Entrepreneurs can boost venture capital by using initial coin offerings (ICOs) as a marketing tool, authorizing crypto tokens, and devoting to concede only those tokens as billing for their products in order to fund the venture startup. The ICO mechanism allows entrepreneurs to generate buyer competition for the token, which in turn increases its value.
On venture capital projects, the return on investment is not dependent on token supply growth, which allows for the maximum amount of initial funding to be raised as token supply growth is set to zero, encouraging early investors. Yet, tokens are only in demand for a short time frame, so the potential for raising funds is curtailed compared to traditional equity financing. A monetary policy that lacks consistency inhibits savings, thus creating inflexibility in future capital raises when using tokens to fund start-up costs. A cryptocurrency token can also act as a communication channel between stakeholders in a digital ecosystem if the ecosystem is network-induced.
This article explores the economic and behavioral factors that influence an entrepreneur’s decision to use initial coin offerings as fundraising.
Table of Contents
Introduction To Initial Coin Offering
In response to the growing popularity of cryptocurrencies as payment methods, many startups have adopted an approach known as an Initial Coin Offering (ICO) as a means of introducing their own cryptocurrency. Since its inception in less than a decade, this new method of fundraising has become the preferred method for companies in the blockchain industry.
To simply put it, an ICO is a way for a startup or project to raise capital by selling its new cryptocurrency to the public for the first time. A new type of cryptocurrency is created through an ICO on an existing blockchain protocol, like Ethereum, or based on its own protocol. When an ICO is launched, the initial price will be set by the project team. These cryptocurrencies might be used as currencies or tokens by investors in a future product, depending on how these projects are designed. From that point forward, the price of a specific cryptocurrency will be determined no longer by a central authority but by supply and demand in the market (Kastelein, 2017).
In the form of an initial coin offering (ICO), new mechanisms for funding entrepreneurial ventures have been developed. A venture offers an ICO in which it sells stock of specialized crypto tokens, which upon issuance will be the only method of exchanging funds for the venture’s future products. Token sales provide capital for initial development, however, the future price of products is not guaranteed. The amount raised by blockchain startups through initial coin offerings has exceeded $7B since 2017, while traditional venture capital firms only raise $1B. US-based teams received 33% of all ICO funding, and over 200 ICOs raised more than $10M.
The internal financing of small businesses often restricts their growth. A startup’s access to capital is critical to its success. This is especially true for capital-intensive, high-technology startups. In order to accomplish their business goals, an entrepreneur must find sources of capital for their startups, as choosing which types of capital they will use can have a drastic impact on their future growth and success. With the advent of blockchain technology, startups are increasingly using initial coin offerings (ICOs) also known as token sales to fund their operations.
Entrepreneurs use ICOs to raise capital by offering digital assets (Coins and Tokens) to investors (Token holders are also known as the investors). As soon as the project is launched, these tokens serve a variety of functions and services within the issuer’s network. It is certain that ICOs differ in some respects from conventional financing methods such as venture capital (VC) and business angels (BA).
It has been observed that ICOs typically raise more funding than most traditional funding rounds, particularly at an early stage. ICOs distinguish themselves from traditional crowdfunding as the blockchain technology transfers certain of its connotations and features into the ICO’s qualities, such as accessibility, transparency, inviolability, and decentralization.
The technological potential of this technology may not only restrict those who can utilize it to their advantage, but also attract an entirely different set of investors. Therefore, ICOs have the potential to give rise to innovation in society as well as technology. In this regard, ICOs represent social and technological innovation. There is no doubt that the analysis of such novel phenomena may be used for the development and extension of existing theories.
ICO awareness is rapidly growing in regard to entrepreneurial finance. Due to the increasing use of this funding vehicle by startups, interest in this topic (ICO Startup Funding) has grown beyond the field of entrepreneurial finance to the field of entrepreneurial decision making. Various aspects of entrepreneurship financing have been studied in the academic literature, including capital structure, equity versus debt finance, and the interaction between demand and supply of financing.
We analyzed some data and developed a decision-making model that has four main components, which serve as the main elements of our study to understand why startups decide to perform an ICO: Among the factors at play are (1) funding, (2) community building, (3) Tokenomics, and (4) personal and ideological factors.
An ICO satisfies both the financial as well as personal dimensions, thus reflecting the behavioral and economic factors that prod firms and entrepreneurs to consider it. Entrepreneurs’ reasons for pursuing an ICO range from merely seeking funding to pursuing a broad spectrum of goals. As a result of lacking traditional attributes that venture capitalists evaluate, blockchain ecosystems and the entrepreneurs within them have developed distinct identities, which are expressed in varying degrees of approach to entrepreneurial selection, decision-making, and management, which, in turn, influence funding selection.
