What happens when projects fail?
The rush to invest in ICO's this year has led to a stark increase in capital flowing into hundreds of projects.
The speed of which this has happened has meant that there has been no real examination of what will actually happen when projects begin to fail to deliver on their promises. I believe there are four main scenarios:
The project fails
There are 143 projects as of today with a market capitalisation of over $20m (and this number would have been much higher last week). Whilst the market capitalisation of the token holdings should not be seen as equivalent to the market capitalisation of an actual company, the fact remains that many of these projects have raised large sums of money and despite this many will not be able to achieve what they have set out to. Some projects will simply realise they have failed, and there is nothing they can do to rectify it.
The major issue here comes from the vast amounts of funds teams hold from the ICO - companies that have raised $20-250m will have been unable to spend all of that on employee costs (at least you'd hope so). What happens to the money in this scenario? Well, they could liquidate their holdings and return it proportionally to token holders - but they are not legally obligated to. They could pivot to a new idea and give token holders a proportional stake in the new token - but they are not legally obligated to. Or they could limp on as 'zombie' companies - unable to fulfil their initial raison d'être, but with too much money to let them go out of business, able to pay themselves for working on a project they know they can't deliver, but which will be much more profitable than starting from scratch again.
This is one (many) reasons why a project like Tezos was an instant no to me. You cannot hand a team such a large sum of money right at the outset, as investors did with Tezos, because it removes all incentive to actually work to make the project a success. Funds should vest automatically (we have smart contracts, lets use them) at each stage of the project when needed according to the roadmap. This will avoid issues with the team being flooded with so much money they could essentially be paid to do nothing for decades, if not the rest of their lives, or wasting it on non-project specific deliverables.
An interesting scenario will be if a team does decide to return all ETH back to token holders and the sum of that ETH is greater than the market cap of the token - currently the case for a number of projects that raised funds earlier this year. In this scenario you might see a run up in the price of a 'dead' token, simply to get the ETH rebate that comes with it, in a manner similar to when a firm is to be acquired and an arbitrage opportunity exists.
The project merges/is bought out by another project
Although there is a great range of projects in the space, the sheer volume has led to a situation where there are clear overlaps in project aims (how many more DEX's do we need?). There will inevitably come a time where teams realise they would be better pooling their intellectual and financial capabilities and working together to accomplish shared goals.
In this event, the sensible move would be to merge the companies and the token offerings into a new token in a move akin to a standard stock for stock merger. Valuation could be done at an agreed average of the respective token market caps over 1-3 months (or longer, given the volatility in the space). This would provide token holders with a fair stake in the new venture and gives the company a larger community/an opportunity to avoid bad PR. The other option would be for the project being bought out to return the remaining ETH/BTC to investors or for the purchasing company to use reserve stacks (if existing) to 'buy' token holders of the other project out - i.e. give them tokens in the continued project, without diluting existing holders. In either case, the merger/buyout of the token holders could be done in an analogous process to that of the formal process for the company itself.
A fundamental part of the project is discarded
This post was partially inspired by the events this week with Monaco. I have previously written about the project, which aims to become your pathway to spending crypto in the real world, as a textbook example of how to alienate your community through a lack of communication. On Tuesday the team announced that they had secured the Visa Program Manager status they had been waiting upon which briefly sent the price spiking north of $12 (from c. $8). The price then reversed spectacularly, dumping down to sub $5. Why? Because the press release had left out a crucial bit of information - that the promised asset management contract which would have seen 1% of the transactions revenue returned to token holders - had been shelved.
I will leave aside the specious reasoning that it was removed because it would have been too much like a security (which should have been immediately obvious) and instead focus on the broader consequences. Not every project will be able to deliver what it promised at ICO. Some teams set achievable roadmaps and goals and will be able to meet those; many others overpromised and will undeliver. What happens in this scenario?
Unfortunately for token holders, it is likely that token prices will simply adjust to the 'new' project aims and holders will absorb losses. Start ups fail often and repeatedly. The difference in this scenario is that it will be most individuals, not venture capital funds, who lose out - just like all of those people such as myself who held an interest in Monaco have experienced this week.
Compared to a few years ago, I do not believe there are too many out and out scams anymore. Why? Because there's been so much money flying around that it's more profitable, and almost as easy, just to create a legitimate looking project. That said, there will obviously be some projects where the founder(s) simply take the money and run. Again, there is no recourse for investors. The SEC and other bodies may take the case up with flagrant abuses, but the chance of redeeming any investment from these projects is going to be minimal.