ICO vs. VC: What is the Best Way of Raising Capital for Crypto Projects?
Venture capitalists (VCs) and DAOs tend to have a complicated relationship. VCs may see the latter as an investment opportunity, or DAOs can mobilize to compete with VCs for other investment opportunities. VCs are not the only fundraising options for the DAOs, though. Initial Coin Offering (ICO) seems to be a viable alternative to a VC. However, it is not possible to claim which one is the better way of raising funds without engaging in a detailed comparison of the two, which we will do in this post.
An ICO is an online crowdsale event carried out to finance a blockchain-based project. In an ICO, a company sells a portion of its crypto tokens to the early supporters of its project. Thanks to ICOs, companies with blockchain-based services can raise capital without selling equity or debt financing. To do that, companies issue tokens that deliver benefits related to the project in question. These tokens do not entitle their holders to equity in the company, but rather the prevailing assumption is that their value will appreciate in time.
Raising a lot of money without giving your funders a say in the management of your company may sound like having your cake and eating it. However, ICOs are not the panacea—they come with their pros and cons, may apply to some companies but not to others, and thus are best analyzed in relation to VCs.
Pros of ICOs
Speed and relative ease
There are two stages to an ICO: The first stage involves preparation of a whitepaper and a website, which explain to the audience the details of the project. The second stage consists of issuing tokens on a blockchain platform like Ethereum. The whole process is fairly straightforward, and the result can be staggering compared to the modest effort required. That Brendan Eich, former CEO of Mozilla, was able to raise $35 million for his “Brave” project in under 30 seconds is a good case in point.
On the other hand, VCs want to see a lot more from a startup before pulling the trigger on an investment decision. First of all, there has to be a sound business model in place. A working prototype or an MVP would go a long way in convincing the VCs to put money into a project. Being business people, VC executives like seeing proof of revenue and financial projections instead of mere feel-good stories or pure hype.
Lack of geographic limitation
ICOs take place online. That’s the main reason behind their success in raising huge amounts of money in impossibly short periods of time. Anybody with an internet connection can buy tokens and become an investor during an ICO.
VCs are more geographically limited. Being organizations that depend on social contact and networking, VCs tend to cluster around major technology and finance centers like the Bay Area or London. Founders would be well advised to be close to such places if they want to pitch their ideas to VCs and win their backing.
ICOs do not involve the sale of equity. In that sense, they are non-dilutive. The tokens sold do not give buyers any form of ownership over the company issuing them. Tokens entitle their buyers to benefits that may accrue to them if the project succeeds.
In contrast, raising capital from VCs always involves the sale of equity to the tune of 20 to 30 percent of the total company stock. This naturally gives VCs a certain level of control in the way the project is being run, which can be regarded as a loss of control. However, having VCs onboard has advantages, too, which we will delve into below.
Pros of VCs
VCs are known to do their due diligence in evaluating investment opportunities. Any startup backed by a VC, in a sense, earns a seal of approval in the public eye. Thanks to this phenomenon, possible failures down the road can be attributed to risk typical of a business venture rather than fraud. This boosts the chances of founders to make a comeback in case of failure.
However, raising money through an ICO involves people who may not have a deep knowledge of the subject, or are just bandwagoners seduced by the hype built around a project. Expectations in an ICO are based more on speculation than facts. We are all familiar with stories of people who considered investing a small sum in Bitcoin before 2014 but did not for some reason, and regret it to this day. These people do not want to miss out on the next big thing, so they may end up investing in projects without the necessary research.
ICOs just bring in capital. That, for sure, is not bad, but for some startups, it may not be enough. Once you have raised the necessary amount in an ICO, you are on your own again, this time with the responsibility to deliver on the promises you made to the token holders.
If you are looking for some guidance, mentoring, or a network that you could leverage to grow your startup after the fundraising stage, VCs are the way to go. In return for selling some equity and giving up some control to the VC executives, you get to pick their brains, and they happen to be quite smart people. VC executives are generally founders of successful startups themselves, have lots of experience under their belts, and know what it takes for a startup to succeed. This sort of experience can come in handy when your startup runs into trouble and needs a course correction.
VCs are highly regulated companies. A lot of bureaucratic work ensues once a VC decides to invest in a project, which slows down the process to the detriment of the cash-strapped startups. Accounting, reporting, and administrative tasks are all performed according to long-established rules and regulations when a VC gets involved in a project.
On the other hand, ICOs are in the legal grey zone. Whether issuance of tokens should be considered a security sale is debatable and contingent on whether the token is linked to the operations of the company. The ambiguity in the legal status of ICOs also poses a serious risk with regards to legal recourse in case there is fraud.
ICOs raised a total of $35 billion in 2016-2019. The golden age of ICOs lasted from mid-2017 to early 2018. The total amount raised in ICOs hit a peak in the first quarter of 2018 and decreased over four consecutive quarters until the second quarter of 2019. Failed projects, scams, and the fact that countries like China and South Korea banned ICOs brought an end to the ICO frenzy.
The VC interest in cryptocurrencies has been on a steady increase in the meanwhile. VCs invested around $30 billion in crypto startups in 2021, a figure higher than the sum total of the VC investment made up to 2021. The venture capital firm Andreessen Horowitz was a pioneer in backing crypto startups. The $25 million worth of investment it made in popular crypto exchange Coinbase in 2013 grew to $11.2 billion in market valuation by 2021 when the company went public. In June 2021, Andreessen Horowitz announced its $2.2 billion Crypto III fund that it set up to invest in crypto startups, the biggest crypto fund at the time of the announcement, only to be replaced by Paradigm’s $2.5 billion fund announced a few months later.
It looks like VCs really took the wind out of the sails of ICOs lately. Despite all the convenience ICOs offer, the legal risks involved, illustrated by the much-publicized scams, must have outweighed the advantages in the eyes of investors. Unless the legal aspects of ICOs get sorted out, and investors are offered some form of protection, VCs are slated to remain the king of crypto investments.