Well-known investors and celebrities are rushing to buy into new virtual currencies, but critics and evangelists alike warn of a potential bubble.
A single Bitcoin is now valued at $7,000, up exponentially from its under-a-dollar modest start less than a decade ago. That has would-be millionaires exploring their options, a phenomenon reflected in Google Trends, which shows that searches for “Bitcoin” alone have spiked in recent months.
The rise in the value of Bitcoin, and so-called cryptocurrencies in general, has led to the explosion of a relatively unregulated trading market. Similar to the more-familiar sales of stock in a company going public, called an initial public offering, or IPO, this new field is holding initial coin offerings, or ICOs.
Hundreds of startups are entering the crypto-space launching tokens to raise money for projects where the verification certainty of blockchain is central to their business.
This ‘Wild West of financing‘ as leading law firm Simmons & Simmons described it, has already made a lot of people rich — as this piece from The Guardian reports — but such investment in cryptocurrencies and ICOs is not universally endorsed. Even those involved say the current boom in the market can’t last.
“People think money solves problems. It doesn’t,” Ameer Rosic, founder of educational platform Blockgeeks, told WikiTribune. “Human beings, intellectual capital, timing, having people work together in unison, builds businesses. Money sometimes is even seen as a disability.
“The technology [that ICOs run on] is not mature enough to support a trillion dollar ecosystem. It’s not mature enough to support millions of users using it every single second.”
The market attracts a lot of scammers because it’s lucrative and unregulated, but that doesn’t mean ICOs can’t or don’t work. Ethereum was crowdfunded and is arguably the “most successful and pure ICO that has delivered beyond its promises,” William Mougayar, author of The Business Blockchain, told WikiTribune.
However, most projects will fail, said Vitalik Buterin, Ethereums’ co-founder, who warned that the ICO market is a bubble and unsustainable. Buterin didn’t respond to request for comments but will be added when he does.
“There are two types of scams,” Mougayar told WikiTribune. “The ones that are real scams that are run by dishonest people, and ones that are run by incompetent teams, or teams that have positioned their projects with high or unrealistic expectations that will be difficult to meet.”
Typically, when a cryptocurrency startup wants to raise money, it does so by selling its own digital assets or “tokens” at a discount. Like stocks in the public market, the investment is based on speculation that these tokens will increase in value. But unlike equity investments, it’s highly risky because companies don’t necessarily offer investors a stake in their business.
But before getting deeper into these initial coin offerings, let’s look at cryptocurrencies in general.
Bitcoin in the wake of the financial crash
It’s estimated that 92 percent of all currency in the world is digital. But unlike traditional money, which is exchanged using trusted intermediaries such as banks, cryptocurrencies are exchanged peer-to-peer on the internet without a central structure, and they can only be exchanged online. Cryptocurrencies run on a technology called blockchain, which is designed to ensure authenticity of transactions.
The most general description for blockchain is that it’s a decentralized and shared ledger of records, or “blocks,” which are secured using cryptography. Every transaction is open and controlled by no one, and each block is maintained and updated in several places simultaneously. Blockchain, as described by The Economist, is “a machine for creating trust.”
“Blockchain is to Bitcoin what the internet is to email: a big electronic system, on top of which you can build applications. Currency is just one” – Sally Davies – FT.com
Nakamoto’s reason for creating Bitcoin according to his White paper posted on Bitcoin.org was that “the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments.” But because this trust-based model has inherent weaknesses, Nakamoto said, he engineered a system based on cryptographic proof.
Financial Times tech reporter Sally Davies offered an apt analogy.
“Blockchain is to Bitcoin what the internet is to email: a big electronic system, on top of which you can build applications. Currency is just one,” she said in this explanatory video.
The inception of initial coin offerings
A clear correlation exists between the rise in the value of cryptocurrencies such as Bitcoin and Ethereum and the surge in initial coin offerings, said Huy Nguyen Trieu, co-founder of the London-based fin-tech education startup, the Center for Finance, Technology and Entrepreneurship (CFTE).
