Assuming you’ve developed an altcoin and you want to conduct an ICO, how do you go about securing investors, their funds, and their trust? Or maybe you are an investor looking to put some spare crypto funds into a potential Initial Coin Offering, what guarantees are there besides the project’s landing page and disclaimer quotes; after all, they – the developers would still have access to the funds anyway, how hard can it be for them to just abscond with the money leaving you and a bunch of other investors with nothing and no one to trace back to. You must have heard about ICO escrows and may be wondering what they are and how they function to protect investors funds and maintain both integrity and reputation of the development team.
Trust issues in a token crowdfunding event are common this is so because, investing in ICOs are quite a risky venture, especially because they are unregulated. Buying tokens involve trading hard earned taxed fiat currencies or precious cryptocurrencies which have potentials to keep appreciating for a digital asset that is only worth the creator’s words. Losing money to phonies, con artists or ‘wannabe’ altcoin founders can be devastating.
Sometimes, the development team can endure to the end of the crowdfunding event only to lower or disappoint investors’ expectations.
The plague of fraudulent practices within crypto-sphere makes it hard for investors to trust one another; regardless of the potential of a tokenized digital asset, it is still at the mercy of the distrust amongst the members of the community. Hence a system that mitigates the issue of trust is essential to the survival of token sale conventions.
The role of escrows in ICO campaign is the proper provision or supervision of the obligations imposed on a service provider as stated in the project’s official documents for the startup. They are instituted to ensure that projects proceed as promised, otherwise, funds are not released to the development team.
This system basically provides an intermediary service ensuring smooth business transactions between two individuals or groups of individuals. Simply put, an escrow will handle transactional values pending when agreements of the set trade are completed. For example, if I want to purchase 10 tokens at the rate of a dollar to a piece in Ethereum coin (ether), rather than sending the equivalent Ether to the developer’s address in blind fate, with the hope that the developer will honor his side of the bargain or the developer sending the tokens first not sure whether it is an efficient method of transacting; a better approach will be to initiate an escrow system that further buttresses the idea of trust. This business intermediary is tasked with the responsibility of holding my funds temporarily until the promised goods (in this case, 10 tokens) are delivered to me in the condition promised.
These intermediaries are usually respected individuals or institutions from the cryptocurrency community or the project support community. They can also be in form of scripts, as in the case of smart contracts.
The escrow system makes it hard or practically impossible for ‘wannabe’ developers to run off with investors’ funds. As one would expect that escrows to deliver money on completion of set parameters within the agreement, however, cases of bad and good escrows have been spotted in many token sales, and distribution events.
In a typical token crowd sale event using an escrow system, they usually consist of 2 to three persons, and one person from the development team. They all serve as multi-signatories to the funds collected. The system may be designed to execute transactions once two of the available signatories or all three are present. The multisig wallets have keys which are required to access the funds and transact on the account. Except these keys interact harmoniously, access to said funds are quite impossible.
As a custom during initial coin offerings, a startup may be divided into many phases for development and it will set its cap, which is the amount of money needed to execute the project. Often time, there is a hard and a soft cap. This cap basically represents estimated budget adjusted to account for inflation. Once the funds are collected, the phases are executed sequentially while the funds are released simultaneously. The digital asset is simply a gesture of good faith from the project team to the investor. On its own, it has no worth and to the holder, it bears no significance until it is tradeable on exchange markets.
While it is often the case with initial coin offerings to send tokens to investors after the completion of the crowd sale, the escrows play the role of an enforcer to ensure that after the digital assets are distributed, the project team can further the development to achieve the set objectives.
Typically, a bad escrow will be one that delivers a 100% of funds to development team after distribution of tokens, but pending the completion of the said project. The token’s worth lies in the completion of the proposed project; although some startups take a while, milestones register progress during the project development. Therefore, a good escrow will be one that releases partial funds on completion of objectives along the timeline of the development. Hence, the conditions for escrows to function is necessary and should be stated or coded in clear terms so that breach of contract is avoided.
An investor will need to watch out and carefully assess the escrow agent types and functions used in any particular token crowd sale before investing into such token sales event.
Basically, smart contracts are referred to as autonomous agents who execute terms of trade inputted as lines of code and decentralized over the blockchain network. These programs are comparable to the legal document in the conventional legal system and enforced by law only in this case, – the blockchain system the contract is automated and expected to run as the creator has programmed it to.
Although the system hasn’t been perfected yet, blockchain developers are still looking for ways to create a smart contract code that has the capacity to replace human middlemen or physical escrow agents. This is so because currently, only the creator of the smart contract determines the context of the agreement. Which in most cases would favor the programmer leaving the not-so-technical investor at the mercy of the contract. In spite of the fact that these codes are also vetted by the blockchain community on GitHub, some investors still fall prey to flawed smart contracts.
Smart contracts are probably the most efficient protocols that enforce trust-based systems. With ICO smart contracts, investors have a level of insurance and assurance that their hard earned money isn’t on a gamble and wagered on luck.
Most blockchain enterprises are considering the inclusion of smart contract applications as this system adds to the robustness of the entire blockchain network. Establishing a business relationship on a ‘trustless’ platform using smart contract’s cryptographic codes, indeed is an evolutionary phase of the blockchain technology.
The current downside to these codes is that they are quite complex in the sense that they only appeal to a set niche in the blockchain system, – in other words, being codes they are not literally interpreted and while Ethereum may provide the legacy tools to build decentralized applications using smart contract codes, delimitation of use cases is considerably thin whereby the computation power required is pliable depending on the code itself and its dependencies.