In its January report, the Organisation for Economic Co-Operation and Development (OECD) explained some of the intricacies of ICOs in modern finance. Although ICOs still offer advantages for startups, it comes at a steep cost. The organization concluded that ICOs can’t be properly harnessed until there is regulatory consensus internationally and it is unlikely to replace venture capital for mainstream seed financing.

The Organisation for Economic Co-operation and Development was founded in 1961 to stimulate economic progress and world trade. Today, the organization is comprised of 36 member countries including the United States, much of the European Union, Korea, and other major economies.

Like most regulatory agencies, the OECD asserts that ICOs, in their current form, are risky:

“ICOs in their current shape and form carry important risks for SME [small and medium enterprise] issuers and investors subscribing to token offerings.”

At face value, an ICO seems like an excellent way to raise funding. Thousands of businesses which otherwise would have never formed have been able to raise hundreds of millions using these offerings.

Yet, to some extent, ICOs can be a trap. Keeping issuers accountable, properly structuring token economics, and evolving definitions for “utility” and “security” token have stunted many companies post-ICO. In extreme cases, the Securities Exchange Commission has even compelled companies that have conducted ICOs to return funds to investors via recision.

Considering the age of the industry, there are still a lot of unanswered questions. The OECD does provide some answers, but even these come with a lot of footnotes and exceptions.

One highly anticipated project in the cryptocurrency space is Grin. The privacy-centric cryptocurrency gained the attention of Peter Thiel and several crypto-minded venture funds, including Primitive Ventures, Iterative Capital, and BlockCypher.

With no ICO, no pre-mine, and some innovative privacy attributes, Grin has some features the crypto-community appears to value.

In his proof of work newsletter, Erik Meltzer, a partner at Primitive Ventures, stated:

“Unlike Bitcoin, which was so maligned and ignored at launch that Satoshi had to mine by himself on a single Intel CPU for most of 2009, there is (by our conservative estimates) 100 million dollars of mostly VC money invested into special-purpose investment vehicles to mine Grin.”

One interesting feature of Grin is “MimbleWimble,” a feature that purportedly hides information related to cryptocurrency transactions. Some have heralded the feature as a “cure” to Bitcoin’s privacy and scalability issues, but the feature has seen limited implementation outside of Grin.

In a video explainer, crypto evangelist Andreas Antonopoulos said that MimbleWimble allows users to “have a much smaller, more private blockchain.” The innovation hides the amounts being transacted, the identities of the transactors, as well as verifies the state of the blockchain without storing all transactions. Allegedly, these are all features that Bitcoin has struggled with.

Grin has been compared a number of times to Bitcoin but implemented in such a way that’s more “fair,” according to advocates on Twitter. Prominent Bitcoin developer Jameson Lopp Tweeted his appreciation for the project on Jan. 15, 2019, saying that “there are no sketchy incentives skewed towards the creators, it’s actually innovating, and it’s a pretty cypherpunk project.”

These questions of fairness are a matter of tokenomics (token economics). The monetary policy surrounding a cryptocurrency defines its use within the ecosystem and has a large impact on a coin’s price.

The OECD offers some insights into this aspect of token offerings. The policy group asserts that “private sales of tokens ahead of ICOs raise a number of issues,” and “not having ‘skin-in-the-game’ is a source of potential conflicts.”

Pre-ICO rounds that offer discounted tokens, but aren’t adjusted for risk compared to those sold during the main ICO, are primarily occupied by what the OECD labels “insiders.” The funds raised by insiders during this period are typically used to pay for marketing and advisory costs needed to establish the project in the first place.

Founders who manage to cover these costs often “carry no personal financial risk in the transaction besides reputation risk,” states OECD. The international agency underlined the importance of having “skin-in-the-game” as this accountability prevents conflicts such as pump and dump schemes.

In the context of traditional startups and small businesses, cryptocurrency entrepreneurs need only pay for marketing expenses and advisory fees. Moreover, the absence of a mandatory lock-up period often tempts startup leaders to leave after they’ve raised the cash, rather than build out a working product.

Initial public offerings (IPOs) for traditional stocks share few similarities with ICOs, other than that they are both fundraising methods.

In the case of an IPO, investors interested in buying shares in a company are betting on a former track record of performance. There is a history of “both operational and financial performance,” explains the OECD, offering much more information than what is possible in an ICO.

IPOs also tend to be much longer events, with planning for an offering lasting three times as long compared to an ICO, according to the OECD. With these features in mind, ICOs are more akin to venture capital-style fundraising:

“IPOs follow series A-D financing or are used as an exit after venture capital funding, while ICOs look for seed/early stage financing, similar to seed financing (or perhaps series A round).”

If IPOs are a bet on a business’ forecasted success, then an ICO is a bet on turning an idea into reality.

Unlike ICOs, venture capitalists (VCs) can meet with startups, get acquainted with the founding team, and then decide whether to provide funding. However, VCs still run into ‘problems’ of liquidity.

For ICOs, as soon as a token is listed, a secondary market becomes available that makes “cashing out” easy. Such ease is tempting for crypto founders:

“Academic research suggests that ICOs are preferred for projects with a high risk of failure and right-skewed payoff distribution, given that in case of some retention of ICO proceeds by the entrepreneur, the payoff for the entrepreneur is positive even when the project fails.”

Establishing a clear alignment of interest between token holders and founders is one of the largest impediments to ICOs succeeding. As the report claims, the OECD anticipates that the only way to harness ICOs is through international regulatory consensus.

This, however, is easier said than done. At the end of the report, the OECD compiled all high-profile regulatory responses worldwide. Such a compilation emphasizes the complexity of “safeguarding” investors in each jurisdiction.

The FMA, the financial authority in Austria, suggested that ICOs require a license to help protect investors. Meanwhile, Thai authorities have simply outlined the benefits and risks associated with the fundraising technique, with few rules on how the practice should actually be regulated.

China and Korea have both outright banned ICOs, with the latter citing “serious concern about the fact that the current market funds are being pushed into a non-productive speculative direction.”

ICOs were once lauded as a potential way to disrupt VC financing. Yet, at the present moment, the lack of accountability for issuers has left the space rife with scams and ill-conceived projects. With this in mind, the OECD concludes their report with the importance of a quality use case:

“It [seems] inappropriate to consider ICOs as a potential ‘mainstream’ financing mechanism for SMEs whose projects are not enabled by DLTs and which would not benefit from network effects.”

By extension, the OECD suggests that it might make sense for projects enabled by distributed ledger technology to raise funds via ICO. Yet, this brings about a whole host of other issues around which projects should use blockchain technology instead of conventional databases. Again, it seems like international decision-makers are leaving more questions than answers.

The post Without Regulation ICOs Unlikely to Disrupt Venture Capital According to OECD appeared first on CryptoSlate.

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