When Bitcoin debuted, I was working at one of the largest financial institutions in the world. Like many others, we assumed it was some sort of novelty destined for the same fleeting fame as MiniDiscs and Pet Rocks. Boy, were we wrong. Today, I believe I’ll live long enough to see initial coin offerings supersede traditional initial public offerings.
While IPOs are experiencing a healthy 2018 (their most robust Q1 in three years), ICOs are quickly catching up. They raised $6.3 billion in the first quarter alone — surpassing the 2017 total and accounting for 40 percent of the IPO market. The meteoric rise of cryptocurrencies drew its share of scams, but ICOs like Ethereum and NEO prove the model can work.
While watchdogs like the Securities and Exchange Commission are scrambling to monitor the industry, the industry itself is maturing to escape legal purgatory and land firmly as a competitive alternative to traditional capital markets. The push to regulate ICOs has many worried, but they’re finding ways to abide by rules like the recent trend toward Regulation D, which allows for public offerings with limited registration with the SEC.
It’s not hard to see why a company would want to avoid an IPO for as long as possible, given the costs and ongoing reporting requirements. An ICO lets companies tap into capital without spending huge amounts of money and offers investors more liquidity.
The Shortcomings of Nasdaq
The walled garden of centralized exchanges limits direct access to larger institutions and forces many clients to intermediaries. These middlemen often have conflicts of interest and add costs and opaqueness. Additionally, limitations like geopolitical variables severely constrain market access.
Centralized players saw the writing on the wall and worked on blockchain projects themselves. Nasdaq and Citi, for example, announced Linq last year, a distributed ledger for their payment platforms.
Decentralizing the investment market benefits both companies and investors. ICO markets will be more transparent and less vulnerable to manipulation, and a wider pool of potential investors will be privy to opportunities. Unnecessary intermediaries are removed; costs are reduced on both sides of the equation.
Believe it or not, trimming all this fat doesn’t reduce compliance for anti-money laundering or know-your-customer rules. When managed and distributed correctly, an ICO scales quickly without error or counter-party risk. So investors get in cheaper, businesses retain more money, and more people can realize larger returns.
A Better Way
The lack of IPOs over the past three years has starved public markets for fresh blood. Though capital keeps pouring into the market, the amount of public companies in the United States has reached a 40-year low. In 1999, tech companies typically went public after four years; today, the average is 11 years. Regulations like the JOBS Act let companies gain far more shareholders before publicly disclosing financials. Perhaps that’s why unicorns like Uber and SpaceX have remained private.
Blockchain solutions and Regulation D alleviate such issues. Access is democratized on these open protocols. Thus, anyone with a website and blockchain address can access capital worldwide. The immutability of the blockchain automates the back-office distribution of these securities to reduce costs and barriers to entry for investors.
The fractional nature built into these blockchain-based assets (often to 18-plus decimal points) guarantees that almost anyone can afford to own at least a small slice of this new asset class — further democratizing access to early-stage investing returns.
ICOs globalize liquidity, but they’re not without problems. Early blockchain projects like Bitcoin and Ethereum quickly hit scalability issues, and only 15.5 percent of ICOs launched so far in 2018 had an alpha project ready for production, highlighting the risky early-stage investment.
Some also argue that the expense of mining cryptocurrency or the number of transactions that can be processed per second detract from the cost savings of running an ICO. Bitcoin, for example, costs as much as $26,170 to mine, and the energy needed to process a single transaction could power 1.57 U.S. households for a day. However, mining costs and power consumption are a red herring, as many protocols don’t require mining, such as XRP.
Newer blockchain projects like the Plasma layer or the Lightning Network are addressing other limitations, but it’s unlikely current public companies will convert in the near term.
Still, the future is clearly decentralized and tokenized. CoinMarketCap tracks over 1,600 cryptocurrencies; they’re learning to coexist with government regulators around the world. For every publicized Ponzi scheme like OneCoin, there’s a legitimate project like Circle, backed by Goldman Sachs and seeking a federal banking license (along with SEC registration as a brokerage and trading venue).
Pioneers are pushing through the paperwork and testing the real-world market to change how we source capital. ICOs were on the fringe two years ago, but in 10 years, they’ll be the new normal.
Bob Rutherford is the CEO and founder of Hedge, a complete software platform that allows traditional financial companies to offer digital currencies to their customers within the current regulatory framework. Bob has spent the past seven years in fintech at J.P. Morgan, Visa, Dwolla, and Carneros Bay Capital. Through Hedge, he’s building the next generation of digital currency custody, market making, prime brokerage, and trade management.
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