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The Blockchain Gang, Part 3

Columnist: Michael E. Duffy
February, 2018 Issue
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Michael E. Duffy
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For the past two months, I’ve been writing about cryptocurrencies like Bitcoin, so-named because the blockchain technology that underlies them is based on cryptography (encoding data so that only people with the proper keys can read it). Bitcoin and other cryptocurrencies like Ether and LiteCoin work like cash, in that they are anonymous.

It’s a fast-moving world. In my first column, written October 31, a single bitcoin was worth $6,447. As I write this on December 23, a single bitcoin is now worth $14,294. In between, it has risen to more than $19,000 and fallen from there to a low of $12,000 or so. Volatile doesn’t begin to describe the mania around Bitcoin. In that regard, Bitcoin is a lot less like cash and more like a speculative stock (or a tulip bulb).
One of the hopes surrounding cryptocurrencies was that they would, like cash, be free of transaction fees. In practice, that promise has eroded, making Bitcoin and its ilk unsuitable for small transactions, and it’s unlikely Bitcoin will replace cash in that regard. It does seem to function well as an anonymous way to store value, however. It is worthwhile to note that 40 percent of all bitcoins are held by an estimated anonymous 1,000 entities (the so-called “bitcoin whales”), and there are exactly zero safeguards against currency price manipulation were they to collude.
Bitcoin is an interesting story that will play out over the next few years. But, I wanted to use this third-and-final column in my series about blockchain technologies and cryptocurrencies to examine “initial coin offerings” (ICOs), which are also receiving their fair share of publicity and hype.
In an initial public offering (IPO), companies sell shares in their company for cash (presumably to run the business). Investors buy those shares in hopes that a share of the company will be worth more in the future (because the company itself becomes more valuable). IPOs are expensive for the company, and heavily regulated by the government to safeguard investors.
An ICO is an attempt to mimic this fundraising mechanism, without the expense or the regulation. Instead, companies use the blockchain (a distributed public ledger, remember?) to ensure that transactions are on the up and up. Think of it as Kickstarter, a crowdfunding site (www.kickstarter.com), except you don’t have to pay a fee to Kickstarter to manage the process of taking money from lots of people.
With Kickstarter’s crowdfunded projects, you pony up money in hopes of getting something back in the form of a usable product (the “reward”). But there is no guarantee that the company which takes your money will produce anything of value (about 9 percent of Kickstarter projects fail to deliver the reward). It’s caveat emptor for the most part. Kickstarter explicitly says “Kickstarter does not guarantee projects or investigate a creator's ability to complete their project.” Despite a name which sounds a lot like equity investment (i.e. stock offerings), don’t be fooled: ICOs are crowdfunding, and share the same perils (and invent some new ones). An ICO starts with a “white paper” which describes what you get in return for your money. In every case, you receive “tokens,” which are coins in a new cryptocurrency (usually based on the Ethereum “smart contract” mechanism). As you might expect, companies have sprung up to automate the process of an ICO. You still have to give people a reason to buy your tokens (the white paper) and evidence that your team has a credible chance of delivering on its promises, but the process of creating and issuing tokens has become a process of filling in a few numbers on a web page and clicking “Submit.”
Most of the hype and excitement around ICOs revolves around the possibility that these tokens will increase in value.
But (and it’s a very big but), in most cases these tokens don’t represent ownership of anything. In some cases, a token gives you a voting right of some sort (e.g. The DAO ICO) or the right to income (e.g. the Augur ICO). But in most cases, you’re buying something, which has no intrinsic value. I’m pretty sure this detail has escaped many uninformed ICO investors. You have no stock in the company, nor right to a dividend stream. You’re basically betting on bigger fools to come along and pay more for your tokens.
Unless you’re a well-heeled speculator, who won’t mind losing everything you invest, stay far, far, far away from ICOs. A background in currency trading probably doesn’t hurt, either.
And then, of course, are the scammers that attach themselves to today’s hyped investment. There is already at least one ICO—Confido—which took $347,000 of investor’s money and vanished without a trace. They did a lovely job of creating a white paper, a website, social media accounts, and lots of evidence that they were real, and people blinded by the prospect of quick and easy returns on their token purchases got taken in.
The amount of mail I’ve received on these “Blockchain Gang” columns has been staggering. (Not really.) So next month, I will return to form. If there’s something technological that you’d like to better understand, drop me a suggestion at mduffy@northbaybiz.com.
 


 

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