The growth of peer-to-peer (P2P) lending and the creation of the blockchain (the technology that underpins bitcoin and other cryptocurrencies) have been two of the most interesting developments in the world of finance in the past few years. Now tech entrepreneurs are combining the two concepts to create a new way of raising money for investments, known as the initial coin offering (ICO).
An ICO is a bit like an initial public offering (IPO), in which a company offers shares to investors. Instead of selling shares for cash through a stock exchange, an ICO involves exhanging "tokens" for cryptocurrencies (such as bitcoin or ether). ICOs are often set up on an existing blockchain platform such as Ethereum or Hyperledger. You could very broadly think of these platforms as performing the role of a stock exchange in an IPO, but it's important to realise that blockchain platforms do not regulate or oversee tokens in the way that traditional stock exchanges regulate listed companies. However, they allow entrepreneurs to easily create "smart contracts" that automatically enforce the rights associated with the tokens.
Most ICOs are carried out to raise funding for startup companies and the tokens they issue are a means for potential users to pay for the firm's services, rather than being an investment (although if the startup is a success, the value of these tokens could rise). However, some ICOs are designed as an investment vehicle. For example, an ICO can be used to "tokenise" a physical asset breaking it up into fractions that can be shared between many individuals. Smart contracts are used to record and distribute income or deduct running expenses associated with the asset. The tokens will be tradeable on the blockchain platform like shares on a stock exchange creating a liquid market in an asset that may originally have been quite illiquid (as long as enough investors remain interested in buying and selling the tokens, which is not certain).
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Real estate is an obvious market for this kind of scheme. For example, Reidao, a Singaporean venture on the Ethereum platform, says it aims to transfer the business model of a traditional real-estate investment trust (Reit) to a blockchain-enabled "decentralised autonomous organisation". This means tokenising commercial property and distributing rental and other income to token owners using smart contracts. The Real Estate Asset Ledger (Real), set up by Spanish property investors, says it will initially invest in Spanish property, with the intention of expanding to North America, Latin America and Asia. (The venture is targeting returns of 12%-20% per year, which sounds ambitious in today's market.)
However, some ICOs go much further. UK startup Populous aims to use tokenisation and smart contracts on the Ethereum platform to provide invoice financing for small businesses. The LAToken (Liquid Asset Token), which is hoping to raise cash via an ICO this month, wants to persuade people to "tokenise" their assets be that property, classic cars or works of art and sell those tokens to investors.
The technology underlying all this is intriguing but ICOs and smart contracts are extremely speculative. Of the hundreds of ventures raising money through ICOs, the vast majority will fail and be worthless. Large numbers are clearly scams. We wouldn't put money into any right now. But it's still worth watching how the field develops. After the technology matures, these innovations could have a big impact on crowdfunding and P2P lending.
Ben studied modern languages at London University's Queen Mary College. After dabbling unhappily in local government finance for a while, he went to work for The Scotsman newspaper in Edinburgh. The launch of the paper's website, scotsman.com, in the early years of the dotcom craze, saw Ben move online to manage the Business and Motors channels before becoming deputy editor with responsibility for all aspects of online production for The Scotsman, Scotland on Sunday and the Edinburgh Evening News websites, along with the papers' Edinburgh Festivals website.
Ben joined MoneyWeek as website editor in 2008, just as the Great Financial Crisis was brewing. He has written extensively for the website and magazine, with a particular emphasis on alternative finance and fintech, including blockchain and bitcoin. As an early adopter of bitcoin, Ben bought when the price was under $200, but went on to spend it all on foolish fripperies.
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