The ways in which entrepreneurial endeavors and processes are shaped have been greatly influenced by blockchain technology. The concept adjusts the context of entrepreneurship, by enabling entrepreneurs with nontraditional ideas to access financial and non-financial supports in order to take their ideas forward, thus diverging from traditional entrepreneurship paths.
Furthermore, the technology reshapes agency structures and facilitates a multidisciplinary collaboration of stakeholders, rewards, and democratizes decision making in early-stage startups, which leads to a more collaborative approach to entrepreneurship based on community building.
In tandem with these technological advances, founders and entrepreneurs also demonstrate a strong sense of their social identity: social cohesion, shared value creation, and a shared commitment dictate the economic interactions among entrepreneurs, communities, and technologies. By becoming a manifestation of both technology and a social network, the ICO becomes more than just a showcase for the underlying technology.
Blockchain And Distributed Ledger Technology
With the introduction of Bitcoin, Satoshi Nakamoto (2008) unveiled a revolutionary new distributed protocol (referred to as blockchain and distributed ledger technology). Providing consensus in permissionless environments (that is, networks where anyone can join without having to reveal any identity information). Nakamoto created a distributed public ledger that fosters trust among participants without the need for intermediaries or central authorities through cryptographic hash functions, computational puzzles, and economic incentives.
The network (collectively known as “nodes”) reports transactions in blocks and verifies their validity across each node. After a majority of participants in the network have reached a consensus on the ledger’s state, the transactions will be recorded permanently in an observable form that cannot be modified or reversed.
The consensus mechanisms make it possible for nodes across a distributed ledger to agree on how transactions should be validated. In DLT technology, determining who validates the next block is of vital importance. This is accomplished through the use of a consensus mechanism. DLT permissionless networks are typically characterized by the simultaneous validation of multiple blocks by many nodes.
A consensus mechanism may take many forms, with the most common types being Proof of Work, Proof of Stake, and Byzantine fault-tolerance.
Proof of work (PoW) systems are based on the principle that each node validates the next block by completing a challenging computational task. Ultimately, the solution to this challenging computational task is the “proof” of their accomplishment. In calculating whether a new block is validated, the computational power devoted to the task is taken into account. Each node (miner) is rewarded with crypto assets and/or transaction fees for validating a block.
A Proof-of-Stake (PoS) is a consensus mechanism based on a stake in a distributed ledger system (such as, the magnitude of accumulated value) that replaces computation-intensive calculations when reaching consensus. Proof of stake (PoS) holds that owing to the user’s direct investment in a particular system to take part in consensus, there is a greater likelihood that they want to see this system succeed rather than destabilizing it. It can be said that a stake is an amount of crypto-asset or token that a user has invested into the DLT network. As part of the PoS consensus mechanism, nodes that are first to successfully validate a block are rewarded with transaction fees that are included in every consecutive block. Another method of implementing proof-of-stake is the delegated proof of stake (DPoS). Under DPoS, a number of nodes are declared and selected to do all the work of creating and validating the blocks on the network.
During the operation of DLT systems, you might encounter Byzantine faults if abnormal behavior is observed on some nodes (In this situation, the Byzantine FT approach is applicable). This problem has been solved by designing and implementing the BFT-based consensus algorithm, ensuring that the distributed ledger system can function normally, even when there are abnormal nodes on the network. Byzantine fault tolerance (BFT) refers to a computer system’s ability to resist failures spawned by the Byzantine Generals’ Problem.
As a result, a BFT system is capable of continuing to function even if one or more nodes fail. Despite the presence of abnormal nodes, the distributed ledger system remains functional. The BFT consensus model places a high emphasis on participation and communication throughout the network so that all nodes in a network are involved in the consensus process. So it’s a better fit for systems with fewer nodes, like small ones. The BFT protocol is also used only in permission distributed ledger systems because all participants must agree on the list of members.
Types Of Distributed Ledger Technology
Three types of DLT systems exist Permissionless, Permissioned, and Hybrid.
Having read up until this level, I want to believe that you already know what permissionless DLS is all about. The permissionless distributed ledger enables anyone to validate blocks without authorization. A permissionless distributed ledger system requires no permissions from users. In many cases, its systems are implemented by means of open-source software that’s freely downloadable by anyone who wants it. The permissionless digital ledger technology is capable of allowing anybody to create an address and interact with the network. Creating a website of your choice is possible on the internet because it is a permissionless platform. The same can be said for permissionless DLS. Anyone can create a blockchain address and interact with other participants. Permissionless DLS, in the context of Business-to-Consumer (B2C) and consumer-to-consumer (C2C) business cases, is increasing in popularity.
Meanwhile, permission-based distributed ledger systems require authorization. A Permissioned distributed ledger must allow only authorized users to validate blocks. Because the distributed ledger is maintained by only authorized nodes, access to it can be restricted, as well as who is able to conduct transactions. Those involved in a consortium run a Permissioned blockchain. A blockchain network is formed by a stakeholder agreement in a Permissioned DLT. In the blockchain, only preapproved entities are permitted to run the nodes responsible for validating transactions and executing smart contracts. By allowing access only to selected blockchains, trusted information can be shared in a secure manner, and data can be protected with the confidentiality businesses depend on.
Hybrid Distributed Ledger Systems
With hybrid distributed ledger systems, you can enjoy the security and transparency of Permissioned distributed ledgers and the privacy benefits of permissionless distributed ledgers. The flexibility this creates allows businesses to choose what data to make transparent and public, as well as what to keep private.
DLT Ecosystem From A Business Perspective
A DLT ecosystem’s business sector is made up of users, developers, investors, block producers, and corporations.
The DLT user is someone who utilizes a DLT application, product, or service to accomplish a specific task, such as transferring assets. Investors provide the capital needed to create the DLT ecosystem. Many investors aim to address social and economic issues as part of their values and mission.
In DLT networks, block producers are full validators that actively participate in the consensus process. Mining is the process by which DLT systems use PoW to validate transactions. Miners intend to earn a profit by validating DLT transactions. The Bitcoin network, for example, is a highly complex and computationally-intensive puzzle on which miners compete to produce the best solution. In exchange for their work, they receive bitcoins.
The use of DLT by corporations for business activities often leads to the dissemination of new technologies to large groups of customers or end-users. Through these platforms, end-users can conduct transactions with greater ease, communicate more effectively with other stakeholders, which will help them with their time and money management while the corporation itself will gain from enhanced data security and integrity. It is important for corporations to comply with legislation and regulations when using DLT. It is the developers who create DLT applications, products, and services. Their responsibilities include developing distributed applications and providing technical support.
A Global Approach To Unlocking Individual Investors’ Capital
ICOs are considered a more advanced form of traditional crowdfunding. The main advantage of ICOs, on the other hand, is that they do not require any intermediary platforms, such as Kickstarter or Indiegogo. In addition to more funding opportunities, the ability to access capital from a large number of investors simultaneously on a global scale frees up a crowdfunding platform’s limitations and costs.
According to one founder, an ICO is similar to crowdfunding, albeit much more ambitious.” Further, individual investors are perceived to not have the same agendas as traditional venture capitalists, making them more likely to consider ideas that wouldn’t be supported by traditional venture capital, such as open-source projects or technological innovations that are hard to commercialize.
The list also includes startups from countries without institutional funding in order to avoid being overlooked by venture capitalists since their markets are too small or their financial infrastructure beyond analysis (Eastern Europe, for instance). It makes no difference where the startup is located when it is an ICO. Despite this, many of our startups were not aligned with a specific geographic location because they were often made up of multiple employees and entities that formed virtual teams across the globe.
ICOs, which have a volume of roughly US$31 billion, has provided startups with a significant advantage. Due to the large amounts of funding raised by this and other competing startups, many saw the ICO boom as a way to take advantage of the current economic climate. A CEO reflected: “We encountered groups that did not have the same level of knowledge and technology as us.”. They had only a white paper but raised millions and millions of dollars. Considering the technology needed for blockchain startups, these were also thought of as the “way [to] raise funds”. Startups that raised funds prior to the 2017 ICO hype will tend to do better than those that raised funds just after.
In the case of startups, ICOs are a way of evaluating the market potential of their ideas. Startups can gauge market demand and future customer willingness to pay without incurring a heavy upfront investment in R&D by selling tokens for products they intend to develop. Due to its disruptive quality, blockchain technology presents a higher level of risk and uncertainty to products and services than more conventional B2C offerings. By creating a token price, startups can assign value to their products and reduce unknowns with their market entry strategy.
Blockchains enable startups to decentralize decision-making by creating a transparent ownership structure. Startups use ICOs to distribute voting rights within the network after being inspired by “The DAO” (decentralized autonomous organization), one of the earliest attempts to form a decentralized autonomous organization.
A certain distribution of bandwidth is essential to the operation of certain protocols because it incentivizes the nodes to confirm just valid new transactions to the ledger. Nevertheless, it can also be used to vote for decisions within organizations: “The organization is autonomous and distributed.”. This implies that decision-making authority does not lie solely with organizations. Therefore, token holders can vote on advancing a business strategy, developing new product features, or deciding how the organization structure and personnel will be built.
According to this article, entrepreneurs who choose to use initial coin offerings to fund their startup operations are motivated by a variety of economic and behavioral factors. With the rise of ICOs, blockchain startups have gained access to a massive amount of capital, driving billions of dollars into the ecosystem while competing with traditional funding vehicles such as BAs and VCs.
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