But he said excitement is driving the market more than savvy investing: “You’re starting to see this market being much, much bigger where you have a lot of new people getting into it, so it’s a raw bubble in that sense.”
“People are having so many friends who know absolutely nothing about cryptocurrencies, nothing about investing in startups,” he told WikiTribune.
The market also surged after celebrities, including socialite Paris Hilton and boxer Floyd Mayweather, crashed onto the crypto-scene. Musician Ghostface Killah of Wu Tang Clan recently backed the venture Cream Capitol, as reported by CNBC, and is one of its co-founders.
Ethereum is the leading blockchain platform for ICOs, according to ICOWatchlist.com, with more than a 50 percent market share. As a result, it has been prone to phishing — says this analysis by the founder of a cyber-security firm — and Ponzi schemes, according to this report from The Atlantic.
Ethereum’s blockchain features ‘smart contracts,’ as this Coindesk.com report shows, which is computer code that can automatically accomplish tasks when specific conditions are met. Ethereum also has its own tokens called “Ethers,” but its pre-eminence is its open software platform which enables developers to build applications on top of it.
Startups have taken to the Ethereum platform in particular for crowdfunding their ICOs. This is because the platform can automatically calculate the amounts of money raised, verify and confirm transactions, and distribute new tokens.
This year, initial coin offerings have raised more than $2 billion, according to Forbes. New companies can generate millions in a matter of minutes. Gnosis, a prediction market, raised $12 million in just 10 minutes in April, industry zine Cointelegraph.com reported. Tezos, a self-proclaimed “digital commonwealth” blockchain, broke the record when it raised $232 million in the largest ICO ever.
“For me, there’s no project which is worth $100 million dollars on a sheet of paper,” CFTE’s Nguyen Trieu said. “If you’re a normal VC [venture capital] investor, you will never, ever invest on a first round for $100 million.”
Backlash and Backers
The central bank of Russia last month called for a ban on all cryptocurrencies exchange within its borders. President Vladimir Putin said that “the usage of cryptocurrencies carries serious risks” and that buyers could be involved in unlawful activities.
Russia’s decision came after China and South Korea imposed similar bans, though China’s one is temporary, according to Chinese officials. Lack of regulation is the main reason for these bans. In China’s case, the nation needs more time to develop and implement appropriate regulations, Cointelegraph.com reported.
In September, the U.S. Securities and Exchange Commission charged businessman Maksim Zaslavskiy and his two companies “with defrauding investors in a pair of so-called initial coin offerings.” Authorities said that the coins being sold “don’t really exist” and that the companies had been selling unregistered securities.
ICOs do have upsides. Business Blockchain author, Mougayar, said one benefit is that “anyone can participate in the potential upside if the network, application, platform or protocol are successfully adopted by users and developers”.
“That upside is both financial from a wealth appreciation point of view, but it also has a beneficial component from a usage vantage point because of the utility created by these new business models.”
“There isn’t enough intellectual capital, or smart people who do their due diligence and take their time to focus more on the technology – Blockgeeks’ Amir Rosic
But Mougayar warned that many of these ICOs won’t succeed, and “their value could go down to zero.”
Rosic of Blockgeeks told WikiTribune that though he’s bullish about ICOs, right now they’re a “race to the bottom,” meaning aggressive competition drives down their value. His rule of thumb for investing in ICOs is to ask whether a token is genuinely needed by the issuer to raise capital. He said 99 percent aren’t — why not just use the Ethereum token? — and if there’s a working product to show it might be worth investing.
“The whole ICOs space right now is going through an evolution, but the money [coming in] is outpacing the reality of the technology, and there’re a lot of new players coming into the space who are obsessed with the gains,” he said. “All of this is creating a system in which there isn’t enough intellectual capital, or smart people who do their due diligence and take their time to focus more on the technology.”