20 February 2019
Billionaire venture capitalist Tim Draper participated in the ICO of a blockchain platform called Tezos, which raised more than US$200 million in just two weeks. Photo: Reuters
Billionaire venture capitalist Tim Draper participated in the ICO of a blockchain platform called Tezos, which raised more than US$200 million in just two weeks. Photo: Reuters

Promises and pitfalls of blockchain tokens

Raising capital is a painful experience.

Whether you are raising early-stage seed funding or preparing for an IPO, nobody enjoys asking (begging) others for money to finance their business, with the numerous pitches, prospectuses and shareholder agreements.

It can usually take several months if not years to obtain the desired funding needed to build the business imagined by its founders. The Lean Startup or self-funded route is simply not an option for businesses creating the next generation of disruptive technologies. Talented engineers don’t work for free.

So, what happens if your promising technology idea and expertise are overlooked by angel investors, venture capitalists and your business isn’t mature enough for an IPO? Does it mean that your idea sucks? Well, yes, maybe, but sometimes these investment professionals might have simply misjudged your proposal. So then where do you turn? Kickstarter? Well, unless your business is consumer or hardware-focused, for example, shark drones, it might not be the best platform.

That’s when it might be worth considering a “token sale” — the process of funding the development of an application or business by issuing tokens through a blockchain platform such as ethereum to public or private investors in exchange for bitcoin, ether and in some cases fiat currency.

Since 2014, more than US$1.7 billion has been raised through more than 160 token sales by startups, technopreneurs and fund managers, with an average of US$10 million per token sale. The nature of these tokens varies greatly, as does the relationship between the token issuers and token holders.

Some tokens represent usage rights to the application that the technologists are building, others could represent stakes in new internet protocols. In both these cases, the token is effectively useless until the application is fully released, thereby inducing a high level of risk on behalf of the token holders. But this also forces similar pressure on token founders to deliver the application that these token holders have funded and maintained frequent communications on the project’s status.

The tokens that are most likely to irk regulators are those offering financial incentives to token holders promising “rewards” from the success of the application or directly describing them as ownership stakes (equity) in the entity (which might only exist on the blockchain) tied to the technology’s development.

The United States, Singapore and Canada have stated to varying degrees of detail that if a project’s proposed tokens fit the interpreted description of security, then the project’s founders should comply with existing securities regulations or apply for exemptions for their token sale through the help of legal advisors.

Hong Kong has yet to release any communications about the token sale phenomenon, but given that the Securities and Futures Ordinance has quite a broad definition of what a security is, it’s likely many token projects may fall within the Securities and Futures Commission’s purview.

Given all the uncertainties surrounding token sales, from their legal status to the risk that the promised application will never be delivered, it may be baffling to see the size and speed of these sales, with some projects, such as Tezos, raising more than US$200 million, and others, such as Basic Attention Token, finishing their sales in seconds. 

Yes, seconds. However, this demonstrates the appetite among a large crowd of technology enthusiasts to fund the development of new and decentralized protocols, which seek to challenge the inefficiencies and dominance of centrally managed internet services, such as Amazon, Google and Facebook through disintermediation and peer to peer networks.

Increasingly, the entrepreneurs looking to token sales aren’t exclusively technologists or looking to build blockchain applications. Instead, they have already founded a business, with working products and paying customers but see blockchain tokens as a more efficient way of raising additional capital from investors distributed globally instead of limiting commitments from those based locally.

The recent token sale of messaging app Kik is an excellent example of this. Even countries are recognizing the promise of token sales, with Estonia announcing its intention to issue its own cryptocurrency to fund the development of its e-residency program, becoming in effect a sovereign wealth fund on the blockchain.

In the coming months and years, as the token sale phenomenon matures, regulators will need to strike a balance between encouraging innovation and protecting investors through “IPO-lite” requirements designed to help real companies and startups access a global pool of capital. Serious entrepreneurs will need to ensure they don’t abuse the token sale hype, and only consider the process if it makes sense for the platform they are trying to build, or if they are that confident that angels and VCs have missed out on the next (decentralized) Facebook.

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Thomas Glucksmann is Head of Marketing at Gatecoin, a cryptocurrency and blockchain token exchange headquartered in Hong Kong. He has been working in the blockchain technology industry for over five years.

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