ICOs created a big stir on the financial market in 2017, and they continued their tremendous growth in 2018 with hundreds of new tokens being issued monthly (literally!). Though market growth is quite visible, the more interesting question here is: what happens to tokens after the ICOs, and do investors actually hold them until the project goes live? Unfortunately, the answer to the last question is “no, they often don’t.” So, how many tokens are there and what should be done to give them more utility?
Too good to be true: the ICO market is growing rapidly
Let’s take a quick look at CoinMarketCap – there are about 1,930 cryptocurrencies listed here, with a total market cap almost reaching $200 billion (as of September 11th, 2018). Impressive, right? Despite the fact that this resource is among the most reliable when it comes to crypto, the picture it creates could actually be misleading. CryptoCoinCharts, for example, lists over 4,600 cryptocoins. So, where are all these coming from?
ICObench, one of the largest ICO listing platforms, has over 4,300 ICOs listed since 2015. ICO Rating’s ICO Market Research Q2 2018 claims that 827 ICOs were launched in the second quarter of 2018 with $8.4 billion funds raised in total, and over half of them (55%) failed, leaving us with 370 successful ICOs in the quarter.
The average supply of tokens for one ICO exceeds 1 billion (this is based on the analysis of the last 30 projects listed on ICOwatchlist, excluding three outliers – projects with over 20 billion tokens issued), which turns into at least 370 billion tokens sold in just three months!
42.5% of the tokens issued were service tokens (those that are used as the internal currency to pay for project services and are replaceable with other cryptocurrencies, such as ETH, without detriment to the product) and 35.4% for utility tokens (tokens of the protocol itself that are also used as a payment for the product), meaning that investors bought about 290 billion tokens used as internal currency in total.
And this is where the problem comes from – just 15% of ICO projects had their business actually running. In fact, over half of all projects just presented the idea, which surprisingly had no effect on their fundraising success! Using the failure rate for the whole sample as a proxy for projects in operation already, we can assume that 56 ICOs with a running business managed to reach their fundraising goals, and only about 56 billion tokens can immediately be used by investors. What does this mean? Simply that people are continuing to buy tokens to get access to products and services, despite the fact that most of the projects still exist only inside their founders’ minds. Why does this happen?
“More is not always better,” especially if it has no utility
Launching a token may sound scary, but it can be as easy as starting up your own social media account. Though you may need to go deep into coding and even find a team to develop your own blockchain, there are much more simple ways for less ambitious tasks. There is a variety of guides to launching your own token on the Ethereum platform in less than half an hour, including the one prepared by Moritz Neto, the co-founder of Tenzorum, and an another alternative on one of our previous articles.
The important thing to keep in mind when issuing a token is regulation. The process may be easy from a technical point of view, however, no one wants to deal with regulators declaring their ICO illegal. Though the topic is still being actively discussed around the world, rules seem to be slowly softening. In the USA, for example, the SEC Chairman declared that every ICO is a security back in February 2018, which implied that all digital tokens issued must be registered with the SEC. However, the situation has been slowly changing since then with both Bitcoin and Ethereum admitting to not meeting the security definition. Currently, the Howey test is used to identify if ICO tokens fall into the respective category – and if they don’t, SEC registration is not obligatory.
There were no ICOs registered with the SEC until March 2018, when the Praetorian Group officially filed for registration of the PAX coin (the company is currently waiting for approval). In addition, at least 18 projects completed offerings using exemptions from regulation in Q2 2018, which is a good sign for the whole industry.
The technical simplicity and legal availability turn into a problem – the majority of ICOs is launched for projects that are in the pre-seed stage in order to fundraise the development of these projects. This basically means that at the moment of an ICO, as well as during the development phase, tokens have no utility since the protocol on which they will be used does not yet exist. As Howard Marks, the CEO at StartEngine and co-founder at Activision/Blizzard, says, “The use case of the tokens is hypothetical, and there are no guarantees that the utility will ever exist in the future apart from the promise of the individuals working on the project. And a promise is not a guarantee.”
These are not just words full of air either. According to Token Report, just under 1 in 10 post-ICO tokens are actively used (excluding Ethereum). In fact, many of them are gone from the wallets of ICO investors in the first few days after token distribution. Alex Svavenik, the chief data scientist at CoinFi and founder of ICOWhitelists.com, shared retention cohorts for several projects on the market: it seems that token retention rates (the share of ICO participants who still hold their tokens in the wallets) quickly decreases during the first days after tokens have been unlocked and distributed, ranging from about 45% to 83% 15 days after.
These results can be explained by the fact that many investors use tokens for trading purposes. “With ICOs, investors purchase tokens that can immediately be traded on crypto exchanges from anywhere around the world. As an investor, I could buy a token for $1 in the morning and sell it at $1.3 in the afternoon,” says Howard Marks.
However, listing the token is not as easy as it may sound. In fact, according to an ICO Rating report, only 7% of all ICOs announced in Q2 2018 were able to be listed on the exchanges, compared to 22% in the previous quarter. This may be explained by stricter exchange rules and high listing costs for some of the exchanges. According to an Autonomous Next study, “The market price to list a crypto token is $1 million for a reasonably regarded token, to $3 million for an opportunity to get quick liquidity.” Let’s take a look at the list of exchanges on CoinMarketCap. HitBTC, the largest exchange in terms of number of markets served, lists less than 800 cryptocurrencies – IDEX, one of the leading decentralized Ethereum exchanges – has less than 500 (as of September 6th, 2018). This means that those token owners who are not familiar with professional trading and have no intention of selling their tokens are stuck with no utility until the project goes live. And that’s definitely a problem for the market as a whole.
