Be Careful of What You Wish For: Token/ICO Edition

I have written several posts on token sales and ICOs already, including some “Thoughts on Regulating ICOs” and  “Optimal Token Sales.” With the continued fundraising success of new projects, here are some observations on investment terms and their potential implications for achieving successful outcomes.

Many projects these days have a private fundraising event that precedes any public token offering. These take varying forms, including investments in corporations and some type of SAFT (Simple Agreement for Future Tokens). Fueled by a lot of demand, the terms of these raises have become more and more project friendly. 

Now at first blush that might seem great, but there is an adverse selection problem that is much more severe for protocols than it was for traditional startups. Why? Because in a traditional startup, if I get shut out as an investor I may never make it in and so strong investors may “hold their nose” at bad terms. With a protocol though there will be a public token sale event and eventually a public token altogether, providing more flexible entry opportunities than in a traditional startup. That in turn means that if the early private terms are not appealing the mix of investors will rapidly shift to lower quality investors.

Now you might still say: who cares about the investors? It’s all about the project creators in any case. And that is likely true once in a while. But overall the initiators of many of these projects are inexperienced when it comes to building an organization, allocating resources, dealing with adversity and so on. The kind of things your early investors and advisors can help you with, if they are good. The evidence from traditional startups that have done “club rounds” as their seed round, with many investors piling in, none with a meaningful equity position and hence skin in the game, suggests that difficult questions often remain unresolved.

I expect that we will unfortunately relearn this same lesson on many projects currently being funded via token sales. It will be fascinating to see how well some of the projects that have recently raised tens and sometimes hundreds of millions of dollars do with putting that money to work sensibly and as they encounter the need to make tough decisions. My sense is that outcomes here will be influenced by the strength of the extended team, including early backers.