@dditommasoDiego Di Tommaso
The future is here. It’s just not evenly distributed.
TLDR: IBCO is the new primitive for crypto projects funding, solving for the main issues of ICOs such as lack of accountability, lack of liquidity and flawed price discovery mechanics for the token itself.
It’s late 2020, enough water under the bridges to write an obituary on ICOs… But what exactly went wrong with ICOs?
Well, many things… but first of all let’s face it, funding early stage projects is a very risky business. VC stats says that even outside of the crypto space, 9 out of 10 startup fail, and that’s between the few selected startups that even get to VC funding after such a brilliant scrutiny. If you add to the statistics 4F (family friends and fools funded) startups, you probably get to 95-99% failure rate. Expecting or pretending that for crypto projects things should work differently… It’s just too much hopium..
With this out of the way, are there any additional risks or false safety connected to ICO fund raising model?
Let’s start from false safety: when you invest in the equity of a traditional startup you have a very big illiquidity problem, transforming your equity stake into cash will require a liquidity event such as an exit or another investor willing to buy up your shares. Such events are rare and far away in time since T0 of your investment. There is no secondary market for traditional startup equity… But here comes the ICOs: who cares about the boomer’s equity? Let’s own a utility token, it does not give you any ownership or control rights on the venture but it exposes you to what actually interests 99.9% of the investors: appreciation/depreciation of the investment. And that’s not all, you have a liquid market where you can sell your tokens whenever you want.
But here comes the trick, it’s all good in theory but is the liquidity on the market really there? Or is that just market maker bots filling a book and performing wash trading? How deep is that book if you really wanted to sell? How much selling pressure does that market can absorb without totally destroying the price of the token?
Very little actually… let’s see why going through the archetypal life of an ICO or Public Sale:
1) A team of brilliant entrepreneurs, developers and advisors pushes out an amazing whitepaper and – in very rare cases – an MVP. 2) The team mints an arbitrary number of tokens with an ERC-20 contract and than offer a % of those at a fixed price during a time limited public sale. 3) If project, team, presentation and market timing are good enough the project will raise a decent amount of crypto from a crowd of Utility Token investors.
So far so good, so what could possibly go wrong?
Flawed price discovery mechanics: during the ICO the price of the token is arbitrarily fixed by the promoters of the project, if investors wants to participate they have to rush in a limited amount of time and buy at that
price, in the meanwhile they – similarly to the promoters – have 0 signal from the market to understand if the token is overpriced or underpriced.
The moment of truth will only come later on, with the token quotation on an exchange, when market price discovery begins.
If, considered the ICO price of the token, the circulating and fully diluted
market cap are reasonable enough – and that’s the hard thing to know without being able to ask to the market how good is your project – your token should not experience any price shock.
And this true in theory…
but let’s add a variable: what if the liquidity of your market is so thin that the even a minimum selling pressure cannot be sustained? And even more importantly, moving to the next point, do you really care?
The liquidity problem: let’s assume you raised 5 Mln USD with a public sale, now for getting your standard ERC-20 token listed in a decent CEX you have pay 500k in fees, how much will you than invest in liquidity? Probably the less the better… in fact funds you raised are safe in your wallet, funds you send to the exchange for market making are exposed to market forces. And don’t be fooled by hope, your crypto asset is a tail asset just like 99.9% of tokens out there, without you engaging with market makers the orders in your book will be as lonely as cathedrals in the desert.
Now let’s say that you used 20% of what you raised for providing market making liquidity, what if the price crashes because a big part of early – AKA discounted – investors decided to exit? Would you take again 1 Mln USD from your treasury and give it to market makers to stabilise the price, or will save those money to develop the project or why not… to buy a Lambo?
Lambo moral hazard: don’t know exactly why but looks like crypto community loves Lambos, especially if they can buy those with crypto they do not really deserve. Why not right? Sometimes morality is very malleable…
Exempli gratia: how Chef Nomi justified himself for cashing out 13 Mln USD and crashing the price of his Sushiswap token by 70%… Than he changed his mind, but that is another story…
If you raise a decent amount of crypto for a whitepaper and some nice graphics on a webpage why not just buy a Lambo instead of at least trying to deliver the project you raised the money for? Of course that is morally wrong but will it also generate legal consequences? Probably not! This lack of accountability if compared to traditional equity creates a very apparent additional risk for ICO investors that have 0 control on the flow of funds.
