1.1 Financial industry background
The recent disruptive phenomenon of the Initial Coin Offerings has emerged when, in the last decade, some specific happenings took place. In order to deeply describe and analyse its development in the upcoming sections, it is worth understanding the background and the features of the financial industry as a whole. Generally, the reasons why ICOs were born rely mostly on the consequences arose after the financial crisis of 2007, on the emergence of crowdfunding platforms, and on the creation of blockchain technology and of cryptocurrencies. Indeed, in this opening section, I examine the major causes and events that triggered the advent and the progress of Initial Coin Offerings. For this purpose, it is definitely crucial to enlighten that the subprime crisis of 2007 was the main event that triggered the phenomenon of cryptocurrencies which, in turn, underlie the ICO transactions (Boreiko, 2017).
Subsequently, it is important to provide a parallel overview about the traditional fundraising methods that have been characterising the financing industry, and to observe characteristics, differences and conflicts among them.1.1.2 Global financial crisis
Firstly, it is appropriate to recall the global financial crisis that started in 2007. This complex and cross-sectional event is not the main focus of my dissertation, but it is supportive for introducing and conceptualising the phenomenon of Initial Coin Offerings. Indeed, in this subsection, I provide a brief outline of the causes and the consequences that are strictly related to the progress of the issue in question.
In 2007 and 2008, with the US housing bubble, the subprime crisis, the deregulation of the financial markets and the resultant creation of several complex
financial innovations, the crisis began to spread out from the United States to all other countries, in a global scale. As Block (2010) explains, the worldwide financial crisis caused the failure of numerous companies and lending institutions, by resulting in a significant drop in consumer wealth, in stock prices, and in market capitalization, and it led to a tremendous decline in the global economic activity. In addition, the crisis created vast financial commitments incurred by governments since some financial institutions, that were close to the bankruptcy, have been saved by government interventions (Block, 2010).
Furthermore, the subprime sector breakdown and the consequential foreclosures on properties originated, since 2007, the credit crisis (also conveniently termed as credit crunch or credit squeeze), which provoked a significant transition in the credit market. Undeniably, this period of recessions, characterized by a lack of transparency and irresponsible operations carried out by centralised third parties, shook the financial industry. In particular, the credit availability to large firms, SMEs and start-up ventures altogether, had been dramatically reduced (Boreiko, 2017).
As any crisis, that of 2007 generated, into the mind of citizens, a loss of trust and confidence in the financial and banking systems. Consequently, people began to distrust financial intermediaries such as banks and financial services providers by arising the need of disintermediating centralized third parties, which, in the past, controlled the entire financing procedures. This is a fundamental aspect that I consider, in the upcoming sections, when approaching the purposes beyond the creation of Initial Coin Offerings.
1.1.3 Financing sources framework
Secondly, for better approaching the phenomenon in examination, it is important to investigate the different financial resources that business ventures could need in order to make investments and/or start operating in the relative market. By opening with a general framework of methods of financing, I then highlight the major points of start-ups fundraising approaches.
Generally, according to Boreiko (2017), there have been three main traditional sources of financing: internally generated funds, external borrowings from financial markets and equity issues. However, these methods are not suitable for every business ventures and for their entire life cycle. This is due to the fact that large corporations have unquestionably different investment projects and much higher internal funds than small and medium enterprises, entrepreneurial ventures or innovative start-ups. Furthermore, there are methods that fit specific business stages and situations, since start-ups could not afford an Initial Public Offering (due to its costs and overregulation) and large corporations would not require a crowdfunding or a venture capital fundraising.
In particular, entrepreneurial ventures, small and medium enterprises and start-ups do not have sufficient internal funds to finance their investment projects and to start running their business. Since few years ago, as Boreiko (2017) enhances, these realities usually had to choose among the possibility to either borrow from a local bank through loans, either to sell equity shares of the business to external investors as, for example, venture capitalists. In addition, Boreiko (2017) points out the demonstration by Berger and Udell (2006) that for small firms is much more complicated to access credit than for large companies.
The difficulty of raising capital and accessing credit for start-ups and small firms, together with the drastic reduction of credit availability during the global financial crisis, amplified the need to find alternative options and new opportunities within the fundraising industry. Indeed, the traditional financial methods of fundraising were no longer appropriate for the new era economy that was emerging. In line with the opinion of Boreiko (2017), the upcoming and innovative approaches have been supported by the rapid technological changes, the internationalization and the advent of the Financial Technology. Therefore, Boreiko (2017) also underlines that a conception of new actors on the financing sector took place in particular for sustaining the growth of innovative and hi-tech start-ups typically developing open-source based projects. From this particular perspective, it is crucial to emphasise the fact that the innovative financing options that have been emerging have the major aim to bypass or alter the conventional financial industry’s channels (Boreiko, 2017). As I introduced in previous section, this was exactly the necessity arisen during the period of the global financial crisis characterised by distrust in the traditional financial intermediaries.
When considering the supportive actions in the topic of start-ups funding, it is important to consider that, in the last decade, several international institutions and national governments have recognised and/or partially established technological hubs, incubators, accelerators, microfinancing and new forms of venture capitalists, such as business angels (Hallen, 2016).