What cryptocurrencies mean for venture capital

Cryptocurrency ICOs Coins VC

By Kirsten Morin, Aberdeen Standard Investments

Venture capitalists are paying close attention to the volume of capital that has been raised via initial coin offerings in 2017, as some industry participants postulate that it could disrupt the way early-stage venture financing will be structured.

As of Nov. 30, 228 ICOs have raised $3.6 billion, CoinSchedule reports. The capital hauled in by these cryptoasset and blockchain-related projects through ICOs eclipsed that of seed-stage venture capital funding for internet companies in 2017.

The numbers have left many VCs speculating about how sharply ICOs might affect the traditional VC model. The same questions were raised when crowdfunding platforms began to gain momentum in 2008-2009.

As for the cryptocurrencies, seldom does a day go by without a prominent headline on the wires: Bitcoin is presently trading above $11,000 and Ethereum is trading more than 40x its price at the start of 2017.

Of course, the sometimes spectacular volatility has also grabbed headlines as the ecosystem rapidly develops. Blockchain technologies, which underpin cryptocurrencies and have a wide range of potentially disruptive applications, have also received plenty of attention in 2017. This has been fueled by the ICO phenomenon this year.

Comparisons between crowdfunding platforms and ICOs can be drawn, but a key difference is the staggering amount of capital that individual projects have been able to raise through ICOs in 2017. In our opinion, some of these nascent projects raised more capital than they rationally needed to launch their projects.

Kirsten Morin, senior investment manager, Aberdeen Standard Investments. Photo courtesy of the firm.

At the other end of the spectrum, we’ve seen some later-stage companies take advantage of the market’s interest in ICOs and raise growth capital by issuing tokens rather than raising traditional growth rounds that would have diluted their ownership stakes.

It is still early days, but various funding models will likely co-exist as they always have.  ICOs remain an unregulated area, and if the inflows persist, regulators will certainly step in and establish guidelines.

Governance issues with ICOs also must be considered. In ICOs, it’s hard to tell who the underlying shareholders of the assets are, which creates a unique set of challenges. In traditional equity the stakeholders are well-known, a board of directors is often established, and governance is very clear.

To date, traditional VC firms have invested little in the way of institutional capital in either blockchain-related tech or cryptoassets. Blockchain relies on a public distributed network that is maintained by each network participant. Market participants across many different industries are evaluating the potential applications of blockchain technologies.

Banks and other financial institutions are paying particular attention, given the technologies’ potential to revolutionize and streamline payments and other financial transactions. Blockchains create a continuous list of records that are distributed, yet linked and thus viewed to be secure.

Ultimately, blockchains have the potential to reduce the need for the middleman, such as banks, as the two parties involved in any given transaction could deal directly with each other.

This, in effect, could streamline transaction costs, given that each transaction would be recorded on a secure shared database that is unchangeable. That would provide an alternative to current banking processes, which are expensive and burdensome from a compliance perspective.

Already, we can see how this kind of decentralized architecture makes sense. That said, much of the investment interest to date has centered on currency speculation, such as the future of bitcoin and other cryptocurrencies. Until recently, there hasn’t been significant institutional interest in the space.

Early on, cryptocurrencies have high volatility and low liquidity, and how the regulatory framework might evolve is a significant unknown. The market isn’t yet using cryptocurrencies for significant numbers of everyday transactions, given that relatively few merchants accept it for payment and that compared with using a credit card, the processing times and transaction costs (at least today) are slower and higher.

While many have focused on currency speculation, we’ve directed our attention to blockchain tech. Blockchain has already proven useful. Now it’s about refinement and uncovering how the technology can be applied. The interest in ICOs, which are funding blockchain-related projects, has demonstrated that many others believe in the technology’s potential as well. We’re firm believers that blockchain’s utility is immense, and that with time, the use cases will be proven out.

Kirsten Morin is a senior investment manager of global venture capital at Aberdeen Standard Investments.

Photo of cryptocurrency concept courtesy of cosinart/iStock/Getty Images

Update: As a result of a merger with Standard Life, the firm is now Aberdeen Standard Investments. The column has been updated.

Digital Edition


To read a digital copy of our latest magazine

click here