiss regulators are becoming relevant again by blessing the token structures of many high profile projects. However, the spineless Swiss turned rat on Americans with supposedly secret bank accounts. If the jealous American regulators start actions against high profile projects blessed in Switzerland, will the Swiss stand up and fight, or kiss the ring like they have in the past?
Teams should polish up on their soap handling skills, for some might spend a few nights in Rikers.
Shitcoin or Supernova?
Armed with a slick website, any two-bit charlatan can seduce money from desperate investors from the comfort of their parent’s basement. Early stage technology projects are inherently extremely risky. There is no proven market or use case for many of the projects coming to market.
The vast majority of tokens are worthless. However, diversification is prudent. If you hit one Ethereum, you can stomach many DAO’s.
The question is how to choose which projects will survive. The need for an expert opinion to help retail investors wade through a sea of shit will be needed. Firms that proport to conduct “research” will begin to produce ratings on projects they deem likely to survive. Many former tech analysts at banks and traditional research houses will transform into ICO analysts.
Hot or Not?
An ICO trader’s time horizon is in a matter of months. If they can get an allocation of the hot deals, they can easily flip them quickly for 50x to 100x returns.
During that time span, it is very difficult to surmise if the project will obtain mass adoption. The success of this strategy depends on a trader’s read on market sentiment, and access to favorable terms on deals.
For those who can’t feel the market well, lengthen your investment time horizon. The gyrations of the price during a less than 1 year time horizon are irrelevant if the technology is actually mass adopted.
Doing actual analysis and engaging in critical thought makes you more of an investor than a trader. Successful investors will hit 10,000x return jackpots over multi-year time frames, that traders would have exited at 100x within a few months.
Insider Trading
Being a successful trader means that you have better information and or access than the majority of the market. The digital token trading markets like traditional forex markets are not regulated, and will struggle to be. Therefore, if you can’t stomach insider trading, then don’t take on short-term positions.
Digital currency influencers and insiders are given discounts or guaranteed allocations so that they will publically lend their name to a project. Sometime exchanges are paid to list certain ICOs on their secondary markets. In other instances, exchange principles acquire a coin OTC, then list it on an exchange they control. Then they dump the shitcoin on unsuspecting newbie traders.
The existence of insider trading does not detract from the usefulness of ICO financing. The digital currency markets are the purest and freest form of trading available today. That is why I love working in this industry.
If insider trading were allowed in all asset classes, price discovery would be continuous. Otherwise the minority that trades using inside information earn above average returns because the plebes are stuck watching Jim Cramer for investment tips.
Onwards and Upwards
Unleashing the power of the 90% of the world’s population that is not served by the traditional financial services industry will be a chaotic experience. There will be booms and busts. The current exuberance borders on manic, but I wouldn’t short it.
The age of the expert is waning. Succeed or fail, adults are making free and clear decisions about how to allocate their precious wealth. If you don’t like it, I hear Bernie Madoff has a nice regulated vehicle open for investment.
It also wants “Enjoyment of the wild startup rodeo. Yee haw!” and most curiously of all, “Total Industry experience myst be 8+ years” (sic). As well as all that, it wants someone with “experience in trade finance, equities, payments processing, wholesale credit”.
