The lessons IEO investors can learn from Venture Capital
IEOs are a form of early-stage investing available to retail investors. This article considers what lessons can be learned from venture capital in order to source liquidity and manage risk.
The Initial Exchange Offering (IEO) boom can be seen in the context of the wider venture capital (VC) and private equity space. Credible blockchain startups are using IEOs to bolster VC funding. Instead of buying company equity – an IEO allows retail investors to invest in the potential utility of a company through its token. In this context – projects with an existing product that provides real token utility are more attractive.
Follow the smart money
The low and negative interest rate environment has distorted the credit markets. Many bonds, instead of offering the traditional safe haven of risk-free interest, have been inverted to present investors with interest-free risk.
This has disrupted asset valuation and risk models, blown up bubbles in the credit and stock markets, and expanded the hunt for yield by fund managers and institutions to more diverse places, particularly private equity and venture capital. The implied future returns for stocks are negligible, and for many bonds they are even negative – rather than looking for equity or credit premia, these investors are now turning to a liquidity premium for their returns.
This strategy of following the ‘smart money’ can be utilized even if managing one’s own portfolio.
The role of IEOs in early stage funding
It is important to point out the role that IEOs play in the larger venture capital scene. Like ICOs they are a form of crowdfunding, but many blockchain projects will have already secured venture capital (VC) or seed funding for the company. IEOs in this sense are an appendage to VC that offers the public a chance to invest in the utility of a private company rather than its equity.
Typically, the VC firm will buy company equity rather than the tokens themselves and the amounts raised in private rounds tend to be much larger than the public IEO.
So far most private funding has come at the seed and early stages from technology VC firms such as Andreessen Horowitz, Outlier Ventures and Union Square Ventures. This can prime companies for investment by private equity (large institutions such as pension funds and high net worth individuals) which typically takeover a company before taking it public.
When investing in an IEO it is important not only to research the team behind the project but also to track the activity of investors entering and exiting the project. The quality of the investment fund or investors can be a risk to crypto projects.
IEOs for portfolio diversification
If one has a portfolio of assets that spans the legacy markets (stocks, bonds, commodities, ETFs) it is prudent to consider how diversified it really is. All markets have become so interdependent and correlated that systemic risk can spread quickly.
Venture capitalists accept the risk of zero liquidity in the early stages of a company – in return for an asset class that is uncorrelated and has a higher historical return than stocks or bonds.
IEOs are a hybrid form of early-stage investing in the utility of a start-up company’s product with the added benefit of having immediate secondary market liquidity. A VC manages the risk that one or more of their startup investments will fail. According to one estimate from Harvard Business School, 3 out of every 4 U.S. startups will fail. By diversifying relatively small amounts across a broad spectrum and averaging in when the project reaches certain milestones – VCs can spread the risk appropriately.
What to consider when investing in an IEO asset
| What to consider when investing in an IEO asset | |
| Diversification | Think of spreading investments across industries, addressable markets, geographic locations, term horizons |
| Patience | Waiting for an asset to be listed on several exchanges can take time: it took Bitcoin four years from inception to become widely tradeable and liquid, whereas a newer asset like Monero created in 2014 took only two years |
| Active management | Use a portfolio management tool such as BNC Pro to keep track of what portion of your overall portfolio is allocated to liquid and illiquid assets |
| Liquidity exit event | Consider what or when your exit strategy will be e.g. when it is accepted on a major global exchange such as Coinbase or perhaps when the project reaches a certain milestone such as a network upgrade |
Those who trade or invest in any crypto asset or asset class are trading liquidity – long-term Bitcion holders believe that the price will increase as the uptake of the asset goes from early adopters to the early majority, bringing more liquidity over time.
Investing in an IEO is more of a liquidity premium trade than other crypto asset class. A successful IEO token becomes more liquid every time it is listed on a new exchange or a new trading pair is added and this is one way to track its progress. Almost all IEOs start out being traded solely against the native token of the exchange itself, for example BNB on the Binance exchange, and then gradually more markets are added. The most desirable trading pairs are BTC and ETH, stablecoins and the major fiat currencies, USD, JPY, GBP, EUR, KRW. Having access to fiat markets gives more utility to a token outside of the crypto-sphere.
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