Buyer Beware

I got this question on Twitter yesterday:

And I responded with this:

I could say a lot more and so I will.

Whether you are buying in a private placement of securities as a venture capitalist or buying in an ICO as a crypto enthusiast, there are certain things that you need to be careful about. And right now, with all of the enthusiasm for crypto assets out there, I am very concerned that nobody is being careful about anything.

So here are some things to think about before placing your order on that next ICO:

  1. The amount raised matters, a lot. More money is not generally a good thing. I wrote a blog post about this a while back. In my experience, the startups that are careful and raise modest amounts of capital outperform the startups that raise crazy amounts of capital and are overly aggressive. I would look for capped ICOs and modest amounts of capital. Teams should raise enough money to do what they want to do but you can do a lot with $10mm and a tremendous amount with $50mm. Ethereum raised $18.5mm USD (in BTC) in their token offering and lost some of that due to a decline in BTC value. And look at what they have been able to accomplish with that funding.
  2. You should understand what the token that is being offered does and have some feel for how large of an opportunity that is. I remember friends buying hot Internet IPOs in the late 90s and I’d ask them why they were investing and they would say to me “I heard its a hot deal” and I would say “But what does the company do?” and they would say to me “I don’t know, but I know I’m going to make a lot of money.” That kind of investing is dumb. Be smart and understand what you are buying and why. And if you can’t hold the investment through to the point at which the token will have real utility and real value, you might want to think twice about buying it in the first place.
  3. Valuation matters. I know that many in startup land don’t really agree with this. There are VCs who want to be in the best deals and don’t really care what they have to pay to get into them. That might work as an investment strategy but it requires a lot of luck and market timing. If, instead, you focus on valuation when you make your investments and buy into investments at prices that make sense to you and have a model for why and how the investment will be worth 10x your entry price in 5+ years, you stand a much better chance at making solid returns. There are people in the crypto space who are building valuation models. You should follow them and understand their work. And you should try to apply that kind of thinking to your crypto investing.
  4. Avoid scams and things that feel like scams. Scams are not limited to the crypto sector. They exist in all forms of investing (and many other sectors too). As VCs we often get pitched an opportunity that has red flags all over it. You learn quickly to delete those emails and not return those calls. But an emerging sector, like crypto, where there is less regulation, scrutiny, due diligence, and knowledge, scams are going to be more common. There have already been a bunch of well publicized scams in the crypto sector and I would bet that one or more successfully funded ICOs that have already been done will turn out to have been a scam in some measure. There is a difference between a intentional scam and an accidental scam, but if you are the investor, you were scammed in both instances. Be on the lookout for scams and avoid them. The best red flag for a scam is lack of detail on the technology, how it will work, and a lack of credibility of the people behind the project. Do you homework on these investments and make sure the technology and the people are credible before you part with your money.
  5. Look for projects where the technology is well specified and is working in the wild. It is much easier as a VC to invest in companies where the product has been shipped and you can use it. I would venture to guess that more than 80% of USV’s investments over the years have been into companies where that was the case. You can use Bitcoin, you can use Ethereum, you can use Steem, you can use Zcash. These are fully functioning crypto assets that have been “shipped” and are widely used. That does not mean they will be successful, but it sure gives you more confidence that they might be successful. Investing on a white paper is way more risky than investing in a working technology that you can use yourself.
  6. Don’t be greedy. This goes for both buyers and sellers in the market. You might be able to make a killing right now. But I would suggest you resist that urge. Those who play this market right over the long term will do extremely well. But trying to make a killing overnight is always a bad idea. So for sellers that means raising reasonable amounts, not all you can get. And selling more into the market over time, as Vitalik suggests in this blog post:
    If we want to strike at the heart of this problem, how would we solve it? I would say the answer is simple: start moving to mechanisms other than single round sales. For the buyers, this means not putting all of your assets to work in one ICO, or even all of your assets into crypto. Markets can crash. You need diversification to manage risk, particularly in highly volatile markets.

I have been a big booster of Bitcoin, blockchain, crypto tokens, and the like on this blog for the past six years. I am a big long term believer in this sector. USV is investing in this sector. We are investors in token funds and I believe we will start directly buying tokens soon. So we are bullish on crypto.

However, there are many things going on in the sector right now that are head shakers to us. We have been investing in startups and emerging tech sectors for over thirty years. We have seen this movie before . We know how it plays out and we know that all is not up and to the right forever.

