Vitalik Buterin And Similar Critics May Well Be Wrong on ICOs

Recently, the creator of Ethereum Vitalik Buterin offered a perhaps suprprisingly critical take on one of the key uses of the platform he was instrumental into bring to life.

This, basically, is tokens1.0,” remarked Buterin, surrounded by antique whiskey barrels. “There are some good ideas, there are a lot of very bad ideas, and there’s a lot of very, very bad ideas, and quite a few scams as well.” Buterin believes that the next phase of token development, something he calls “tokens2.0,” will benefit from the current rudimentary experimentation with tokens. Moreover, Buterin seems to believe a certain amount of maturity will be gained once tokens1.0 has run its course and disposed of the hype surrounding token price discovery. “I expect that tokens2.0 and the kinds of things that people will start building in 2018 and 2019 will generally be of substantially higher quality. Especially once we start seeing what the consequences of the first wave of tokens are in the medium-to-longer term … What is a good role for them and what is a role that doesn’t really make sense?

I have to say from the start that I have a lot of respect for Vitalik Buterin and his achievements and continued work on various aspects of Ethereum. However, even geniuses aren’t infalliable, and I think that on the particular issue of ICOs, Buterin and similar critics may well be mistaken. I am certain that most of them (especially Buterin) are driven by serious reflection and desire for the blockchain space to succeed rather than, as it seems to be the case for some other detractors, by the frustration that many DApps are using app-specific tokens instead of ETH, potentially reducing ETH’s current and future price.

The well-intentioned ICO critics appear to believe that, if ICOs fail at the same rate as startups tend to, there is something wrong about that. Otherwise, he wouldn’t say that the second generation of ICOs will be better than the current one.

Why would that be? The most plausible answer is that ICOs have attracted a lot more money than startups could ever hope to attract. When something like Kik collects around $100 mln., surely something is fundamentally amiss with this whole ICO thing, right?

Not so fast. The measurement of the usefulness of ICOs in terms of the monetary equivalent of the ETH (and sometimes BTC) contributed is rather misleading. What ultimately matters for evaluating the ICOs’ impact on welfare is how much resources those projects will use the ETH and BTC they have received to divert from other uses over the duration of the underlying projects, and whether this reallocation will be suboptimal on net.

It is important to realize in this regard that, given that there are no things, except tokens, that can only be purchased with ETH, most people who invested into ICOs would probably not have spent their ETH but would have held on to them as an investment. Thus, in terms of resource diversion what matters is how much resources the token-offering projects will be able to divert when they either exchange their ETH into fiat or pay their contributors in ETH directly.

In software development, this mostly translates into the reallocation of talent, and ICO startups like Brave do not seem to be able to quickly spend the ICO proceeds to lure it away. That is because the nature of the technical challenges blockchain development projects is probably significantly different from that of the existing software development processes. Hence, in the end, spending actual fiat or fiat equivalent in ETH may take ICO projects as a class much longer than it takes the normal startups, if they will ever be able to spend most of it. Thus, the ultimate damage in terms of suboptimal resource reallocation that ICO projects may cause may be far smaller than their ETH haul suggests. In the end, a large part if not the bulk of the ICOs overall impact may consist in redistributing some ETH from investors to developers.

Also, Buterin and other critics appear to imply that in many cases most legit Ethereum DApp projects could have attracted investment in some other way than through ICOs, while the bad projects would just have been excluded. This essentially implies a belief that the pre-ETH supply of venture capitalists was capable of meeting the investment demand, and the VC newbies investing ETH are mostly just inexperienced nouveaux riches whose participation is not necessary.

This logic is rather problematic, even if we set aside the open-source nature of most ICO projects that may or may not make it difficult for them to attract VC funding the traditional way. Blockchain-oriented development is a major domain of R&D that comes mostly in addition to the existing domains rather than at the expense of some of them. This almost necessarily means that the financial capacity of VCs in the global economy must increase to accommodate it.

However, one may still object that there are no barriers for new VCs to come in and finance blockchain development projects the traditional way. This is far from obvious, however. First of all, in many countries, especially the developing ones like China, there are serious regulatory and other hurdles for people desiring to invest into foreign ventures. This has to do with the apparent determination to stem capital outflows that reduce GDP, whose numeric growth has been sort of a holy grail for the regime in the last 30 years. In fact, part of the motivation for the recent crackdown on ICOs in China seems to have been motivated by the desire to close the cryptocurrency-enabled loophole. The Chinese government has also generally been essentially forcing people to channel savings into mostly state-controlled banks that seem to have created and sustained the greatest artificial fixed investment boom in human history. It is probably better if some of the money in question ends up being mostly wasted on blockchain startups propping up a few good ones rather than used to finance the construction of another ghost city.

And even in the developed countries, given how much rigidity financial regulation (whose extension to ICOs many well-intentioned people mistakenly crave) creates, as well as factors like the U.S. Federal Reserve paying banks not to make loans, it may be plausibly argued that venture capital is substantially undersupplied via the traditional channels.

None of this is to say, of course, that there are no rotten ICOs or that most ICO projects probably will not fail. But it does not in itself follow from this that we are better off without them on the whole.

PhD, economics (2018) from Aix-Marseille University, independent blockchain adoption consultant based in Aix-en-Provence, France, Email: