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The article is penned by Charles Ehredt. He is an entrepreneur, investor, and works for Greenlabzmedia. He loves to talk about emerging crypto firms doing their ICOs and can be contacted on [email protected]
I do not generally hang around with crypto-currency enthusiasts, so the increased frequency of discussion about ICOs, Bitcoin, and Blockchain has been quite surprising to me – especially over the past 30 days. I´ve even had longtime friends who work in traditional industries call and ask for a primer on crypto-currencies because they ´want to get in on the craze.´ This is a pretty good sign that dumb money is being gambled by people who just want to get rich quick (with minimal effort).
During the past 40 years, I´ve studied economic bubbles as far back as the Tulip Mania bubble in Holland during the 1630s, witnessed first-hand the Dot Com bubble, and seen 2 significant economic bubbles – that led to global recessions. My objective with this article is not to explain how or why economic or pricing bubbles occur (you can find that here or here), but rather to suggest why many characteristics of the current ICO market look to me like a bubble.
Are ´bubbles´ bad? That depends on whether you are one of the last people to get involved, how much of your wealth you have exposed, and how you prepare to protect your downside. At a minimum, don´t borrow money to chase a bubble.
Let me also say that much of the $700B in Market Capitalization for blockchain-based crypto-currencies has been created with less than $10B of fiat currency (traditional money issued by a central bank) flowing into the crypto-currency market. Therefore, much of the ´paper profit´ that has been created did not come from people´s life´s savings, but rather is the result of escalating prices for an increasingly broad number of crypto-assets.
In such a scenario, someone could claim to have lost $2M worth of value in their crypto-asset portfolio, but that person might have only had $5,000 (real dollars) invested in the first place – and it grew (“on paper,” or in a more modern sense “in bytes”) to $2M before it crashed. In reality, such a loss is not $2M, but rather $5,000 – even if the market does not rebound.
Finding Investors has been hard work
Over the past 20 years, I´ve created 12 companies as an entrepreneur – and in many cases, I had to go find investors who believed in my business idea (enough) to give me money to finance the business. Finding capital for new business ideas has been going on for over 500+ years (the King of Spain financed Columbus´ adventure to America). Finding investment capital is really hard work because you need to find, and then talk to dozens (or hundreds) of people in the hopes of convincing a few to give you their money in exchange for future dividends.
ICOs are a great method of raising money for a business idea (or business expansion) from a worldwide audience in a manner that is far more efficient. For that reason, I believe ICOs are here to stay and will even grow much more prevalent over time.
ICOs still represent the Wild West
To help protect common people (investors) from cleaver entrepreneurs who might not have the investor´s best interests at heart, governments have created agencies to apply lots of rules so the investors don´t get deceived about the real business opportunity. The United States Security and Exchange Commission alone has 4,300 employees trying to protect average US citizens from deceptive practices.
There are almost no people in the world today trying to help protect the millions of people who have recently started investing in crypto-currencies (beyond a few jurisdictions that have simply made ICOs illegal). And, because many people (teams, companies ??) conducting ICOs cannot easily be tracked down and held accountable, it is fertile ground for someone to publish an interesting whitepaper about a business idea to see how much money they can get from others – even if they have no real intention of building the business.
Having said that, I do think the vast majority of whitepapers are published by people with a sincere desire to implement their business idea. Whether they have the talent, determination, and experience to achieve their goals is a completely separate question. Whether their business attracts paying customers and therefore could turn a profit is another question. And finally, whether competition and other market conditions favor the business idea and lead to a successful venture is even harder to determine. Time would tell on all these questions, but since the investor has to fork over their money at the beginning based mostly on the ´idea´ and cannot get their investment back if things don´t go as planned, this is kind of important stuff.
Businesses normally fail – so be prepared
I personally don´t think most people running ICOs are as experienced in business as the entrepreneurs who have been raising Venture Capital over the past 40 years, but for the sake of argument, let´s say they do have equal experience. The odds for a Venture Capital backed business to survive 3 years is less than 50%. The odds for any new start up to survive 5 years are less than 10%. Therefore, even if the ICO entrepreneurs are as good, the probability that the business linked to the coin/token still exists in a form similar to that described in the whitepaper after 5 years would be less than 10%. The coin/token is likely to still exist on some blockchain, but the administrators of it will likely have moved on to some other innovative, entrepreneurial endeavor.
Investors in ICOs should assume 90% of the things they invest in will turn out to be worthless – but hope that across their portfolio of 20-30 investments, 2 or 3 of them are quite successful – and the benefits from this minority more than make up for the losses elsewhere. That is the gamble that thousands of Venture Capitalists make every day – and I don´t think we should assume ICOs will perform any better.
In fact, I´m fairly certain that ICOs will fare much worse than Venture-backed businesses.
Does that mean that we should not invest in ICOs. No. I am a huge believer in innovation and that young, nimble companies are the best at creating new products, services, and markets. About half of the companies on NASDAQ did not exist 30-40 years ago. These huge, newer companies that have generated huge enterprise value were once a start up with 3-5 team members.
If 40 years ago, you could have selected Microsoft, Oracle, Dell, Amazon, and a few dozen other companies for your stock portfolio, you would be rich. If you chose Netscape, Broadcast.com, Info-Space, TheGlobe, or Altavista, you would not have done so well. In fact, 99% of companies started two or three decades ago no longer exist.
Keep in mind that Cisco, Amazon, Pricline Group (Booking.com), and Expedia (that are quite valuable today) did lose about 90% of their Market Capitalization when the Dot Com Bubble burst. But they were solid companies and they rebounded. If you bought their stock in 2002, you would also be rich today.
It is often the second generation around any new wave of innovation where the majority of king-makers are born. Certainly, some of the ICOs from 2017 are going to do great – but which of the 885 ICOs in 2017 are you betting on? I will bet that 800+ of them are not around in 3-5 years. In fact, some of the crappy business ideas I´ve seen in whitepapers from 2017 would make an experienced investor cringe.
But 2018 is a new year, there are now professionals reviewing ICOs and opining on the prospects for the underlying business idea based on the assembled team, traction in the market, and size of the addressable market. This is a big step forward – if you believe these ICO analysts have the relevant experience and are not just trying to fuel the ICO hype.
In my opinion, the quality of whitepapers and business ideas has matured tremendously in the past few months. There are still many ambitious projects with very low probabilities of success – or even if the technology project itself is successful, there is no waiting market willing to pay for the services – but I think a selective investor has a better choice of opportunities now than just a few months ago.
A diversified portfolio includes some ´safe havens´
I also think that even if the bubble bursts, there are ´Safe Haven´ tokens/coins that will ride out any market decline and rebound not only to today´s price levels, but possibly grow much higher.
Digital payments via crypto-currencies is here to stay. This is a mega-trend that no governments are going to be able to curtail (entirely). The convenience for real people is just too great, and the potential cost savings for merchants in not handling cash can be tremendous. Furthermore, in spite of the fact that governments exist in large part to protect us, they are also rife with corruption. Not necessarily the employees that administer government agencies, but the politicians – that if not financially corrupt are increasingly morally corrupt – in that they will say or do whatever it takes to get re-elected. For that reason, crypto-currency ownership can be a hedge against government-issued money that is certain to be devalued over time through inflation in order to reduce the burden of growing government debt worldwide.
So, if I had $10,000 to invest in crypto-currencies, I would put about 35% in Bitcoin and Ether because they will certainly survive a bubble. I would put 30% in companies that had a ´purpose/mission´ I believed strongly in, and I would put about 35% in companies that operate a token/coin with high utility (like loyalty points or a payment currency).
Moeda Loyalty Points ran an ICO last summer and their $1 token has consistently been trading in the $3 – $4 range. They raised about $19M in a matter of days because the crypto-currency has high utility, the team is solid, and the mission is both appealing and clear. What they did not have was an existing business (but I believe they will build what they said they would and be successful).
Another example is EZToken from EZSolution – which is also a loyalty crypto-currency. They completed their first ICO round on January 1st 2018 and sold 1M tokens in less than 2 minutes. They will sell another 3M tokens on January 8th, 2018 and hold a 3rd round later in January. They have a solid team, are far along with the development of their technology, but the most compelling reason is because they are adding EZToken as their Loyalty crypto-currency – to an existing business with 10,000+ merchants already using their Point of Sale payments system. This means there is already a huge installed base of businesses that will get significant, instant utility out of the EZToken. Customers and investors can actually spend it. This is real utility.
As suggested above, if there is a correction in the pricing levels for ICO tokens, all crypto-currencies are likely to suffer, but those associated with the weakest business models will collapse and probably never recover. This type of market cleansing is important – so that the strongest survive through various waves of innovation. But those currencies with the greatest utility will decline less; and, they will be the fastest to recover.
So, are we in a bubble?
Dogecoin now has a market capitalization of over $1B. Remember, that this coin was created as a joke. It is not useful for anything – yet more people are buying it than selling – so the price keeps climbing. When people buy junk, it is a strong indicator of a bubble.
Will people lose money? The last people into crypto-currencies will lose the most, but I hope for the majority of investors, any losses are simply declines over the highest level their portfolio reached – and not life-changing losses.
Are cryto-currencies here to stay? Yes. If they represented a scam, the Chicago Mercantile Exchange and other futures exchanges would not be building derivative products around crypto-currencies, and hedge funds (usually the “smartest” money) would not be investing. These actions show that crypto-currencies are maturing and represent an investment class of assets.
In such a scenario, I would invest in tokens/coins that have real utility and a type of safe haven during periods of high volatility – like EZToken, which is meant to be a global loyalty currency for people´s everyday shopping. If utility tokens like EZToken continue to be as popular with consumers as they have been with investors, this everyday use will provide a great price support and we should expect to see appreciation over time. Furthermore, if you hold EZTokens or something similar, you can use them at thousands of merchants to buy real products and services.
I would also NOT just ´plan´ to migrate from my risky tokens to safer tokens when the bubble bursts – because the level of volatility in the market will be so great that the crypto-currency exchanges themselves are likely to shut down for hours or even days. These exchanges are all ´for-profit´ businesses and the last thing they will want to risk in a market collapse is holding a lot of coins that nobody wants. Therefore, once a correction starts, it may be next to impossible to unload your tokens until after they have already lost 60% to 80% (or 95%) of their value. You need to have some safe haven currencies in your portfolio already.
ICOs will actually change the world
2017 was an amazing and unexpected year for ICOs. The hubris seems to be producing a bubble, but a healthy correction will simply cleans the market so that it can get stronger. A lot more value will flow into crypto-currencies over the next decade and I actually think 2018 will be at least twice as vibrant as 2017 because in spite of the dramatic increases in volume last year, most people have only been dipping their toe in the water. As we all get more comfortable with digital currencies, and crypto-currencies become increasingly useful in our everyday lives, the toe-dipping will lead to a massive migration of funds to buy the most interesting and useful crypto-assets.
Furthermore, if the idiocy of the Trump administration does not turn out to be the biggest story of 2017 (which I sincerely hope this topic dies away), then the big story of 2017 in the history books will be the advent of ICOs – as a new model for funding innovation. The implications for the next 10-20 years are just tremendous, much like the advent of the Internet itself, or electricity before that.
I have invested in 23 companies as a Business Angel investor. To find those 23 investments, I evaluated nearly 3,000 startups. That represents many thousands of hours of my life searching for excellent investment opportunities. The ICO phenomenon represents a much more efficient way to find investment opportunities – but we still have to be very selective to avoid the 90% +/- that would likely fail regardless of how they raised money.
The final thought as I sit in Barcelona thinking about crypto-assets is that I´m actually not where the action is. Americans and Europeans like to think they are the economic and innovation leaders of the world. But the epicenter for innovation around customer-facing technologies and financial services for the mass market is actually in Southeast Asia. That region might seem far away for many people reading this article, but that is where the most innovation is taking place and where crypto-currencies are most rapidly being put to use. The companies learning in Southeast Asia will get smarter faster, evolve faster, and find the pools of profit faster – so I would look for investment opportunities there first. And, for investors, buying a crypto-currency in Vietnam or Singapore is just as easy as investing in Silicon Valley.
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