When people are afraid, be greedy. And when people are greedy, be afraid. We are much closer to the latter scenario in crypto right now and while I am not afraid for my investments and USV’s investments in this sector, I am afraid for the sector and those who are being the most greedy right now. I am cautioning our portfolio companies to tread carefully and we are treading carefully. And I would advise all of you to do the same.


Comments (Archived):

  1. Vitomir Jevremovic

    Would you think ICOs would be more legitimate and successful if well known VCs announced their involvement and support, or VCs invest in ICOs in secret?

    1. fredwilson

      we have been public about the projects we are involved in. we believe in transparency. i think being public and transparent will benefit everyone the most

  2. Joe Cardillo

    Not a cryptocurrency investor, but one thing that’s stuck out to me lately as an enthusiast is that (similar to the .com’s) the real leaders are the ones that acknowledge it’s an emerging market and welcome transparency, learning, and rapid development in the actual world (to point #5 about clear spec + shipping product).Re: the raise amount, much bigger problem than people realize. Never had the hammer come down on my neck personally, but watched in others and taking more money than you know what to do with is never a good idea.

  3. cavepainting

    People who launch new ICOs need to provide color and context on their fundamentals, the market they are addressing, why and how their business will grow, and why these tokens might gain in value.We expect this in seed investing, in late stage financing, and in IPOs. Why is it different for ICOs? Anyone putting their money in without asking the basic questions deserves to lose their money.Greed and FOMO can make otherwise sharp and even-keeled people do incredibly stupid things. It has been this way since the ages of the Pharaohs and it will always be. Such is the nature of the human mind.

  4. jason wright

    super post Fred. i’ll frame it on my wall.

  5. Alice

    Hay Fred, have you heard of Polybius? In my opinion it checks the boxes, what do you think?

    1. fredwilson

      no i have not

  6. Chimpwithcans

    Thanks for a great post. Question re. number 5 – How large a community should a token attract before it can be said to be working in the wild? Is there a critical mass for an investment case? I guess each case is unique. Do you have adoption models / thresholds you use, to help you make this investment decision?

    1. fredwilson

      there is no hard rule of thumb, but 100s of thousands seems like a good minimum and millions would be even better

    2. jason wright

      the number of addresses/ wallets is a tangible metric. doesn’t reveal all, but it’s a start.

  7. Robert Lyttle

    Although I respect Bancor’s mission and team, it seems odd to me that a company executing a “Token Generation Event” would allocate a portion (10%) of what is contributed/raised, to employees/early contributors/advisors. Even with a vesting schedule. Participating doesn’t award you securities despite the trend of many uninformed crypto-investors treating their tokens as such. In a conventional setting, sure. But I thought ICOs were a novel way to facilitate user adoption of the company’s monetary unit and platform at discount while crowdsourcing a development budget to materialize the proposed? It seems counterintuitive that they would create a liquidation scenario for themselves despite the fundamental philosophy of discouraging such.What’s your view on this?

    1. fredwilson

      i have not dug deeply into the Bancor deal. I know some people who have and are uncomfortable with various aspects of it. but i can’t comment intelligently unfortunately

      1. Robert Lyttle

        Interested to hear your thoughts eventually. Maybe post-worthy…We need experienced people publicly dissecting these deals. My hope is that this doesn’t become widely accepted in ICOs. Worse in this case when Bancor’s “minimum time” mechanism was extended (effectively increasing the sum of the employee pool) and then arbitrarily terminated before the new extension elapsed (which too is counterintuitive to their extension reasoning to allow as many participants to get in since the Ethereum blockchain was bogged down).It just perpetuates the problem that ICOs are becoming. Having participated in all of the major crypto offerings so far, it’s already beginning to feel like we’re regressing back to the start rather than finding equally as novel solutions to solve the common issues highly-anticipated ICOs face.

      1. rowgraus

        Very curious to hear what their email response to you was that you mention in the post above.I was interested in Bancor’s solution and possibilities, and I thought their model of providing a price floor to the token was investor friendly.However, I’ve been pretty disappointed with their handling of their ICO. I was shocked at how high the “hidden cap” ended up being (Vitalik had speculated ~$30m in his post and that seemed about right to me as well), and I also am concerned about their communication post-ICO which has not acknowledged that the ICO had issues and done nothing to alleviate community fears. If they’re going out of their way to silence you as well that’s a pretty serious red flag (in addition to the others) IMO.