How to give tokens more utility?
The utility problem could be addressed from different perspectives. The first one is replacing the ICO with an alternative fundraising method, such as a Security Token Offering, or STO. An ICO and STO are similar in their general principle of selling tokens to the crowd, however, security tokens derive their value from tradable assets and are bought by contributors who anticipate future profits in the form of dividends, asset value appreciation, etc. Tatiana Koffman, Chief Token Officer at FullCycle Energy and asset tokenization evangelist, explains in her article that security tokens “can provide financial rights to an investor such as equity, dividends, profit share rights, voting rights, buy-back rights, etc. Often these tokens represent a right to an underlying asset such as a pool of real estate, cash flow, or holdings in another fund.”
STOs require legal compliance apart from technical knowledge, meaning more hardships for project founders. They do, however, provide more governance and transparency to the market and may help crypto enthusiasts and regulators finally find a common language. The utility problem is automatically solved for STOs – it simply does not exist for securities. However, given the current market trends, it is unlikely that traditional ICOs with utility tokens issued will be replaced any time soon.
Kyle Samani, the Managing Partner at Multicoin Capital, describes the alternative models for utility tokens that allow for the reduction of token velocity – calculated as the total transaction value divided by the average network value, reflecting how fast the tokens circulate in the ecosystem.
The velocity problem is discussed in detail in a separate article by Samani using the example with ticket sales in the blockchain. The idea is that token mechanics for some projects is simply not structured in an appropriate way for the token to appreciate in value. In case users have no incentives to hold tokens and find it more beneficial to exchange them quickly for a product, fiat, or other cryptocurrencies (meaning that token velocity is too high), there will always be an excessive supply of tokens, so there is no reason for investors to hold them either, as appreciation is not possible.
He also suggests different models to make utility tokens more valuable by reducing their velocity. We will describe one of them as an example – a work token model. The pioneer of this model is Augur, a decentralized oracle and prediction market protocol. In the work token model, any token holder can become a service provider who does work for the network and is paid in proportion to the number of tokens it stakes.
Lets explain it in the context of the Augur business model. With Augur, users can trade or gamble, trying to predict the outcomes of future real-world events (e.g. “Will SpaceX successfully compete a manned flight to the International Space Station by the end of 2018?”). Reporters (service providers in this business model) report on the winning outcome of the event after it occurs by staking their native Augur tokens, REP, onto one of the market’s possible outcomes, thus declaring that this particular outcome matches the real-world one. Other users are able to dispute the report in case they don’t agree. By owning tokens and participating in accurate reporting, token holders do work for the network and are entitled to a portion of the fees on the platform. The more REP reporters own and report correctly with, the more fees they can earn. In this case, there is a positive linear dependence between the demand for tokens and their value – given the fixed supply of tokens, in case the demand for them grows, “service providers will pay more for the right to earn part of a growing cash flow stream,” as Samani said.
Alternative models may encourage users and investors to hold tokens issued until the project goes live, as they are more confident in their value; however, new models don’t give these tokens utility during the waiting period. So, something else is needed.
But what exactly is it?
A New Infrastructure
Creating a new infrastructure to give utility to tokens may be the simplest and most easily implemented solution. Currently, most ICO tokens have no use case rather than just being an internal currency for a particular project. However, in case token holders could use their tokens to pay for other products and services, the share of post-ICO tokens actively used and held till the project goes live would rise significantly. This goal could be achieved by creating a new infrastructure that would allow merchants to accept specific ICO tokens for payments.
FiiiLab is one of the companies dedicated to implementing this solution. The group is developing a range of products to make cryptocurrencies more accessible to the public. These include a consumer payment platform and a mobile payment point-of-sale terminal, called FiiiPOS, that accepts crypto payments for merchants.
At least 4,300 ICOs were launched during the past three years, with 370 successfully finishing in Q2 2018; each of them offered over 1 billion tokens to investors on average. Almost 80% of them are tokens aimed to be internal currency for the ICO project, waiting for their finest hour when this project goes live. FiiiGroup created a strategic alliance program for successful ICOs and they fundraised blockchain companies to make their tokens usable for the time of project development.
As a blockchain-based project founder who started an ICO, you can join the FiiiEcosystem, which gets your token added to it. After this, all FiiiPOS devices around the world that are already in use will start to accept your tokens for payments. It means that your project investors no longer need to wait, they can use their tokens right away as a payment method. The initial use case of paying for a particular service is expanded to many others. This is how Fiii’s infrastructure allows cryptocurrency holders to make their tokens usable in real life even before the protocol is built, solving the lack of utility problem.
The ICO market is certainly blooming, despite all of the debates and regulation concerns. Statistics clearly show that an increasing number of founders fundraise their projects by issuing tokens, which will be used to pay for future services. However, with most of the projects being at the pre-seed stage, issuing utility tokens means testing investor patience, unless these tokens can actually be used.
Though there are options like changing token mechanics to increase investor confidence, or even replacing ICOs with alternatives such as STOs, creating an infrastructure which would allow one to use utility tokens as a payment method before their protocol is actually built may be the most straightforward and fast solution. And this one is already on its way.