The Fat Startup: the terrible incentives of ICOs


ICOs keep growing

I remember ICOs being a really hot topic last year. They were hailed as “revolutionary” and will possibly displace venture capital, but I haven’t heard as much about them lately. Someone recently told me that ICO activity has died down, so I decided to check to see if that was true. It turns out to be extremely false. In fact, so far in 2018 the average ICO is 50% bigger than in 2017 (though that might be skewed by the massive Telegram ICO), and halfway through the year they have already raised 140% of 2017’s total:

ICO Tracker

My impression for why the chatter around ICOs seems to have died down even as ICOs have increased is that companies are more cautious now about how they talk about it and are more likely to stay under the radar due to government regulators taking notice. Unlike the early days when ICOs were advertising aggressively (ICO advertising has now been banned on Facebook and restricted on Google), spamming inboxes, and making outrageous claims, companies today take a somewhat more sober approach.

The lessening of outrageous PR, however, has not made the underlying incentives for ICOs any better than they were before. No matter how you look at it, raising millions (or tens of millions or hundreds of millions) on no product and no users is rarely (ever?) economically justifiable and leads to extremely bad incentives.

In recent years, the “Lean Startup” method of experimentation, customer feedback, and prudent stewardship of money had become the standard in the startup world. This made sense – business plans are made up of hypotheses, not truths, and you have to test your hypotheses by building, releasing, getting feedback, and iterating in order to find product/market fit. ICOs are rolling back all the gains from Lean Startup insights and getting back to raising millions (or hundreds of millions) on business plans (white papers) alone. And fat startups lead to terrible incentives.

Why stay when you can leave?

Token whitepapers love to mention how they use game theory and economic incentives to revolutionize XYZ industry, but what they fail to mention is that if they indeed raised $XXX millions on no product and no users, they have no incentive to spend that money doing the hard work of making their whitepaper predictions come true – instead, the bigger incentive is simply to walk away.

I’m not even talking about straight up scams. I’m talking about teams that go into an ICO fully intending to realize their blockchain vision – they are still incentivized to walk away the moment things get difficult. Building a company is tremendously hard – getting rejections, managing conflicts, shattering your assumptions – none of that is fun or easy. Anyone in startups knows that trying isn’t enough – there’s a lot of grinding through, a lot of staring collapse in the face and being forced to come up with solutions that you didn’t think were possible a short while before. Part of what gets teams through the grind is the big payoff at the end – and a legal obligation to stay with it or return investor money. An ICO team that has raised $XXX millions on just a white paper doesn’t have those incentivizing factors because they’ve already gotten their big payoff, and they are not obligated to stay until all the capital is spent – they can walk away with it.

An ICO team may have good intentions. They may even try to tackle the problems that inevitably come up. And when they finally walk away from a project they may really believe that they did all they could, but would that be true? What if they could’ve succeed if they grinded for another few months? Or a few years? But what is the incentive to stay with the grind when you can walk away with millions of dollars and no real consequences? Founders may say at this point that this doesn’t apply to them because they’re “not in it for the money”. That’s bullocks. Money is never the sole reason for doing a startup, but it’s a pretty big incentive. To say that “money isn’t an incentive” is basically to undercut the whole premise of tokens, which is to use money to incentivize good behavior. Except in the case of ICOs, money incentivizes bad behavior.

Discipline, please

Let’s say a team decides to stay with the product until the money they raised runs out (or perhaps laws are passed compelling them to do so). Does that solve our problems then? Unfortunately, even then, their likelihood of success is probably lower than a similarly situated startup that raised money the traditional fashion. Outside the world of blockchain, discipline happens because professional investors and the demands of the market keep you accountable. At much lower raises, the need to make revenue and get to product market fit before your funding runs out acts as a disciplining factor that forces companies to focus on building the features most likely to create value. If you raise millions upfront, you can spend years in a basement somewhere building features without any care of whether it creates economic value for society or whether it justifies the capital you raised. That’s fine if you’re a scientist or researcher and your ICO specifies that you’re looking for donations, but most ICOs are advertised as investments that give a return.

People often think that startups fail because they run out of money. This is technically true since by definition a startup has not failed unless it has closed up shop (barring acquisition), and they usually don’t close up shop unless they run out of money. But what led it to that point in the first place? For a lot of startups, it’s because they raised too much money. The frank post mortem of this fintech startup hits on all of the problems I mentioned and more: when you raise too much money, you’re not forced to be close to the customer so you build things the market doesn’t want, you treat your company like a “science project” instead of a real product, having more money simply leads to spending more money in ways that are not value creating, you make suboptimal decisions that are not caught because money hides these issues, etc etc. The startup world is littered with such examples.

Some might argue that blockchain companies raise money not to build profitable companies but to build new technologies. If that were the case, they need to make clear to investors that the money raised is being donated to a research charity and that investors should not expect a return. New technology, no matter how innovative, is not automatically useful. The startup world is littered with even more examples of startups that failed because they focused too much on the technology at the expense of customers, and ended up with great technology that nobody wanted.


Some justify the need to raise large ICO rounds because 1) blockchain developers are rarer and more expensive so development on blockchain requires more capital than normal, and 2) there aren’t follow-on rounds in blockchain funding because there’s an ethos against dilution and token inflation. When I was starting out, I didn’t have a lot of money, so I asked a mentor: “should I hire someone cheap who isn’t very good, or should I hire someone expensive who is very good?” His reply was: “You should hire someone cheap who is very good, and if you cannot solve that problem, your startup will fail and you mind as well quit now.” The fact that costs are high doesn’t justify inflated valuations or change any of the bad incentives. And as for follow on funding, there is nothing stopping blockchain companies from raising future rounds. If a team shows real traction and their investors are actually committed to their success (which is supposed to be the whole point of tokens), those investors should be perfectly ok with companies raising future rounds as needed.

Here’s my prediction with ICO companies: they will fail at higher rates than traditional startups, even controlling for the maturity of technology and market. They will fail sooner because founders don’t want to put in the work when they can walk away with millions. And founders will stick with them for less time even if the startup hasn’t failed, because why stay and build long term when you already have your payoff – just leave the project to someone else while you chase newer and shinier opportunities. We already see this starting to happen.

Despite all the above, I’m not anti-ICO (surprise!). ICOs open up a new way of funding projects. This is great for a lot of projects that can’t get traditional funding (e.g. because the problem they’re solving is too big or not easily defined), for organizations that are indeed looking for donations for research and innovation, and for teams in countries with less developed VC networks. Just as crowdfunding opened up opportunities for new entrepreneurs and new innovation, ICOs will do so as well. But at least with the current set up, many if not most (all?) of the companies raising money this way are shooting themselves in the foot, and burning up investor money in the process. Speculate at your own risk.

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