  8. jason wright

    Chris Burniske’s approach is interesting. i like it. his zcash example, and a $40 billion network value by 2025, is one to ponder. the numbers and the extrapolation probably are valid on paper, however, it does seem to disregard the tech issues for that platform (and for any platform – i’m not picking on zcash here). as i understand (and please do jump in and correct me if i’m wrong) snark tech and stark tech do not solve the present limitations of transaction speed and transaction volume per second across the network. a $40 billion network will need to have solved the issues of speed and volume. is this guaranteed? no.i signed up to Zerocoin’s newsletter in December 2013. things have evolved since then, but this isn’t a mature tech. it could very easily hit a wall. many platforms could hit the same scaling wall.i love crypto tech and its potential to change the world for the better. i haven’t ventured a single new penny of my fiat since May 2016. i have rebalanced. i am waiting for fear.

  9. awaldstein

    I agree with you about the overarching logic of value and core business sense that is the connecting thread cross all businesses even in these market communities.Makes me want to go back and read Zen and the Art of Motorcycle Maintenance as even when there are new paradigms of thought (which this most certainly is) they tend to have analogs to core truths that guide us through them on steadier ground.To your idea of the rhyming of history.Thanks Fred.

  10. Tom Labus

    This post is an Aaron Judge shot to the upper deck of the stadium. Especially 2 and 3. Half the public markets have no idea why they are in any position.

    1. Sebastien Latapie

      The news and coverage of ICOs and crypto has also been insane. They have attention grabbing headlines showing how much they raised in a short time frame or how much the value has increased, with no coverage of what the coin actually does.

      1. sigmaalgebra

        “The news and coverage” is to grab people, by the heart, the gut, and below the belt, always below the shoulders, never between the ears. The goal is eyeballs for ad revenue.A little more generally, the newsies need their audience to be naive, gullible, uninformed, really, ignorant so try to keep their audience ignorant, etc. and. thus, avoid passing out solid information. Also it helps if the newsies are ignorant, and that’s always been easy for the news media.The newsies just stir up nonsense, get some eyeballs, hope their audience will forget the more obvious nonsense, and stir up more nonsense the next day.Long, with news just on paper, radio, or TV, the audience did quickly forget the nonsense. But, now, with the Internet, it’s easy to accumulate a collection of the nonsense and a list of the offending newsies and media companies.People have long known that the news was garbage: E.g., there’s a 1930s Andy Hardy movie where Andy is laughing at the nonsense level of the news; the movie makers understood that the movie audience would understand and agree quickly.E.g., there is Jefferson’shttp://press-pubs.uchicago….The news was garbage then too.With the Internet, there is an opportunity to have many more media companies, and some of those can step up and out of the nonsense sewer and start to provide information, at first on relatively narrow technical topics.IIRC this week I read that Time will lay off 200 or so people. No wonder. I used to subscribe to Time; eventually I concluded that it was all just newsie nonsense and refused to pay attention again. So, Time learned that they can’t sell nonsense. Okay.Newsweek? IIRC it sold for $1, and that price may have been too high.NYT? Last I heard, they’ve mostly moved our of their building, leased the space to others, and are working out of somewhere else. But their nonsense continues. Really slow learners.WaPo? Sold for next to nothing, and that was likely more than it was worth.The mainstream media (MSM)? Propaganda for the Democrat party.MSM financial values? Headed for the toilet where their content has long been, back to Jefferson. Good riddance.

      2. Vasudev Ram

        Sounds like the dot com boom, and if so, a bust like the dot com bust is likely coming (“eyeballs”, FFS). Head for the hills, greenhorns!:)”Those who cannot remember (or learn from) the past are condemned to repeat it.”-

    2. pointsnfigures

      Agree 100%. And that was a helluva shot.

    3. Girish Mehta

      “We are all at a wonderful party, and by the rules of the game we know that at some point in time the Black Horsemen will burst through the great terrace doors to cut down the revelers; those who leave early may be saved, but the music and wines are so seductive that we do not want to leave, but we do ask, ‘What time is it? what time is it?’ Only none of the clocks have any hands”. – Adam Smith (George Goodman).

      1. Tom Labus

        I’ve stayed too long so many times but the hangover can be brutal. Great quote too

        1. Girish Mehta

          I remembered your comment about this, and thought you’d like that extract.There’s wisdom in those lines. And good writing.

