Basic ways to finance your project: the differences between ICO and crowdfunding

The modern digital world has witnessed the creation of fundraising platforms due to the growing need for real opportunities for developing small private businesses, as well as the financing of innovative ideas that have come to us via the internet.

Long before the ICO model entered the market and made a small coup, platforms that made it possible to promote and finance online projects enjoyed considerable popularity. The most significant and major representatives of this business, of course, is Kickstarter and IndieGoGo.

Currently, promising start-ups have the opportunity to use another means of raising funds, an alternative to classical venture funds — an ICO. Nevertheless, both models currently exist and each of them has obvious advantages and disadvantages, their own pros and cons. Let’s take a closer look at the ICO and crowdfunding models and compare their strengths and weaknesses.

The rise and fall of crowdfunding: from the first success to serious problems

The first case of a successful fundraising with the help of the public was recorded 21 years ago — in 1997, the British group Marillion successfully raised $60,000 for their successful American tour.

However, this model of financing only became seriously popular after a little more than a decade — when the development of specialized sites such as Kickstarter and IndieGoGo began. Over time private business also went online. But despite the fact that the amount of money invested by the public grew every year, the main problem was still not solved. The growing number of technological solutions had seriously increased competition, while different ways of financing independent projects had not been created.

The undisputed market leader among crowdfunding platforms is now, of course, Kickstarter. The platform, launched in 2010, demonstrated consistent growth of almost 200% annually, but since 2014 the situation has begun to change. At the same time some serious problems began to manifest themselves.

Nevertheless, as the number of ambitious projects increased, the total amount of funds raised eventually reached tens of millions of dollars. Unfortunately, some of the extremely expensive projects have turned out to become an excellent example of successful fraud and how to deceive a gullible public. The other, negative side of the coin is dissatisfaction with the final product after its release, which has happened to more than one investor.

The most striking example is the story of the team that was behind the creation of the Coolest Cooler. The project raised $13 million but did not fulfill its promises, with the result being that the people who invested in it lost quite impressive amounts of money. Another example of significant losses was the Ouya micro video console which cost its investors almost $9 million. The project was successfully financed but the final prototype turned out to be completely different from what was expected — despite the hopes of users, its sales slumped. Also worth mentioning is the infamous Zano drone project which removed $3 million from the pockets of its investors.

At that time Kickstarter was one of the most successful European fundraising platforms. But after 12,000 investors expressed extreme dissatisfaction with unfulfilled promises from developers and poorly functioning final prototypes, there was general disappointment in the platform. The crowdfunding model was undoubtedly a gold mine for video game developers — many teams collected huge amounts of money, but their projects often did not even reach the beta stage. Others focused their efforts simply on theft — for example, the developer of the indie project «Mansion Lord» simply disappeared several years ago, along with the $30,000 they collected.

All of these stories have significantly influenced the popularity of Kickstarter: during 2013 more than 44,000 campaigns were started on the platform and in 2014 their number increased to 67,000. Then in 2015 there was a slowdown in growth — only 77,000 projects. In 2016, the number of campaigns created decreased to 58,000. Based on this a rather negative outlook can be made for the future. That is, of course, if the rules of the game on the platform remain unchanged.

Another serious problem is that the platform’s original idea, to develop and finance independent projects, was blurred at one point and was almost completely lost. After the repeated success of individual small projects, stable large-budget companies came to the platform which already had enormous financing.

The indisputable fact is that even more significant investments lead to even more significant losses.

There were new schemes of fraud using several hundred or more users, when companies financed the initial successful launch of the project from their own pockets — just to get real users involved in the project through hype (and not ideas). Because of such dishonest practices, the chances of small developers and ordinary enthusiasts to be successful have decreased significantly. Without proper investment in PR campaigns and internet traffic, they risked either not collecting anything at all or failing halfway.

According to the official statistics of the platform more than $3.3 billion in investments have been attracted since its launch. 13.6 million users have supported at least one campaign and the total number of successfully financed projects currently stands at more than 132,000.

If measures to regulate domestic competition are not taken in the near future, large players from the business world will continue to influence an even greater reduction in the number of independent projects on the platform. In addition, fraud, deception, and failure to meet obligations by the project organizers have not gone away.

With the growing demand for independent funding, the number of crowdfunding sites is growing. But they have basically just copied Kickstarter’s functionality and added a number of minor details. However, with the development of blockchain technology and the emergence of ICOs, independent entrepreneurs finally got a real chance.

ICO features

An ICO is a crowdfunding campaign based on blockchain technology. They have much in common with traditional crowdfunding, but also have a number of significant differences. Originally, an ICO was a variant of crowdfunding which specialized in cryptocurrency projects that did not want to work with traditional venture funds and capital because it would mean the loss of their desired independence.

The most important difference between an ICO and crowdfunding is the nature of the asset that the investor acquires. In the course of crowdfunding, projects receive real fiat funds from their investors and this is, in fact, an advance payment for the final product. An ICO, on the other hand, involves the purchase of a digital token for use by the investor after the project is launched. In most cases, tokens can be sold on a crypto-exchange and some investors even have the opportunity to receive exclusive shareholder rights.

ICO organizers seek investment in the project from a specific, interested community where funding is likely to be made using Bitcoin or other cryptocurrencies. The nature of these digital assets allows you to send them to the recipient anywhere in the world quickly and practically at no cost, all the while avoiding the traditional banking system. Undoubtedly, these benefits will be appreciated by everyone who has ever transferred money abroad.

It should also be noted that over time fundraising has ceased to be the most important part of an ICO — tokens are often bought because they can be used as a local currency to perform various actions on a platform specially created for this.

