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Initial coin offerings: a risky ride into the Wild West of finance
Companies can now raise funds by issuing their own digital currencies. Ben Judge explains how initial coin offerings work.
There's a new way to dial up funding for your start-up
(Image credit: This content is subject to copyright.)
When a company needs funds it can do one of two things: borrow money, or raise it by selling shares in the business. Crowdfunding and P2P platforms have shaken things up a bit, but ultimately they're still dealing in debt or equity. But now there is a third way, one that sits almost entirely outside the traditional financial system: initial coin offerings (ICOs) issuing your own currency.
ICOs have grown out of the world of cryptocurrencies (digital currencies). They are typically built on the Bitcoin or Ethereum blockchains (Ethereum allows users to create "smart contracts"), and are usually used to raise funds for blockchain-related projects. (The blockchain is the public ledger of transactions on which the technology is based.) The start-up creates its own cryptocurrency or token, which will be used to access its services. This can be freely traded against more established cyptocurrencies, such as Bitcoin. The idea is that if the business takes off, demand for its related tokens will grow and everyone makes money.
ICOs are becoming wildly popular, with more and more venture capitalists (VCs) investing, says Gertrude Chavez-Dreyfuss on Reuters. For example, Tim Draper, the billionaire VC backer of Skype and Baidu, is investing in Tezos, a blockchain that plans to "underpin secure, decentralised applications and smart contracts", but avoids some of the political and technological problems faced by the likes of Bitcoin and Ethereum. Fundraising for Tezos begins next week.
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There have been some huge successes. Blockchain entrepreneur Richard Kastelein, writing in the Harvard Business Review, notes that some cryptocurrencies rose by as much as 2000% during 2016. And last month, notes The Economist, an ICO for Gnosis, an Ethereum-based "prediction market" that allows users to "speculate on anything", sold out in less than 15 minutes. Investors bought 5% of the tokens (GNOs) that will power the market for a combined $12m. Gnosis founders hold the other 95%. The business is now valued at over $300m.
The potential for huge gains is a big part of the appeal of ICOs to investors. But so is the promise of liquidity, says Kastelein. Investing in start-ups usually takes patience and means tying up capital until the company is bought or goes public. With ICOs, "investors can see gains more quickly, and can pull profits out more easily".
But there have also been some high-profile disasters.The DAO an Ethereum-based blockchain application raised more than $150m in April 2016. By June it had been hacked, and more than $50m had disappeared. Others worry that many of these start-up propositions are, at best, flimsy. And with the issuers having almost immediate access to the funds raised, there's not much investors can do if "issuers abscond with their money", says The Economist.
"ICOs are the Wild West of financing," agrees Kastelein. "They don't fit into the current definition of a security, and are technically outside of traditional legal frameworks." Their global nature means they are not controlled by any national authority, and the use of cryptocurrencies means investors can buy in "pseudo-anonymously". The Canadian regulator, the Ontario Securities Commission, has "warned that issuers may need to meet legal requirements, such as registration and filing an official prospectus", says The Economist. But that is hard to enforce, given that "some ICOs are created expressly to avoid regulations".
If this all sounds rather speculative, that's because it is. As Kastelein says, "blockchain technology is at the stage where the internet was in 1992, and it's opening up a wealth of new possibilities". But before ICOs and blockchain fulfil their promise, notes The Economist, "they may well have to endure a cycle of boom and bust". As with the tech bubble, that could be "a step toward some rather useful innovations". But it will be a costly experience for unwary investors.
The virus that causes mostly red faces
The WannaCry computer virus that swept around the world at the end of last week and crippled the NHS "has quickly become the worst digital disaster to strike the internet in years", says Andy Greenberg on Wired.com. The virus hit 200,000 computers in 150 countries. It spread rapidly through out-of-date versions of Microsoft's Windows operating system, using a technique first identified by the US National Security Agency (NSA), then stolen and leaked onto the internet by a group of hackers.
The virus encrypted files on infected computers and demanded a ransom of $300-worth of bitcoins for the perpetrators to unlock them. "Experts said the attackers might eventually pocket more than $1bn worldwide before the deadline ran out to unlock the computers," reported The New York Times.
Yet in reality, from a financial point of view, the attack has been a resounding flop. Every transaction on Bitcoin's blockchain is traceable, so it has been possible to see just how much the hackers have made. In fact, @ransomtracker, a bot on microblogging service Twitter, is recording every payment to the hackers' Bitcoin addresses. At the time of writing, the total paid was just under $75,000, and so far, says Business Insider, there have been "no attempts to move the funds or cash out". Indeed, says Greenberg, WannaCry has caused "so much damage with such little profit that some security researchers have begun to suspect that it may not be a money-making scheme at all", but rather a plot to embarrass the NSA.
The "just the one" app
Contactless payments may be convenient, but they can make it all too easy to buy "just one more round" during a night of excess down the pub. Now, however, there's a solution cautious millennials can sign up for an app called DrnkPay to curb their spending while under the influence. Users must link their credit and debit cards to the DrnkPay app and select the number of drinks they intend to consume before they go out. Every time they want to use their card, they must use a breathalyser connected to the app via Bluetooth. If it looks like the user has had one too many, the card payment won't be authorised although presumably it means someone else in the party will be left holding the bill for the drinks order.
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