July 23, 2018

Talking About ICOs - A Q&A with COSIMO Ventures' Rob Frasca

Initial coin offerings, or ICOs as they are commonly known, have been surrounded by some controversy in the blockchain/cryptocurrency space. But they offer distinctive benefits, particularly for companies looking to raise capital. We’ve seen several companies in the Boston tech scene foray into this emerging capital market, with one of the most prominent being Airfox.

COSIMO Ventures is a venture capitalist firm focusing on deep technology innovations, blockchain included. Last month, they started an ICO with one of their portfolio companies, GECKO Governance, to start a governance and compliance solution for token sales. The ultimate goal of this new service platform is to stabilize the market and create a more welcoming environment for companies to undergo an ICO.

COSIMO Ventures Co-Founder and Managing Partner Rob Frasca spoke with us about the ins and outs of ICOs and how his firm is helping other startups by providing assistance to those who are thinking about doing one. Frasca also went into detail on what he thinks is going to change the game with tokens in the blockchain ecosystem.

Colin Barry [CB]: For starters, in your own words, what is an Initial Coin Offering (ICO) and what is your point of view on this space?

Rob Frasca [RF]: The definition of what an ICO is has changed since the overall landscape, and the market is evolving. Two or three years ago, it was two guys in a garage writing a white paper on what they want to do, post an address online and let anyone know that, ‘Hey, we’re raising some money to go do this project and we’re going to sell tokens in this project.’ To give you an example of this, say their project is a new file storage system and in order to use the system, they are going to charge users with tokens. In exchange for using this new service, the two guys are going to sell those tokens at a discounted price. The proceeds can then be used to put towards the development of the project.

If you think about Kickstarter, it kind of works the same way: You’ve just come up with a new gadget, pre-sell them at cost, and raise the money. The early customers who took the risk and donated early get their product at a discount and your gadget goes to market. ICOs use a similar philosophy.

Now, think about venture capital funding. You’re only going to get so many deals out of the funding pipeline. With an ICO, everything is decentralized and everyone around the world can participate in this market, when they couldn’t necessarily participate in the venture market.

Around last year, when Bitcoin and Ethereum started to become mainstream, people started looking at ICOs as an alternative, more decentralized way to raise money. However, as you can imagine, when something like this takes off like wildfire, people, especially us venture capitalists start asking, “What are the problems with it?”

At COSIMO we believe in blockchain and we believe in it wholeheartedly, and just last year there were hundreds of blockchain-based deals. However most capital invested into start-up blockchain companies was done through an ICO.  Chances are that if you’re a blockchain-based company, you’ve gone through the ICO process. Most blockchain entrepreneurs may not want to give out equity for their company, but instead want to go through this ‘new’ way of funding. And as an investor, you are sometimes forced to go through with it. I know I’ve asked myself, “OK, what am I getting myself into?” before.

I think it’s important when looking at ICOs to not look in the rearview mirror and look forward. A job of an entrepreneur is to see problems as opportunities. It’s fun to act as the media and dive into these problems, but as an investor or entrepreneur you have to look at how do you solve those problems?

CB: Why do you think so many companies are eager to file an ICO as opposed to venture funding?

RF: Number one, it’s non-dilutive, so they aren’t giving up any equity in the company. Number two, it’s faster. Number three, it’s more liquid. And number four, it’s more democratized.

If you’re an entrepreneur, what are you going to do? You can go on a roadshow and talk to a dozen investors and maybe get funding for your company, or you can go global and talk to a much larger group of people and potentially raise more by selling tokens.

At COSIMO, we believe ICOs are moving from seed stage to later stage. It is becoming more expensive to do an ICO nowadays. Sometimes, it can cost a company anywhere between $500,000 to $1,000,000, while investors are becoming more selective with which blockchain companies they want to invest in.

What I mean by that is I think they aren’t going to replace the seed round, but rather the A round. In my opinion, as an entrepreneur whose done it multiple times, the hardest round to raise is the Series A. If you’re a good enough entrepreneur, you can raise angel money and get something launched. But for a Series A, you need a product market fit, revenue coming in and much more.

CB: ICOs are almost always involved with blockchain-based companies and the space itself. Why is that? Are there other non-blockchain-based companies out there taking advantage of this new way of funding?

RF: Ultimately, the token system itself is blockchain-based and it makes sense to do an ICO if you are doing something within the blockchain ecosystem. Say I’m building a blockchain identification system where everyone in a company is putting their personal credentials on the blockchain. If my product is on the blockchain, why not put the payment system on the same blockchain? Then you have an ICO. It lends itself really well.

Now, we have companies in our portfolio where it doesn’t make sense to sell tokens on an ICO. For example, one is cybersecurity for medical devices company. They aren’t blockchain, so selling tokens doesn’t have much of a point.

CB: Is every token in this space the same or are there different types of tokens?

RF: If you’re early in this process, you can’t call everything in an ICO a token. There’s the common type of token that represents value, like Bitcoin or Ethereum. On the other hand, there are utility tokens, which are used to buy services through a company.

Again, going back to a previous example, if I am a customer of a data storage blockchain company, and I want to buy more storage, I would use the utility token from that company.

Then there are security or securitized tokens. I’ve heard it both ways. These tokens represent ownership of a startup, and need to be protected by the SEC as if they are equity. Let me give you yet another example: You own a large number of real estate properties as part of a fund you represent. Instead of sharing partnership interests with your limited partners, you tokenize it and sell tokens, which represent the partnership interests in your real estate fund. I believe that there will be more funds, either real estate, venture, or hedge funds, that will start to participate in this practice. Tokens could revolutionize the entire fund landscape.

But why are these security tokens so exciting and promising? If you want to get into a private equity investment fund, you’ll have to have a large amount of capital and a commitment for at least 10 years. Now, if you tokenize it, it lowers the minimum commitment and expands the pool of investors, who do have to be accredited by the way, that can participate in this investment. It also makes it more liquid so investors aren’t locked up for 10 years.

CB: From your perspective, what are some of the common mistakes companies make when going through with an ICO?

RF: I think the biggest mistake for companies is being naïve about the process. It’s a lot of work and a lot money. Many companies underestimate how much time it takes as well. You need a serious legal counsel and most lawyers in the world don’t understand the blockchain market.

Another problem is the lack of understanding of why they need a token in the first place. Most startups should ask themselves, ‘Ok, am I doing an ICO to get some quick money? Or do I do an ICO because I understand the importance of a token and how it can help grow the ecosystem?’ I see too many companies that want to launch a token.

That’s why at COSIMO, we help our portfolio companies think about their options and advise them along the way.

Colin Barry is an Editor & Staff Writer to VentureFizz. Follow him on Twitter @ColinKrash

Images courtesy of ArcPoint Strategy and COSIMO Ventures