Initially, ICOs were performed through a Decentralized Autonomous Organization (DAO) that placed investors in full control of the funds with the most famous being the Slockit DAO that proposed, among other things, an innovative and breakthrough new business model.
Unlike in a simple crowdsale, the idea was for investors to became the CEOs and board of directors, in charge of the project by giving the green or red light to proposals on how funds are to be spent.
That concept, however, has seemingly been shelved after the Slockit DAO was hacked last summer, with ICOs now little different than an ordinary crowdfunding as far as the funds themselves are concerned.
Although the token aspect does add new dynamics, most ICOs are now undertaken by sending eth to a simple smart contract address which is fully controlled by the project developers. They can therefore simply withdraw the funds once the sale is over and use them as they please.
That means there is as good as no accountability regarding how the funds are to be spent, with the question of any legal liability being uncertain at best. Moreover, if projects abscond with the funds there is little anyone can do, except for law enforcement which is already very stretched with many other perhaps more serious matters.
The ICO Conundrum
A solution to the problem isn’t obvious as the available options aren’t very appealing. If projects put a cap on token sales, for example, there’s a bot race scooping it all up in seconds as they did with the BAT ICO.
That’s because the cap distorts the relationship between supply and demand, so once the token hits exchanges and that relationship is restored, the bot owners may turn huge profits as supply becomes available to the unmet demand.
Projects therefore have seemingly started increasing their caps to huge sums of 300,000 eth or more to better meet demand, but since most of them are start-ups with hardly any market share and a fairly high risk of failure, questions arise regarding how such funds are handled.
Concerns range from the obviously criminal absconding with the money – like some projects may have done – to the more complex question of accountability. Who is to prevent all the participants in the project from buying a lambo, for example, sending all the money down the drain?
And even if developers can be trusted to use all the funds appropriately, what is to incentivize them to achieve the best result once the ICO is over since at that point they have already received the rewards.
They are basically being paid upfront on a promise to deliver a product or increase its market share with little if anything to keep them accountable or to motivate them towards achieving the best result they possibly can.
At $1 million, $5 million or even $10 million, that would probably be fine, but at $100 million, without any significant user base or substantial revenue, the available ecosystem funds aimed at lifting up start-ups may become too concentrated, with risk becoming too concentrated too.
For example, if there are 100 projects, 90 of them go under while 10 of them become successful, everyone would benefit. But how will four projects return on an investment of nearly half a billion and where is the risk diversification here?
The incentives are somewhat distorted by the fact that project tokens can themselves increase or decrease in value. So investors may be moving in a heard, with all of them wanting one token not necessarily because of any fundamentals, but in the hope that it will increase in value once it is listed on exchanges.
Traditional VCs do not have that option initially, with most of them striking it lucky if their investment eventually IPOs. With tokens, the investment and the IPO occur around the same time, thus the incentives change.
What the effects of that will be remains to be seen, but many would feel more comfortable if a DAO like sale with a cap of $10 million was implemented to allow us to experiment with a new business model where investors retain the funds throughout and in effect become the CEOs, thus keeping projects in check and incentivizing them to perform their best so that the investors can release more funds.
That would prevent the risk of absconding, or the use of funds for lambos, but on the other hand it runs the risk of being hacked – even though at $10 million that risk might be acceptable to see how the experiment runs out – and of course developers would probably rather receive the funds upfront than have to account to investors and keep asking them for money after showing progress and achievement.
So developers might not volunteer such ICO until, perhaps, they are left with little choice as the SEC may eventually consider the appropriateness of raising such huge sums through an ICO.
On that point, there is one thing to be said on top of what’s covered above. Most investors that find their way to an ICO are probably experienced investors, especially if the sum invested is substantial. The rest are probably sending small sums of maybe less than $10,000.
That’s because considering the complex nature of this space it is unlikely some helpless grandma has found their way and decided to invest their life savings on a very risky ICO. Instead, most are probably well earning tech and finance professionals.
If they want to take the risk perhaps they should be allowed to until this space develops further and we gain some better understanding, but developers do have a duty to be responsible as they are operating in a grey area.
That means they need to take great care to behave in a manner a reasonable observer would say is appropriate, as otherwise even the application of old laws may be appropriate if project leaders act irresponsibly.
Because we do want innovation, but we can’t ignore human nature, so there needs to be a debate on how best to balance all the considerations to achieve the optimal result for all parties concerned.