Recently I came across an article by Jeff Lin, Principal of iGlobe Partners, on Wechat and was blown away by his the depth of his analysis and his unique perspective towards the inter-dependencies between VCs, and trends in ICOs across different regional markets. In this article, I will provide a partial translation of his article, supplementing it with additional explanations of the jargon used while injecting some of my personal opinions.
Cryptocurrencies and Initial Coins Offerings
Before we move on any further, I shall elaborate a little on cryptocurrencies and ICO.
Cryptocurrencies are a medium of exchange for peer-to-peer (decentralized) electronic cash systems, which utilizes encryption techniques to control the creation of monetary units. Fund transfers are verified via Blockchain. The first and most well-known cryptocurrency, Bitcoin, was created by Satoshi Nakamoto in late 2008.
ICO, an abbreviation of Initial Coin Offering, is a means of raising funds for a project, venture, or a decentralized application in exchange for other digital tokens. Its valuation is comparable to IPOs (Initial Public Offerings) on a stock exchange and crowd-funding initiatives. The only difference is that investors of ICOs receive digital tokens instead of regular equity shares.
Since the start of 2017, cryptocurrencies have been all the rage, sweeping through several major regions around the globe (excluding Africa and Latin America). Statistics have shown that there were only 15 instances of ICOs in 2015, whilst in 2016 there was a small monthly increase of 3.6 cases. However, there was a shocking swell in 2017, with 28.6 per month. Following this wave of passion for cryptocurrencies, several enterprises which failed to raise funds from VCs rebranded themselves through Blockchain and began raking in capital through ICOs. Yet, as cryptocurrency fever slowly fades away, early bird investors are stuck in a grimy mess, and those earlier institutional investors have ended up suffering losses in digital tokens following the lock-up period.
The once-touted prosperity offered by cryptocurrencies has inevitably raised the question of whether ICOs can serve as a financing alternative, and whether this might lead to VCs becoming marginalized. Should VCs follow the trend as well?
In the following paragraphs, we will look closely at the ICO trends in different regions and what to expect for the future of cryptocurrencies.
ICO trends in different regions
US and Europe
Constrained by fundraising regulations, most PEs are not allowed to invest in cryptocurrencies. Thus, most US GPs have gathered special funds or particular investment vehicles for token investments, as Sequoia Capital has done.
Through the optimization of company structures, many recent ICO projects in the US and Europe have facilitated early-stage investments for potential value-added investors. The approach? All Security Tokens to be released and Treasury Security Tokens in stock are recorded as assets on the company’s balance sheet. This allows institutional investors to invest in equity and thereby indirectly own some of the company’s Token assets.
Other investors can also share in the Security Tokens that a company sells through private placements in early rounds. By purchasing at a lower price and withdrawing from the Cryptocurrency Exchange, this act helps investors recover their investment principal. Additionally, selling residual shares from the company in the future guarantees a net profit.
These practices retain the enthusiasm of traditional VC investors to invest early in these companies (before ICO) because a company’s equity value is tied to the value of tokens held by company.
In a nutshell, what VC institutional investors look for when investing is an enterprise’s overall room for growth and the possibility of subsequent mergers, acquisitions, and listings. As a result, VCs have a continuous drive to help companies solve problems and improve corporate governance, which is a relatively benign business model.
On the other hand, the situation in Asian countries is quite different. With varied stances on cryptocurrencies, China and South Korea are amongst those with the most rigid jurisdictions. On the other hand, countries such as Singapore and Japan adopt more laissez-faire approaches.
In Southeast Asian countries, a majority of new token projects are publicly launched by the Singapore Registered Fund. Thanks to the convenient taxation rules and supportive governmental stance towards fintech, many lawyers have earned enough for themselves in the past 10 months following a repetitive process. Yet this breed a reluctance in lawyers to innovate and alter legislations. As a result, funding institutions aren’t able to offer protection or guarantees to individual investors.
From our observations, what Southeast Asian VCs have gained from ICO fundraising is quite limited, which can be explained with two reasons. Firstly, LPA regulations for funds serve as a deterrence for VCs to subscribe directly. Additionally, cryptocurrencies which are in demand are limited in supply. Unless one had boarded the bandwagon in 2017 when cryptocurrencies exhibited better performance, one has already missed out.
This stagnant situation is largely due to the overall low quality of ICO projects. It seems as though enterprises rushing for ICOs are simply trying out their luck. One noteworthy point is that when VCs don’t provide any value and simply show up at these events, it is hazardous to their own branding due to an evident deviation from their core business.
What to expect
In the long run, if regulatory measures can keep up with the rapid changes in the cryptocurrency trade, it is highly recommended that emerging Blockchain enterprises take reference from the approach taken in US, binding Tokens to companies’ balance sheets for equity financing. In such a case, it is worthwhile for early stage VCs to intervene. However, it still ultimately depends on the quality of the ICO projects. Purchasing and selling tokens remains a practical exiting strategy.
As an add-on to Jeff Lin’s recommendations on how traditional VCs and companies should react to ICOs, it is still too early to tell whether and how cryptocurrencies can tide over their current troubles and make their way into the financial system. As techniques for fraud and related regulations become more mature, it is fair to say that we expect there to be great things in store in this field that will open up a brand-new era for business.
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