Initial coin offerings suggest financial system fragility

There is a fin de siècle feel to the sudden desperation of investors to throw away their money on cryptocurrency start-ups funded through initial coin offerings. ICO has come to appear in financial headlines more frequently than IPO in recent months. For the uninitiated, ICOs are offerings of the tokens used to exchange value on blockchain networks. The most famous token is bitcoin but there are now dozens being exchanged and traded, including Ethereum, Ripple, Litecoin, Dash, Monero, IOTA and Stratis.

In theory, the more a network is used the higher the value of its associated tokens and so if a business idea takes off, early investors should benefit – rather like holders of private equity in a conventional start-up.

More and more conventional companies are accepting payment in cryptocurrency. Overstock, the US based online retailer that competes with Amazon selling furniture, household and kitchen accessories, bedding, décor, and more, announced in August a deal with altcoin exchange ShapeShift, to accept all the major cryptocurrencies, including Ethereum, Litecoin, Dash, Monero, and the new Bitcoin Cash.

A year ago, buying one bitcoin would have cost you $576. You could sell it today for $4,442. Crypto is booming. Investors want in on the next Facebook or Google or Amazon at a time when technology companies are staying private for longer, delivering more value to insiders’ hands, and ICOs look like a new way to gain exposure to a high-growth area.

One warning sign here, however, is the misleading echo of the financial phraseology. No company raising money through an ICO would be ready for an initial public offering (IPO), which requires a business to mature over a number of years, generate revenue and even profit. ICOs aren’t disintermediating public equity markets, but rather early stage venture capital investing in which the majority of companies fail and which is usually the preserve of specialist institutional money invested across diverse portfolios. ICOs typically fund the build-out of business ideas whose only asset is a white paper.

The SEC warned in July that it would regulate them as securities, even though they do not denote equity ownership. But that’s an empty threat. The censorship-resistant cryptocurrency world is populated by unregistered entities often anonymized.

Some of them are clearly going to be fraudsters happy to take advantage of individual investors now being driven by obvious greed and fear of missing out to buy any new coin offering they can get their virtual hands on.

For all the obvious dangers, ICOs have grown suddenly into a sizeable capital market. Autonomous Next calculates that in the first half of this year they raised $1.2 billion, easily eclipsing the value of conventional venture capital raised by blockchain-focused technology firms. Other estimates put the total at $1.7 billion and growing fast, with more money raised after the SEC’s shot across the bows in July than in the previous six months. Many deals are for $5 million or under, but there are more and more larger ones, some bigger than the typical IPO for a proven company.

In August, for example, Filecoin, a decentralized storage network – a kind of Airbnb for companies to rent out temporary excess capacity on their hard drives for others to store files on and for which they are paid in Filecoin – was so overwhelmed by investors bidding for $250 million of these new tokens in the first minutes after opening its ICO, that its systems couldn’t cope. That’s not a great sign for a technology company – it had to pause the sale.

Many of the people buying these things clearly need protecting from themselves. What’s to stop the so-called developers just taking investors’ cash and heading to the beach? Nothing. One head of technology at a large bank tells Euromoney: “There should be some protocol for funds to be held in escrow until the code is written at the very least. I would even say that if a fintech company came to us with a banking application that it had funded from an ICO, we probably wouldn’t do business with them for that very reason alone.”

To Euromoney it feels like something else is going on here beyond the obvious: a tech bubble reminiscent of the one in internet stocks that first began to inflate 20 years ago before the inevitable crash four years later.

How has the market capitalization of bitcoin risen from $6.5 billion at the start of 2016 to $72 billion at the start of September 2017, even after all the hacks from wallets and exchanges? Sure, it’s the criminal currency of choice on the dark web, but that’s more likely to put off users than attract them.

Developed world central banks have been printing money hand over fist for years now, obviously financing – for all their denials – vastly swollen government debts which the central banks are increasingly desperate to inflate away as they approach the point when it becomes obvious they cannot be repaid in any accepted definition of that term.

Faith in fiat currency is stretched. The world monetary system has never seemed so vulnerable.