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Illustration by Tech in Asia’s Andre Gunawan.

In today’s cryptocurrency market, where valuations can skyrocket and plunge within a day, it has never been easier to make – or lose – a fortune. But behind the scenes, well-connected elites in the blockchain industry are making their own luck by buying virtual currency before the public gains access, often at a cheaper price.

Called presales, these deals and negotiations are a lesser-known part of ‘initial coin offerings’ or ICOs, the new normal for fundraising in the blockchain industry. During an ICO, startups mint and sell their own cryptocurrency to supporters via crowdsale. But before they open the floodgate to retail investors, many projects run a round of presales.

See: Everything you wanted to know about ICOs but were too afraid to ask 

Organized through private chat groups on messaging apps like Telegram and WeChat, these pre-ICOs allow startups to attract influential blockchain figures and institutional investors in exchange for discounted tokens.

For example, a startup selling 100 tokens for 1 ether in its crowdsale may offer early investors 130 tokens instead, if it’s a 30 percent discount. By the time the token hits the exchanges, presale participants can usually turn these crypto-tokens into a hefty return.

The worse the project, the higher the discount.

“Most of these private groups are free and anonymous,” says William Fan, who co-runs a private investment group on WeChat, where members pay a yearly fee of 500 ether or about US$595,000 to gain exclusive access to token presales.

But groups that feature more high-profile investors will have higher barriers to entry, he explains, such as a higher minimum amount of investment. Participants often need to be institutional investors or own a certain amount of assets as well. This year, Fan estimates that around 1,000 projects will be shared to his group, which is capped at 200 members. Last year, they had one to two projects to choose from every week.

When asked if his group receives discounts on tokens, he exclaims, “Of course there are discounts. Otherwise, why would these people help you promote your project?”

Apart from guaranteeing a number of sold tokens, running presales helps startups boost the value of their cryptocoins once they are sold publicly or traded on exchanges. Early investors, such as those in Fan’s groups, can tap their own networks and advertise the project.

Token discounts range from 5 to 60 percent, depending on the quality of the project, says Fan. “The worse the project, the higher the discount.”

Data from Coinschedule shows that startups raised US$3.7 billion in cryptocurrency from ICOs in 2017.

Information asymmetry

The idea that early-stage investors get access to better deals than the public isn’t new – that’s how venture capital works.

But ICOs are fundamentally different because of its speed. Instead of trudging through various rounds of investment, blockchain startups can compress the entire process into just two stages – presale and crowdsale – with no restrictions on how soon one follows the other.

That means retail investors who jump in at the ICO phase sometimes take on just as much risk as those who had a headstart – except they have more to lose, since they weren’t privy to any discounts. Compounding the issue is the lack of information around projects. Many have little to show beyond a white paper and roster of advisors and team members at the time of their ICO, which isn’t surprising given how early-stage most projects are.

Due to China’s ban on ICOs, public sales have been driven underground.

That hasn’t stopped the mad rush of capital towards token crowdsales, though. Last year, startups raised more than US$3.7 billion in cryptocurrency through ICOs. Competition over popular projects can be fierce, too. Last May, an US$187 million crowdsale raised by privacy-focused web browser Brave ended in less than a minute.

Anticipation for Telegram’s ICO – rumored to target US$1.2 billion – is so high that scammers are advertising fake Telegram token sales to trick unwitting investors into sending cryptocurrency to the wrong address.

“The issue is that investors have different levels of access to investment information or investment opportunities,” a Chinese cryptocurrency investor tells Tech in Asia, requesting anonymity.

Particularly in China, where ICOs are banned, public sales have been driven underground into private groups, making an opaque industry even less transparent. Local investors interested in overseas projects may not be able to find publicly available information in Chinese either, the unnamed investor adds.

See: China’s blockchain industry looks overseas as ICO blanket ban stirs fear 

That only increases the appeal of private investment groups, despite the exorbitant participation fees. The reputable ones provide rare access to project information and other high net worth individuals. Some groups even include “whales,” an elite group of cryptocurrency highrollers who collectively control 40 percent of the global supply of bitcoin.

One of the most well-known bitcoin “whales” is Roger Ver, featured on the left. Photo credit: Roger Ver’s Twitter.

Organizers of private investment groups don’t have to be “associated with the ICO project at all, but you need access to the founders to secure yourself an allocation into the deal,” explains a member of such a group, which has about 200 people.