2017 showed a real boom in the growth of ICO projects. According to CoinSchedule, the number of successful and active ICOs increased significantly last year from 46 in 2016 to several hundred in 2017. As of the end of 2017, Bloomberg reported that funds raised in the United States through an ICO exceeded $4 billion, citing data from Autonomous Research LLP.

Unfortunately, there is still a lack of solutions that would make it easy for investors and start-ups to find each other because technological complexity sometimes goes beyond the understanding of project participants, and even between the developers themselves and the organizers.

In addition to their approach to financing, there are other significant differences: the principles of an ICO and crowdfunding do not coincide as much as their audience.

The main differences between an ICO and crowdfunding

1. Product

By investing in crowdfunding projects, investors pay for the result of the work of a specific team in which they are interested — roughly speaking, the final product. Investors in cryptocurrency projects are mainly motivated by the ability to quickly earn money or promote new technologies in specific areas. In the first case, funds are invested in the product, in the second — the idea or concept is financed.

2. Campaign duration

Preparing and running a campaign for crowdfunding projects takes a lot of time. For example, it took LHV two long years. Crowd funding is not best suited for independent startups. The only exceptions are campaigns funded by venture capital investors.

An ICO, on the other hand, can take place much faster — from weeks to minutes, and even seconds! For example, Brave, an internet browser based on blockchain technology collected $35 million. And although this is not so much by the standards of the modern ICO market, an important detail is that the full amount was collected in just 24 seconds. And after a week, the project investors achieved an amazing profit of 676%. A recent example is the launch on December 27th of Singularity Net which was developed to create a decentralized framework based on artificial intelligence based on blockchain. In just 66 seconds the project raised $36 million.

3. Financial features

Even the largest crowdfunding projects with a multi-million dollar budget, as mentioned above, can fail or even turn out to be fraudsters. The investor must first invest his money and then wait for the company to start creating the product. The money may be lost if the product simply fails. In traditional crowdfunding, users lose their investments made in fiat funds.

In the case of an ICO, an investor can track what is happening with the project and so the potential benefit for future investors increases several times as a result.

4. Accessibility for the investor

Currently, most crowdfunding projects are limited to a specific region or a specific country native to the developers. Although there are global projects also, there are not many of them in contrast to ICO projects.

On the other hand, many people can participate in an ICO since crypto projects are usually available for a wider range of countries and regions. Many ICOs have gathered investors from all over the world, since they were accessible and well advertised on social media networks. Although some new ICOs have put restrictions on the sale of tokens and the opportunity to join the project as investors, most people can still participate in them.

5. Investor confidence

Unlike the dynamically growing market for ICO projects, crowdfunding platforms, in particular Kickstarter, are inferior not only in growth rates but also in the steady reduction in the number of completed projects. Total statistics: in 2015, this figure was 22,000 projects, and in 2016 went down to 18,800. The percentage of successful projects from 2011 to 2014 ranged from 45 to 50% on average, and in some categories from 20 to 25%. Things are a little better in budget projects with financing up to $10,000 — 69% of them are being completed successfully.

6. Regulations

Existing crowdfunding platforms are registered and regulated by law. It is expected that by 2025 this promising market will reach $96 billion.

Not surprisingly, the governments of some countries have already established specific rules that define the requirements for crowdfunding projects and their obligations. One of these rules is the JOBS law, issued in the U.S. in 2012, which states that only qualified investors can invest in projects. If we talk about Europe, France is the only country that can exercise state control over crowdfunding in the European sector.

Currently, ICOs are still not regulated (in the overwhelming majority of cases), which results in the fact that ICO investors are still exposed to certain risks. They cannot be fully protected and because of this many have already lost their money. According to Chainalysis, as of 2017 fraudsters have appropriated about 14% of funds raised by projects through an ICO — approximately $225 million of the total $1.6 billion. As a result of these fraudulent activities, about 30,000 investors have suffered losses with an average of $7,500.

Cybercrime in relation to the financial means of investors is growing faster than the number of investments attracted through ICO. A significant increase in both of these indicators has become particularly noticeable since March of 2017.

The U.S. Securities and Exchange Commission (SEC) recently charged companies associated with ICO fraud for the first time.

Other risks include technical errors in smart contracts that underlie the ICO process. One of the most prominent examples is the project The DAO which raised more than $150 million and lost one third of its funding due to a vulnerability found by hackers in smart contracts.

The first regulated ICO was the Filecoin campaign which collected a record $252 million in less than an hour.

7. Awards and profits

Crowdfunding investors usually do not expect any substantial rewards. Companies or enthusiasts who launch their projects may offer interesting, but useless, rewards: T-shirts, a copy of the final product after its release, or given thanks in the credits. In other cases, the reward model involves the ability to pre-order the product.

ICO members receive tokens according to the amount they contributed. Some released tokens provide access to services that the platform will offer in the future. The ICO may also link shares to a token, which provides voting rights and access to future dividends. A typical example of the use of issued tokens is the creation of assets that give access to project functions. In addition, some types of tokens can be considered a delayed earning opportunity, since investors often expect the value of the token to increase.

Summary

Both models, an ICO and crowdfunding, have many significant advantages and opportunities for their use. At first glance they may seem similar, but they are distinguished from each other by a number of key aspects. Traditional crowdfunding is regulated and less risky for investors and projects, while an ICO is a convenient, fast, and easy way to raise money.

In some cases, the amount of funds raised may even exceed the amount needed to start a project. So technical progress always wins: there is no doubt about the future triumph of new technologies, such as blockchain startups.