So considered all of the problems emerging from ICO funding, should we totally abandon it? Absolutely not! Let’s see how we can fix it
It was January 2018, the peak of the ICO bubble, while everybody was very busy on their trip to the moon, Vitalik Buterin came out with a succinct yet powerful post highlighting the risks of ICO funding and purposing a new primitive for fundraising: DAICO the intersection of an ICO with a DAO.
The concept is addressing the “Lambo moral hazard” problem, introducing two main new features to the classic ICO structure: a) limiting the ability of the team to immediately withdraw all the liquidity by creating a tap function that gradually “vests” the raised capital B) allowing to token holders to vote in order the enact the liquidation of the raised funds just in case they are “very unhappy” about what the team is doing.
Very cool, but can we also find a way to address flawed price discovery mechanics and the liquidity problem that afflicted ICOs?
Probably not in 2018 but in the meanwhile, something very relevant happened in the crypto space that paved the way for solving those problems: the rise of decentralised exchanges based on bonding curves such as Uniswap. Bonding Curve Decentralised Exchanges opened up a whole new set of opportunities for crypto projects, basically disrupting the relations and power structure between centralised exchanges – once the gatekeepers of the crypto world – and crypto projects.
Now thanks to Bonding Curve Dexes a project does not have to beg and pay huge fees to an exchange to get listed, it can create a market by himself by providing his token + collateral to a bonding curve pool. A project does not even have to run an ICO and then wait to get listed, it can directly perform the fundraising by creating a market on a DEX or by implementing his own custom made bonding curve. Such a fund raising technique is called IDO (Initial Dex Offering) or more generally IBCO (Initial Bonding Curve Offering). Currently there is no chrystallized structure for IBCOs, all of project embracing this new funding primitive implemented their own special flavour of it: Hegic with a linear buy-only bonding curve where at the end all of the participants payed the same price, DIA that used MESA protocol with pre-minted tokens, PERP that used Balancer’s liquidity bootstrapping pool or Aavegotchi that is using Bancor Liquidity Protocol to mint/burn and distribute the tokens.
Wrapping it up, let’s see how the concepts outlined in the DAICO post combined with the IBCO funding mechanics could lead to a revolution in fundraising, solving the 3 previously mentioned problems of ICOs, AKA risks for investors.
In our archetypal DAO ruled IBCO, a project will solve the “flawed price discovery mechanics” by not pre-minting the tokens that are going to be sold during the fundraising, instead those will be minted and burned on a bonding curve using the Bancor Formula. If participants to the funding activity will buy, tokens will be created and price will raise, if tokens are sold back to the bonding curve, the sold tokens will be burned – decreasing supply – and price will go down.
In this way no uninformed educated guessing will be made on the amount of tokens that should be created and on the price they should be offered to the public. The market will immediately decide by himself how many tokens of the project should be out there and at what price they should trade. Of course IBCOs have a starting price, so it can be argued that such a price is again guessing with 0 signal from the market. Fair enough but we should not forget that such a choice on starting price will have a direct impact on the number of tokens that will come into existence, so total implied market cap is again fully assigned to the market to be decided.
A project would solve the “liquidity problem” by using the TAP concept described by Vitalik in his DAICO post, applied to IBCOs. Only a publicly known and pre-determined amount of collateral – funds raised – will be allowed for monthly withdrawal, all the rest of it will stay in the IBCO AMM to ensure liquidity to contributors who may want to get out from their investment. Such an IBCO is in fact the collapse of a primary and a secondary market in a single entity, nothing stops the project to also provide liquidity to other markets such as Uniswap, Balancer or even a CEX
but basically the IBCO already works as a secondary market. The only difference – in this configuration – is that differently from other secondary markets, when tokens are sold to the IBCO market those are destroyed.
And finally the above mentioned TAP mechanic would also solve the “Lambo moral hazard” since the team will simply have no chance to run away with all of the raised funds. Also the team will always have “skin in the game” since raised funds which stays in the bonding curve are always subject to withdraw by investors that can exit by simply selling the tokens back to the Bonding curve. A very strong incentive to keep delivering!
All of the mechanics just described are not just a collection of abstract ideas waiting for someone to make those real, there are frameworks ready to use for creating such IBCOs. Aragon is one of those, where with a few clicks you can create your own DAO governed IBCO. And finally there are real projects that saw the potential of this new funding primitive, you can find a live example with Aavegotchi that is running his IBCO since one
month now and OVR that will be launching his DAO governed IBCO in late November.