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Why Tokenized Startups Are No Different Than Tech Startups

Forbes Technology Council
POST WRITTEN BY
Mike Brusov

Initial coin offerings and token sales raised $5.4 billion in 2017 and over $14.2 billion in 2018, according to KPMG . The rapid surge of Bitcoin created an impression that blockchain as a technology is going to disrupt everything. Bold, futuristic ideas emerged and raised money.  

Now, after the price of Bitcoin slid from $20,000 last December to below $4,000, new funding for token sales has significantly declined. By October, token sales funding was down 90% from the peak level of $3 billion in January 2018. I believe most projects that raised money during the boom will fail over the next few years.

Was the upcoming wave of failures pre-determined by the nature of venture investments and specific differences that tokenization has introduced? Let's look at the source of the funding, how it was used and the outcomes for tokenized companies and the industry. What we'll find is that, just like e-commerce businesses are still retail companies, token-based blockchain projects are still startups.

Where The Money Came From

The funding that fueled the token sale boom was drastically different from traditional VC investments. Most venture capital money comes from institutional investors and wealthy individuals. The VC industry has decades of history with well-developed frameworks, valuation methods, metrics and expectations. There was none of that during the boom.

It is now apparent that the vast majority of funding came from people who did not evaluate their risks rationally.

Some buyers were the early adopters who bought or mined Bitcoin and other cryptocurrencies for pennies before the rest of the world awoke to this phenomenon. I personally know some of the individuals who amassed millions (at least in paper gains), and most of them are technologists. Some were trying to diversify by investing in new projects. For many, it was an experiment -- they wanted to support projects that were close to ideologies of decentralization and privacy.

The second category were professional investors who saw token sales as a way to make money. In the beginning of 2018, there were already over 200 crypto hedge funds. These players understood risks and rewards.

Finally, a large group of buyers entered the market due to the hype created by the media. Neither techies nor savvy investors, those people were motivated by greed. This also included some very wealthy individuals.

Overall, there was simply too much not “very smart” money around. For our own token sale, we’ve received $500 million worth of applications to buy tokens. We set our hard cap at just $15 million, which was the exact sum we needed to develop our ecosystem and scale the community of users. At that point, we have already been developing our company for three years, gained clients and launched working products.

Where The Money Went

Projects that sold tokens started to build their products. The spending wasn’t any different from a typical tech startup: a team, product development, marketing, infrastructure. Companies simply went ahead to spend according to their financial models.

Why did companies make mistakes and spend before the model started to work? Most startups use existing business models and do not try to reinvent the wheel. Yet almost nobody starts with the correct model. From personal experience, I know that a startup goes through three pivots -- or major shifts in business strategy -- to become a stable company. 

Most Raised Way Too Much, Too Early

The real problem is that companies raised funds that were not appropriate for their product and development stage.

Some raised tens of millions of dollars without a working prototype. Just a vague idea, a hypothesis. That is actually the stage for a pre-seed investment of up to $500,000. Early in the startup journey, VC investors expect the founders to quickly create and test a prototype to show some hints of a product-market fit.

Only about half of all startups get the follow-on investments, according to CB Insights. This likely means that the other half fails to create a working prototype with some potential in the market. Maybe they couldn’t build the core technology. Others developed the technology but not the product. Some built products that the market didn’t need.

Some Will Survive

Some projects will be successful. Startups with working prototypes and initial market traction are more likely to succeed. These companies have already passed through several death valleys.

However, nothing is certain. A lot of factors must coincide: the team, the technology, the product, the market, the timing. Even if you have everything lined up, there is still no guarantee of success. A black swan event might disrupt it overnight.

Tokenization Is Here To Stay

There is one forecast that can be made confidently: The 2017 token euphoria will never be repeated. It’s history.

Yet I believe the token sale as a funding mechanism will remain. It will become more regulated and professionalized, evolving into something between traditional VC investments and crowd sales.

The token sale boom opened up venture investments to individuals. Previously, if private investors wanted to invest in tech startups, the deals would start at $25,000 and upwards. They needed to invest time in sourcing opportunities. Tokenization changed this. People can now invest several thousand or even hundreds of dollars. Wider participation is one of the main benefits as it makes both diversification and price discovery easier.

What To Do Now

For projects that have are already gone through a token sale, there is the only thing to do: work, work, work. Build. Just like a regular tech startup, create value and distribute/sell it to customers. When everybody sells and panics, keep working. Be prepared financially, emotionally and structurally to work during a prolonged downturn. It’s also important to stay open, communicate and show your plans. That’s why I’m here, sharing my thoughts with you.

Those who took part in the 2017-2018 cycle will be vaccinated against unreasonable hype. People who got burned will come back but will be more careful. New, robust methodologies for evaluating tokenized businesses will emerge. Due diligence, risk management and legal frameworks will be developed. Expectations will be more rational. Overall, the new decentralized economy will evolve to be more intelligent, creating new opportunities for investors and entrepreneurs.

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