Numerous current examples exist where an initial coin offering or token crowdsale has been initiated with no real clear path toward true sustainability.
We are back to the dotcom days where simply including blockchain or cryptocurrency into a company’s name or business plan creates a illogical but euphoric sense of value in the eyes of the investing public.
Unfortunate as it may be, the reality of the amount of capital raised into token and coin offerings is not currently justified by standard business valuation techniques and practices. Such is froth.
Most issuers of new coins or tokens fail to consider more than the promise of some tie to the blockchain with their ICO. In reality, a truly successful token or coin offering includes implications for long-term sustainability of the token or coin. Ensuring such sustainability means considering the network ecosystem requirements of supply and demand, ensuring the token remains viable for what it is intended: a medium of exchange.
A Medium of Exchange
The struggle with many token or coin offerings is the lack of a true ecosystem which includes a medium of exchange for the token. What products or services are available through the company or existing (or future promised) network that a user would want to buy or sell? How are users interacting in a way that may potentially require disintermediation completely from a third part AND which requires monetary exchange?
Unfortunately most investors fail to understand the true requirement of finding and building a true market for the token. I would liken it to yesteryear’s Disney Dollars.
In the past, users of the family-friendly Disneyland resort could exchange USD for Disney Dollars, dollars that could be used within the theme park—and within the theme park only—to purchase goods and services, often at a discount. In a similar way, most companies issuing tokens or coins should be offering their tokens as a medium of exchange directly within the closed-loop ecosystem and network. Many fail to pass this simple bar.
Supply & Demand Economics
Not far removed from using a new coin as a true medium of exchange is the need for true supply and demand for the new currency. Token supply and demand cannot be fully controlled by network operators, but there are influential factors a network architect can employ to ensure long term sustainability. The best insurance policy against fleeting price in a token is creating a large network of willing participants, something we will discuss shortly.
While supply demand is often driven by a large and growing market, it can also be driven and controlled by perceptions and internal controls within an ecosystem, managed by token governance and smart contracts. The truly brilliant will understand that slowing the outflow of tokens and creating incentive and reward pools for members of a community can have the effect of both increasing the price of a token and creating a viable long-term ecosystem for a given market for that medium of exchange.
Another issue with most token or coins is their application does not directly relate to the functional tie to the blockchain. For instance, I have seen blockchain-enabled medical records companies issue token and coin offerings, touting the company’s issued coins could be used for such things as travel,
When there is a rewards-based ecosystem that token will perform best when the rewards are tightly tied to the functionality of the technology. When such a tie is indirect, the reasoning for individuals using the token and thus creating a natural network effect and ecosystem greatly diminishes. It’
Network Growth Difficulties
Mitigating the investment risks of a token or coin offering includes seeing the need to find opportunities with large, existing network effects. One of my biggest concerns with many of the available offerings that exist in this new and expanding marketplace is not only the lack of use of traditional regulatory frameworks and rules, but also the lack of existing market traction for many of the proposed applications.
Most offerings are promising the future potential of a given distributed ledger application, with no real existing traction, traffic or an ecosystem. Such an network ecosystem is perhaps the most crucial element in creating proper market demand and a network for using a token or coin as a medium of exchange. A network also helps to more clearly define the token-function alignment in the products and services exchanged on a particular platform.
On the other hand, if such a network of promise raises enough capital in an ICO or token offering, the potential of failure in eventually garnering and maintaining a viable network diminishes. However, it is still not complete mitigated. Beware of promises of sourcing and growing a new network of participants post-ICO when one does not already exist. In my mind, this is one of the largest red flags to any such offering. The questions to ask:
–What is the existing market regularly using the product?
–Is there an existing product?
What is stated here is not meant to be investment advice, particularly when it comes to any single offering or opportunity. In contrast, it should act more as a voice of warning against unscrupulous offerings promising blue sky opportunities without any existing traction or network in the market in which the business operates.
Nate Nead is an investment banking and corporate finance professional, specializing in mergers and acquisitions for software and technology companies across the United States. He has worked with numerous business in accessing growth capital toward a meaningful exit in strategic M&A. He resides in Seattle, Washington with his family.