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'Unsustainable' crypto startup funding bubble has burst

Oscar Williams-Grut
Senior City Correspondent, Yahoo Finance UK
Talking crypto: Dan Roberts, Brad Garlinghouse, and Andy Serwer attend the Yahoo Finance All Markets Summit: Crypto on February 7, 2018 in New York City. Photo: Eugene Gologursky/Getty Images for Yahoo Finance/Oath.

The “initial coin offering” (ICO) funding market is being crushed by the “crypto winter”, according to two new reports.

ICOs are where startups and projects raise money by issuing digital coins or tokens, similar to bitcoin, in exchange for real money. The majority of tokens are snapped up by ordinary retail investors, cutting out venture capitalists and other early-stage institutional investors.

The fundraising method emerged in 2017 and almost 500 projects raised more than $5bn (£3.8bn) through ICOs last year. ICOs continued to be popular at the start of 2018, with the total raised through the method surpassing 2017 levels in April. But the market has since collapsed as cryptocurrency prices dived.

Reports from ICORating, an independent crypto ratings agency, and Outlier Ventures, a blockchain and crypto-focused venture capital firm, show that the third quarter was brutal for the market.

The amount of money raised and quality of startups declines, returns on investments were negative, and apparent scams have become commonplace.

The reports show:

  • Startups raised 48% less through ICOs in the third quarter compared to the second.
  • 75% of startups trying to raise money had nothing but an idea.
  • The average return from ICO tokens in the quarter was -22%.
  • 64% of attempted ICOs failed.
  • 19% of companies that raised money through ICOs in the third quarter have deleted their websites and social media accounts, suggesting they were scams.

Outlier Venture’s report blamed the “crypto winter” for part of the slowdown, while ICORating said it expects to see projects go bust in the coming months.

On the slide: The number of ICOs and amount raised through the method has been steadily declining since May. Photo: ICORating.

“We expect some strongly hyped projects which raised significant funding to actually fail for a variety of reasons – due to being compromised as scams, to conflicts between founders, failure to deliver the promised technology or a failure of solutions offered to be widely adopted,” ICORating’s report said.

Jamie Burke, the founder and CEO of Outlier Ventures, told Yahoo Finance UK: “We knew what was happening towards the end of last year was unsustainable. The reason it was unsustainable was a lot of it was not tied to underlying value. Being more technically involved in the industry, we were aware that the hype was running ahead of technology.”

The majority of projects that raise money through ICOs rely on blockchain technology in some form or another. However, Burke said that the infrastructure is not yet developed enough to support many of the ideas that projects raised money for last year.

The market got a bit of itself,” Burke said. “All the possibilities that blockchains and distributed ledgers offered, everybody rushed to try and realise those and the capital rushed to follow them. But the reality is the technical cycle is much further behind the market cycle.”

‘A vast number are scams’

ICORating’s report found scams are increasingly common in the market: 19% of ICO projects from the third quarter have already deleted their social network accounts and websites, suggesting they were scams. The projects collectively raised $62m, 3% of the total $1.8bn raised through ICOs in the third quarter.

“The key problem with ICOs is that a vast number of them are scams or scam-like projects,” the report said, noting that there has been an “an increasing lack of transparency from ICO teams/projects” that makes it harder to tell the good from the bad.

However, Burke said: “A large majority of ICOs shouldn’t have ICOed full-stop. Now, does that make them a fraud? I don’t think so. 90% of startups fail in their first three years. The numbers pretty much mirror traditional early-stage ventures.”

Outlier Venture’s report found that venture capital is increasingly filling the void left by ICOs when it comes to digital token-based projects. VCs have invested almost $3bn in these projects in 2018, which is “more venture capital inflow than all previous years combined,” according to Outlier Ventures.

“Although the number and size of public token fundraises has reduced, startups, corporates and regulators continue to believe that tokens are foundational to Web 3.0 infrastructure and represent the opportunity for new business models,” Outlier Ventures’ report said.

Burke said: “We don’t see ICOs as dead. They are just evolving as the industry professionalises.