The Cult-Like Religion of ICOs and The End of Amazon

As an angel investor, I am always looking for transformational businesses. And marketplaces are arguably one of the strongest and most time-tested business models of all time. From early Rome and milenia earlier, merchants conducted commerce in markets. Thanks to efficiency gains for both buyers and sellers, the market thrived. Sellers could set up shop and instantly access customers. And buyers found everything under the sun, all in one place.

While initially these merchants operated caravans to cover more ground, reach more consumers and acquire more valued commodities, the model has changed. Today more and more commerce happens online. You buy an iPad, book a room, grab an Uber and get Ticketmaster tickets to the last game — all online, all in 10 minutes.

Everything is conducted online and marketplaces are the means that make this happen. They are the backbone of the modern economy and are constantly changing and evolving, adding efficiencies while stripping out waste.

(For more on the dangers of marketplaces and Amazon, be sure to read how Amazon is killing ecommerce.)

Why marketplaces make so much money

Marketplaces are like matchmakers. They hook you up with a product or service and take a small commission (sometimes from buyers, sometimes from sellers — occasionally both). Marketplaces are middlemen in the truest sense of the word. Yet marketplaces have replaced many of the middlemen of old. Wholesalers and distributors? Most marketplaces don’t need them. The reason markets have evolved as they have is the reduction of waste. Time, energy and cost are continuously optimized, making the experience better for buyers and sellers.

The network effect of marketplaces are known as the flywheel. The more travellers on Airbnb, the more homeowners want to list their properties. And of course more choices and destinations means consumers are more likely to join or refer friends… and so on and so forth.

The law of diminishing risk

The bigger they are, the harder they fall, normally. The problem with this statement is that it almost never applies to marketplaces. The reason: the larger the market, the more valuable it is for everyone involved. Everyone is winning.

This makes displacement and disruption incredibly hard. Up-and-comers must 10x the value to convert the faithful. How can you 10x a system that is ever increasing in value for its users?

So unlike most conventional business models where rewards diminish as efforts increase, marketplaces buck this trend. While direct profits are more challenging to impact at scale and individual users add less and less to the overall, every user adds buffer to the business model. Markets become exponentially more defensible — the risk goes down. Hence why venture valuations explode as marketplace companies start to reach scale. VCs recognize that much of the battle is already won in the hearts and minds (and most importantly wallets) of users.

NOTE: An important distinction — Almost all two sided networks are considered marketplaces for the purposes of this article and analysis. For example: Uber is a marketplace, and a service.

ICOs upset this balance

Blockchain business models have blown up the world of traditional VC lately. Startups, many with little more than an idea, a white paper and a vision are raising 10s if not 100s of millions of dollars. The froth is crazy. (To read about the boom, bust and re-birth of ICOs, check out this post.)

But looking beyond the absurd valuations, tokenizations and ICOs represent the largest threat to incumbents since Trump (too soon?)

And one needs only look at the incentivizes to understand why.

Cryptocurrency costs are not that important

I was speaking with a blockchain founder about a week ago. He was building a decentralized system and excited about saving the sellers money. Rather than charging 10–15% commissions, he’d charge 0.5%.

And he, like many founders and crypto-enthusiasts thought this would change the world. It won’t.

Ever reducing margins/commissions is not the way to disrupt incumbents. It will never work. Here is why.

Buyers don’t care about seller fees

Whether this is tickets, physical products, rentals or services, customers couldn’t care less how sellers are affected. It is not in their core interest to worry about saving money for sellers (use a credit card — that’s 3% immediately)

If an Amazon clone came along offering 0% commissions to sellers, would customers bite? Well Jet.com pretty much tried just that and struggled and still have yet to die. Even founder Marc Lore admits they failed to disrupt Amazon as they intended.

The reason? Buyer’s don’t care. They want options. They want convenience. And people don’t change for a 10% better solution.

Ownership is everything

What decentralized startups need to stress is the ownership. That is the only barrier holding back true disruption.

Instead of trying to convince customers to switch to save 10%, ask if they’d like to own a piece of Amazon (Airbnb, Uber, Etsy etc…). Most early adopters would say heck yeah! And even significant portions of the population would try.

This is doable with tokens. Entrepreneurs can incentivize early adopters, just like with Bitcoin and Ethereum, to become users/owners of the system. Every customer that signs up gets a token. Refer a friend, you both get another. Leave a review, same thing. Promote on Facebook, Youtube, etc and get X tokens per # of users/visitors acquired. The list goes on and on on the the buyer side.

And for sellers it is no different. List your products and get a token for every Y # of items you list. Bring customers to the site and get more.

Eventually start facilitating transactions via token XYZ and charge sellers a one token per item listing fee and you are in business.

Suddenly you have a pretty basic, easy to follow incentive structure that encourages people to try it and tell their friends. And you bet your bottom dollar they will…

The perfectly legal ponzi scheme

Bitcoin is the best example ever of a Ponzi scheme (next to Fiat currencies). Early adopters bought in at a penny, 10 cents, a dollar etc… And because of excitement over decentralizing money, and more importantly increasing the size and value of the network, crypto-enthusiasts spread the scripture of Bitcoin to anyone who would listen.

They didn’t want their friends to miss out on the action. Plus every new user meant their piece of the pie grew. Fast forward to 2017 and BTC and ETH have cult like followings with diehard religious-like fervor in converting non-believers.

I’ll bet an NPS (net promoter score) survey for BTC or ETH holders would be about a 10, higher than ANY company, government or world religion.

And the best part is that cryptocurrencies until further notice are 100% legal.

ICO or no?

The beauty of the ICO is two-fold: the tokenization and joint ownership of the network and money to build and grow.

Startups tackling enormous industries can suddenly raise serious dough to disrupt giants. And on the funding side this is working. What we cannot be sure is the execution of said startups. Many of the founders doing ICOs are weak in my opinion and appear to getting in on a goldrush.

But you should not overlook the disruptive impact of this industry.

Tokens allow users to get high on their own supply, so to speak. That gets them hooked and users become your strongest, most loyal advocates — and friends trust friends, that’s how monopolies end.

The question is, should you do an ICO or just reward early adopters with tokens? There are two schools of thought here. Personally I would never back on ICO that did not previously raise angel or VC money to build out a product. From my perspective bootstrapping the network has significant value in vetting the idea (and founder!!!).

And ICOs take at least $100k to do right. If you don’t do them right you could get screwed. The US will be 90% of the risk, with the SEC posing a significant threat. If your tokens are classified as securities (consult with a lawyer on this), you risk being shut down, fined and dragged through the legal system.

But again, you could raise $100M.

But let’s be real, if you could raise $100M, you have the connections to raise a real round. I believe you should do that first. If you are considering an ICO later on, discuss it with investors. The idea of equity and token value creates complications for investors.

Perhaps the ideal would be a little bit of both. Seed your existing users with tokens and let the mechanisms go to work. As you grow and scale, you can always do a coin offering to raise additional funds. And at this point you have proven the concept, the business and the team and can much more easily raise.

BTW we ran a Cryptocurrency Round Table with Gil Penchina (angel investor in 6 unicorns, Pryze ICO), Andy Bromberg (CEO of CoinList), Joey Krug (Augur and Pantera Capital) and Lou Kerner (venture capitalist, crypto expert) - check it out here.

Don’t forget developers

The other critical component to decentralized success is developers. Devs build the backbone of most major systems and create apps and add-ons to add value to the network.

But, rather than owning a piece of the network, they are only rewarded with only small sales of their product. This is piddling compared to the value of the network as a whole.

How much did Zynga add to Facebook before it blew up?

And decentralized means self-control. Developers don’t need to worry about Facebook pulling the plug (or copy/pasting), Apple changing the iTunes store algorithm or Airbnb turning off their APIs.

Developers could be easily compensated. Look at the value their creations create for users and distribute tokens accordingly. And because devs own a piece of the system and are incentivized to work on the chain, developers overall value grows as the network does.

And devs talk. Reddit and HackerNews are huge hubs for tech talent. And onboarding developers is one of the most important keys to success.

If Facebook and Google are offering $150k + benefits, how can a small startup compete for talent? Tokens!

And unlike a startup where early employees might get 0.25–1% of equity, the more developers build on the system, the greater the ownership stake. And the more talent they bring onboard, the numbers go even further.

Thoughts from smart folks

And as we get to the end of the article, I am going to ask you to share your opinions and thoughts on the subject. Am I right? Am I wrong?

Amazon owns the world, unless distributed systems disrupt it. Will it happen? What does the future hold?

I certainly don’t know, but our syndicate makes investments in startups changing the world and in my opinion blockchain is fundamentally disruptive. What ICOs and startups are you interested in? (NOTE: If you run a startup doing an ICO, please don’t spam it here.)

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