Noelle Acheson is a 10-year veteran of company analysis, corporate finance and fund management, and a member of CoinDesk's product team.
The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday, exclusively to our subscribers.
Our latest State of Blockchain report is a good read, full of original graphics, details and quotes that highlight shifts and market trends in the public and enterprise blockchain sectors.
But, one slide (pictured below) got me thinking...
The lack of funding announcements for ethereum-based businesses compared to those relying on bitcoin is striking, even when you narrow the focus to just this year.
It's also surprising, taking into account the overall positive market sentiment towards the blockchain platform (see our Spotlight Study), and it's worrying.
The business case appears to be there. Ethereum appeals to large enterprises, and startups are using it to develop decentralized applications (dapps) with interesting use cases. Most have a relatively clear path to monetization.
Given ethereum's business-friendly smart contracts functionality, why aren't more VCs nosing around?
Part of the answer lies in the graphic above: check out the box at the right. ICOs are initial coin offerings, or tokens issued by a dapp and offered to the public.
The participants in these crowdsales tend to be either potential users of the service, or investors who hope to re-sell the token on an exchange at a higher price. The trickle turning into a stream that you see in the list has not slowed down – in November alone, there will have been at least five.
Obviously, ICOs are a much more predominant source of financing for ethereum businesses than VC capital.
But why? And what does it mean?
- ICOs carry significant strategic advantages: The business retains its independence, does not have to give away any equity (though this depends on the type of token it uses) and has no outside interference in its board.
- The application in question gets access to an engaged community of users and investors. In a way, it efficiently takes care of the financing and marketing at the same time.
- ICOs are easier to pull off than VC investment, since the business does not have to run the gamut of vetting by analysts and seasoned investors. The "market" will decide if the idea is good or not.
- For many, ICOs may be the only option. VC investors are probably staying away from ethereum businesses for now because of the digital currency's relative youth. And The DAO hack as well as recent DDoS attacks on its blockchain will almost certainly have impacted their eagerness to jump into untested waters.
These compelling reasons highlight why ICOs are a good fit for young startups looking to harness a public blockchain.
However, they reveal an underlying weakness in the ethereum startup sector, one which could affect its development and sustainability going forward.
Let's take a look at the dangers hidden in those advantages:
- Less interference means less support, which means less "mature" management and experienced leadership. Startups that go straight to ICO will miss out on the benefits VCs can bring, including contacts, vision and expertise.
- The engaged community of users and investors is probably not in it for the long haul, and is not really interested in the health of the business. Users may end up dumping the assets if the utility doesn't meet expectations or if something better comes along. Token investors want trading gains more than they want profits (since they generally don’t get to share in those), and can exit any time.
- Relying on the judgement of the "market" for the ICO tokens as a barometer of sustainability is misleading, since it does not generally focus on the fundamentals. The product-market fit, long-term strategy and strength of the management team are secondary to short-term traction and cool functions.
- VC investment in ethereum is likely to pick up as the technology evolves. Unless, of course, ICOs become so entrenched in the market’s mentality that venture capital is edged out.
There you have one of the biggest risks to the sector: that it becomes addicted to the quick thrill of crowdfunding at the expense of future development.
The current focus on crowdsourced finance may be ideal for raising visibility and getting test models out into the market. It could, however, end up undermining the resources and the resilience of the industry of tomorrow.
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