The source, who declined to be named, said some groups charge a one-time entry fee – some as high as US$79,000 – while others take “pool fees” of 5 to 10 percent, based on the total amount the group invests in a deal. Because these groups are so exclusive, joining is often done through referral. Group owners may also conduct their own due diligence on members. The source recalls “an interview of sorts,” where they were asked how they would provide value to the group.

Trust issues

The challenge with many of these private chat groups, however, is that they depend on word-of-mouth referrals. Trust and reputation are paramount, and scams where people pretend to have presale access before disappearing with your ether are not unheard of.

“The lesser known the group owner is, the bigger the risk,” says Fan. “Some [groups] will start accepting money for projects that haven’t even began their private sales yet. Those definitely have issues or risks.”

A more formal version of these private investment groups are syndicates, which serve as middlemen between investors and blockchain companies. Blockchain Capital, one of the earliest blockchain-focused venture capital funds, runs its own through AngelList. Through this syndicate, accredited investors – defined by their income or the number of assets they own – can gain access to the fund’s investment deals. In exchange, Blockchain Capital takes a 25 percent fee per profitable deal.

You can’t really trust syndicates.

Other organizations, such as ICO Syndicate, have emerged as the appetite for discounted tokens grows. However, like private chat groups, there’s a wide spectrum of credibility among syndicates.

“You can’t really trust syndicates. Unless the guy running that syndicate is someone you went to school with, he’s a stranger,” notes Rudy Lee, a retail investor in Seoul who started investing in cryptocurrency last July. Since then, he has traded and invested in around 20 tokens.

Lee believes that access to top-tier syndicates is restricted, anyway. “If you want to get a piece of a really great syndicate, you would have to be a whale.”

Finally, venture capital firms can also use their network and clout to gain access to token presales, though they are typically closed to outside investors. Zeroth, a Hong Kong-based AI accelerator, has its own cryptocurrency fund that negotiates presale deals for its cohort, free of charge.

“That is our value-add to them as a portfolio company,” explains Sherman Lee, founder of RavenProtocol.com and partner at Zeroth in charge of crypto investments.

Public backlash

The benefits reaped by presale investors have not gone unnoticed, especially when they come at the expense of retail investors. Earlier this month, blockchain startup Theta came under fire when it canceled its crowdsale after raising US$12 million from its presale. Some believed that the company had opted to allot tokens to whales and institutional investors, instead of the public.

“We were oversubscribed and had to cut back most of the presale in order to protect our hardcap. We believe in self-discipline and “running lean” in order to achieve long-term success for the whole community,” wrote Theta in a blog post on Medium.

Others in the blockchain industry have criticized presales for incentivizing early investors with quick profits, and not genuine interest in the company’s project. This is especially apparent in cases where the presale occurs right before the public crowdsale.

“The presale discount should reflect the risk being taken on by the early project backers,” said Sid Kalla, co-founder of token sale consulting firm, Turing Advisory Group, in an interview with CoinDesk last November. “Otherwise, they have an incentive to invest in projects without proper due diligence because they can take a profit with minimal risk when the token is traded on exchanges.”

What we’re recreating is Wall Street – just without the regulation.

The system of underwriter-like individuals and groups that connect projects to exchanges, institutional investors, and syndicates is also an unpleasant reminder of the investment banking world for some. “What we’re recreating is Wall Street – just without the regulation,” says Sean Moss-Pultz, CEO of Bitmark, a Taiwan-based startup that records property rights to digital assets on blockchain technology.

While many blockchain entrepreneurs and investors look at these issues as future areas of reform, they generally remain positive about the crowdsale model. After all, not all blockchain startups run presales, and those that do sometimes enforce lockup periods, where investors aren’t allowed to liquidate their tokens within a set period of time.

A Chinese cryptocurrency investor called ICOs a “revolutionary process, where everyone can be an angel investor and invest in a good project.”

“If we weren’t in this industry, we’d have to do roadshows 30 times a year and beg those investors who can be hostile towards startups,” adds the investor, who asked for anonymity due to China’s ICO ban.

Currency converted from Chinese yuan. Rate: US$1 = RMB 6.32 = ETH 0.00084.

This post Amid fierce competition over ICOs, elite investors are paying for early, exclusive access appeared first on Tech in Asia.

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