      2. Vasudev Ram

        Fantastic quote, hearing it for the first time.Reminds me a bit (by some of the words) of the Hotel California song.…”Last thing I remember, I wasRunning for the doorI had to find the passage backTo the place I was before”Relax, ” said the night man,”We are programmed to receive.You can check-out any time you like,But you can never leave! “…

    4. creative group

      Tom Labus:the fundamentals are not fundamentally sound. Reason we are out of this Shark Tank.Let all the Mr. Wonderful’s continue to fund .

  11. William Mougayar

    Amen. I’ve been saying similar things differently, but more bluntly, and by calling out 2 of the recent red flags in the greed category I saw: Bancor and IOTA.This is so true:”nobody is being careful about anything.””There is a difference between a intentional scam and an accidental scam, but if you are the investor, you were scammed in both instances.”Many of these companies are running on, and selling their story on the most optimistic scenarios, where everything will happen perfectly, and up to the right we go, with teams of 2-12 people, some on their first startup. This also reminded me of 99-00 when I was tracking and publishing these IPOs for the Business 2.0 magazine as part of my B2Index, and there was a feeling that the sky was the limit, until it wasn’t anymore. I tweeted this yesterday:

    1. Sebastien Latapie

      Spot on!

    2. prankeapple

      Yes – the Bancor ICO was a clusterf*ck. I think the even more damning occurrence was that the entire ETH network was clogged while it was happening. So many people are disconnected from the reality that Geth and Parity are still quite immature, and that writing software to multiple implementations is hard, takes a long time, and will likely result in production bugs of varying degrees of severity, especially with crypto where attackers have massively huge financial incentives and the ability to hide themselves with relative ease.Another thing that worries me is the demographic composition of ETH holders. Increasingly, ICOed projects are acquiring large amounts of ETH. Will they panic sell en masse when the price starts plummeting in order to ensure they have sufficient development funds for the foreseeable future? If so, will that cause a downward feedback loop in the markets? We live in “interesting times.”

    3. Vasudev Ram

      Same thing had been happening for the last few years in the Indian startup scene, particularly the e-commerce sector. After some high-profile disasters, bailouts, buyouts, layoffs, etc., I’m now reading (e.g. in ET Tech news) that startups are now trying for profits. Duh.

    4. avip

      Very interested to hear your reasoning why Bancor is a scam (or ‘red flag’).

      1. William Mougayar

        They abused & milked what could possibly be done via an ICO, while marketing the token sales quite aggressively. I have written up on it:http://startupmanagement.or

  12. awaldstein

    So where do ‘meme markets’ play into this?Basically themed crowdsourcing not tied to a model or performance.https://uploads.disquscdn.c

    1. LE

      That’s hilarious. Remember back in the day how Playboy (or was it Penthouse?) used to get all sorts of free publicity by saying they would pay some celebrity to pose nude? Most of the time they never had to pay the money. Because the celebrity would turn them down. But they would still get the publicity.A twist on this meme therefore would be another coin offering to send another celebrity to North Korea and pay expenses. That has even less chance of happening but would definitely gain favorable attention (until it became overused).

  13. iggyfanlo

    FredI’ve been following your and Albert’s comments on crypto and blockchain for years and they all made great sense.You’ve also quoted Carlotta Perez and her innovations model (roughly) of “irrational exuberance–>trough of disillusionment–> useful deployment”…In addition, I’d argue/agree with many other commenters that the “usage value (e.g. currency)” is FAR exceeded by the current “hoarding value (e.g. gold)”. These two things need to be close to or at least trade around equilibriumAlso, given the glut of capital, the irrational exuberance seems to be on a path to almost unprecedented heights (Tulips in Holland in 1700s??)Finally all stages seem to play out faster than the previous onePutting this all together… Feels like the trough of disillusionment is inevitable and not too far away

    1. David Spencer

      Common misconception. Tulipmania was the result of nascent day trading (it was, in fact, midnight trading while very, very drunk) in Dutch pubs combined with the invention of an unregulated futures market + derivatives.The largest contributing factor was the quality of the bulbs, which rapidly deteriorated over the winter of 1637-38. Ultra-scarce variants like Semper Augustus were still highly sought after by wealthy collectors after the crash.

  14. ZekeV

    No one knows how to value an ICO token. As Nick Szabo said, this problem creates a misperception similar to Pascal’s wager. My personal selection heuristic is not to buy any asset that has an automatic developer distribution, whether before or after publication. This admittedly does not look very good compared to say, someone who just went all-in on Ethereum.

  15. JLM

    .Excellent advice on a subject which is like “Radioactivity for Dummies” or “How it is safe to play with radioactive materials at home — what could go wrong?”JLMwww.themusingsofthebigredca…

    1. Vasudev Ram

      Famous last wor

      1. Matt A. Myers

        Unfortunately it could spread and contaminate the rest of societ

  16. pointsnfigures

    The hot deal. Seen em turn pretty cold. The hot trade. Seen it turn pretty cold too.

  17. LE

    and a lack of credibility of the people behind the projectIn business credibility definitely matters and is a big factor, but there are also cases where credibility is what got someone to be able to scam in the first place. [1] Some of the best con artists are people that nobody would have expected to be doing a con. The reason for this is simple. When (as I like to say) evil shows up at your door it’s not going to look like evil. Most people are aware and alert enough to stay away from that.[1] Madoff

  18. Vince Kuraitis

    It’s becoming almost conventional wisdom that the cryptoasset market is in a bubble phase. Not so fast.I think it’s worth offering a distinction here for consideration. I see two classes of assets.1) For Bitcoin and Ethereum (and perhaps a few others), network effects have kicked and are playing out strongly. While there will continue to be volatility, I don’t see a bubble here.2) Others are still early stage — network effect critical mass has not been reached — not yet past the tipping point. Crashes very possible.I understand that this distinction might not be very meaningful to those who have a sophisticated understanding of the cryptotech/asset world.However, for a minute, put on a “mainstream” investor/businessman hat for a minute — and I think the distinction paints helps rationalize an otherwise broadly painted CW re “bubble”.

    1. JamesHRH

      I tend to agree – crypto is not on radar in MSM.

  19. Liam Horne

    Hey @fredwilson:disqus , is having more VC funds create their own crypto funds / allocations good or bad for the ecosystem (agnostic of if the money is “smart” or not)? I’ve been thinking about this lately, and it seems like there is already far more capital than is needed, and the real focus should be on talent to build the underlying infrastructure which, as far as I can tell, is simply not there yet.

  20. Evan Van Ness

    Great post. One of the reasons I’ve advocated for reverse dutch auctions in this space is that it gets us closer to multiple rounds or even continuous rounds

  21. creative group

    FRED:Great post.We are unable to justify entry with the current unjustified multiples with little reasoning behind the why. Bubble on thehorizon the tea leafs are saying.

  22. prankeapple

    Good post.I’d take exception with point 3 – I don’t really think it’s possible to meaningfully value a lot of these ICOs with a single framework. It’s the same issue you encounter when you try to do a DCF analysis on a traditional tech company which doesn’t start earning cash flows until time t=10 (or higher) and all the value is captured by the terminal value component. Except in this case, it’s on crack. And I think where that leaves you is having to do good old fashioned thinking from first principles, looking especially carefully at the teams and the ICOs’ business models and tech architecture, not to mention their levels of abstraction in the blockchain stack. Olaf is right – infrastructure is the play right now.Ultimately, a lot of the success or failure of these ICOs will be determined by whether Vitalik & Co. can deliver on scaling. Most buyers don’t understand that, and hence don’t think in terms of contingent probabilities of success (there’s no way your ICO will be successful if ETH is unsuccessful, but ETH itself can be successful while your ICO can still fail), which causes them to massively overvalue these investments.This whole market reminds me of that scene from “The Big Short” when Steve Carrell is talking to a stripper in Florida who owns 6 houses:

  23. Inna Raykhman

    “And if you can’t hold the investment through to the point at which the token will have real utility and real value” – how long would that be? For a startup to become at least somewhat liquid it takes 7-10 years or longer, is it faster for a cryptoken related investment? or is it only faster now because we are in the feverish stage?

  24. mplsvbhvr

    Hey Fred (or anyone else) – just curious if anyone looked at since it swims in the VC/Crypto universe.

  25. Fraser

    Buyer beware. But also: buy and be aware. Best way to learn is to use.

  26. rogerthat33

    Please explain to me: why would any of these tokens be worth anything? They don’t represent equity. They may or may not represent value to be applied towards a particular service (if it ever comes to fruition). Why wouldn’t you just wait until the service is up and running and if you want to use it then buy the tokens? Maybe i’m missing something, but this seems like the biggest scam i’ve seen in a while.

  27. Brian447

    You think ETH is gonna over take BTC in market cap this year, so you’re shaking your head at some of the stuff you see happening in ICO but I’m shaking my head at you bying into ponzi tech..just cause you got money doesn’t mean you understand decentralized blockchains.

  28. fredwilson

    maybe. history doesn’t repeat itself but it does rhyme

  29. pointsnfigures

    all the time