Blockchain seems to be the ‘next big thing’, with limitless opportunities to revolutionize our economy.
But, like all things with enormous potential, there is considerable controversy, and where it relates to blockchain, not surprisingly, is in regards to regulation. From the perspective of the issuer however, how can a company raise capital through blockchain, and how realistic is this ‘enormous opportunity’?
Alex Tapscott, founder of Nextblock Global, defines blockchain as “an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”
Blockchain allows digital information to be distributed but not copied, and thus, blockchain technology allows for the existence of cryptocurrencies, such as Bitcoin. The major advantage of cryptocurrencies is that management is decentralized, or not controlled by a central bank, and thus peer to peer transactions are able to be accomplished instantly and without the cost of banking fees.
A growing number of companies are considering the use of blockchain to overcome the challenges and inefficiencies of traditional capital markets when raising capital. This process is known as an ‘Initial Coin Offering’ or ‘ICO’.
The strategy behind an ICO is that a company releases crypto-tokens (a digital representation of the company’s shares) in exchange for a certain amount of cryptocurrencies, predominantly Bitcoins or Ethereum. As a result, the company is able to convert the cryptocurrency into cash and then use this capital to grow. ICOs are an alternative to raising money from banks or Venture Capital firms.
A company’s ability to raise capital through an ICO faces two major challenges. The first one is the regulation surrounding this process. Given that the blockchain is ‘decentralized’ essentially means that the central bank has little to no ability to control or monitor what happens within it. Aside from the financial and economic implications, there is a potential use for malicious intent with regards to money-laundering, the financing of terrorist organizations, and fraud. Moreover, a private company with thousands of investors they have never interacted with prior leaves virtually no possibility for KYC (‘know your client’) and proper governance.
It is for these reasons a myriad of regulatory bodies (i.e. securities commissions, anti money laundering and terrorist financing organizations, central banks, federal and national police forces, homeland security etc.) will want to be involved and have control over this medium, thus potentially stifling its opportunity and making efforts to use it onerous, expensive and risky. An example of this can be seen in China where there was an outright ban on all ICOs nationwide.
The second major challenge is market perception. There are a number of psychological hurdles, regarding the multiple layers of risk, involved with the general public parting with their hard-earned dollars to invest in an ICO. Investing in a private, early-stage company (which makes up the majority of those looking to use ICOs given they have the most challenges in raising capital in the traditional sense) is risky because the company does not have a long track record, and it does not have the transparency a publicly traded company would have.
Also, with all the promise that crowdfunding had, it is extremely difficult for most companies to get the message out to enough people to have their campaign turn into the needed capital to fill out the issuer’s financing round.
There is too much competition, with consumer products and real estate seeming to be the only sectors able to resonate with the general public, and there are not enough investors yet to consider crowdfunding as a viable asset class. Add to this, the new phenomenon of blockchain and its complexity, and that translates into even fewer investors.
Although there are a few encouraging success stories of ICOs, and the potential is enormous, companies considering using an ICO to fund their business, at least for the time being, should definitely still consider the traditional sources as well.