Future or fad: Are initial coin offers the tulip auctions of our time?

13 Nov 2017

Remember tulip mania in the 17th century? Image: Kichivan/Shutterstock

With amounts raised by offers of cryptocurrencies surpassing equity funding this year, are initial coin offers the future or are they a ticking time bomb? John Kennedy investigates.

You have to admit, we live in extraordinary times. Money has never been easy to come by, but yet now all someone has to do is dream up a cryptocurrency, get a bit of online PR around it, launch their initial coin offers (ICOs) and potentially reap millions of dollars from mysterious backers they will never meet.

It’s all down to the blockchain mechanism of course and, yes, I am being flippant – to a point – about how easy ICOs seem to occur, but their sudden emergence as an apparent valid funding route requires consideration. They could be the future, they could be a fad – but we need to know more about them.

First off, what are they? Well, consider ICOs a form of crowdfunding using cryptocurrencies. When an ICO occurs, a percentage of a newly created cryptocurrency will be sold to investors for legal tender, or other cryptocurrencies such as ethereum or bitcoin.

The origins of ICO funding has roots in the Great Recession of 2008, when bitcoin’s anonymous creator (or creators) proposed a ‘peer to peer’ transfer of virtual cash that would allow online payments to be sent between parties without the need for a financial institution.

Within a year, the first bitcoin block was mined online and today, the total market cap of cryptocurrencies hovers at around $150bn. A single bitcoin can trade at more than $5,000.

The use of cryptocurrency or the leverage of blockchain to create value isn’t the work of some mysterious lunatic fringe on the web – it is in fact being taken very seriously by established companies. Walmart and Pfizer, for example, have completed successful blockchain pilots in food safety and medicine tracking.

According to a recent report by CB Insights, in the second quarter of 2017, the total funding raised by ICOs surpassed equity financing for the first time, and the trend is forecast to continue to more than $2bn in 2017.

It is understood that more than 250 blockchain teams have completed ICOs since January 2016, and the number of ICOs in 2017 is tipped to surpass the number of traditional equity deals.

To put it mildly, ICOs are a thing and are occurring with a velocity that is hard to ignore.

In June, the Bancor token project based on the ethereum blockchain raised $154m in an ICO.

According to ICO Bench, a tracking site for ICOs, there are (at the time of writing) about 205 upcoming ICOs, 340 ongoing ICOs and 410 completed ICOs so far.

Cryptic thoughts about ICOs

Governments and regulators are watching ICOs closely and, in some cases, are keeping them at arm’s length – and for good reason.

The ethereum network of ICOs has already succumbed to various scams, including phishing and Ponzi schemes, and such scams are understood to account for about 10pc of ICOs, according to research by Chainalysis.

Out of an estimated $1.6bn invested in ICOs by September, about $150m ended up in the hands of criminals. And some of the heists have been considerable.

The previous ICO record prior to Bancor was held by cryptocurrency The DAO, which was famously hacked and saw $55m siphoned off by cyber-criminals.

China recently instigated a crackdown on virtual currencies, beginning with the ceasing of all ICOs. This followed hot on the heels of similar moves by financial authorities in Singapore and South Korea.

On 1 November, the US Securities and Exchange Commission (SEC) delivered a statement, commenting on the celebrity endorsements of ICOs and questioning the legality of the promotions. “These endorsements may be unlawful if they do not disclose the nature, source and amount of any compensation paid, directly or indirectly, by the company in exchange for the endorsement.

“The SEC’s Enforcement Division and Office of Compliance Inspections and Examinations encourage investors to be wary of investment opportunities that sound too good to be true. We encourage investors to research potential investments rather than rely on paid endorsements from artists, sports figures or other icons.”

ICOs are only in their nascent stages in Ireland and it was recently reported how Enterprise Ireland ordered two locally based fintech firms, MingoCoin and Confideal, to remove website information that appeared to suggest that the State agency had endorsed their upcoming ICOs.

According to ICO Bench, MingoCoin, which is chaired by former Baltimore Technologies chief executive Fran Rooney and has One Direction star Niall Horan as a brand ambassador, is targeting a capitalisation of €40m.

Another company, Confideal, which has headquarters in Blackrock in Cork, is understood to have already raised €550,000 in a pre-sale for an ICO that is scheduled to begin nine days from now.

ICOs represent a potentially fascinating new option for start-ups to raise cash rather than take the arduous route of equity funding through venture capital or achieving a public listing on a stock exchange.

It is understood that start-ups raised a record $1.27bn in the first half of 2017, according to equity research firm Autonomous. This outstrips the amount of venture capital investment in fintech start-ups in the same period.

Last week, I wrote about a Dutch and Malta-based company called Web3 Ventures, which is planning an ICO in the first quarter of 2018. The company’s founders, Emanuele Francioni and Fulvio Venturelli, explained that they plan to create a new cryptocurrency called the GeoToken in an ICO, to fund a new standard for a blockchain-based digital address system called the Universal Name Locator.

Both founders were quite upfront about their intentions and explained that they hoped to use the funding raised through their ICO to incubate other promising blockchain start-ups.

Francioni likened the model to how movies are financed in Hollywood.

“ICOs can render technology monetisable using the Hollywood model, where people develop on behalf of the community and step back from product ownership after the release,” he said.

And, while it is too early to dismiss ICOs as a valid and irresistible platform for funding, there is no denying the fact that some of them have already been abused by cyber-criminals, hence the suspicion from governments and regulators.

There are many good reasons why venture capital firms are led by seasoned and experienced investors, and why financial regulators and bodies such as the SEC exist, such as to protect the investor and enable entrepreneurs to flourish.

But possibly, ICOs are a digital reaction to the failings of the financial world in the past decade, with the emergence of new capabilities to seemingly print money, and the feeling that the equity world is ring-fenced by gilt and velvet rope.

For example, it is highly likely that the difficulties women entrepreneurs and minorities experience in trying to get venture capital firms to invest in them could be the genesis for a slew of ICOs by these disenfranchised groups.

ICOs might be fad, or they could potentially herald a new digital standard that will be hard to ignore long into the future.

There is only one certainty right now: they are happening.

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John Kennedy is a journalist who served as editor of Silicon Republic for 17 years