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).
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.
The path to enlightenment
The Lotos Network is holding an ICO on the Ethereum platform to build “a complete ecosystem for Buddhist and secular meditation”. Buddhism has become “a huge business accumulating vast sums of wealth”, says Lotos, and corruption is “eroding trust”. “Transparent and immutable financial records” on the blockchain are “the only feasible way” to counter this. Lotos hopes to build a digital temple where gurus teaching meditation can earn “Karma Tokens” and a “BuddhaBrain” chatbot AI interacts with worshippers. Lotos is not the only cryptocurrency with religious roots; a Russian developer is aiming to raise $20m from Jewish users for a “kosher cryptocurrency”, BitCoen, reports The Register.
In the news…
► P2P lending platform RateSetter has left the Peer-to-Peer Finance Association (P2PFA), the industry’s trade body, after breaching the P2PFA’s operating principles. Last month, RateSetter revealed that it had invested directly into three struggling business that had borrowed through its platform. This prevented the firms from defaulting on their debts, which could have led to losses for RateSetter users, and broke the P2PFA’s rules on transparency. The P2PFA had been investigating complaints from investors about RateSetter’s wholesale lending activities that could have led to its dismissal from the body, reports The Times.
► Tezos, a Swiss tech startup that is building a blockchain platform on which developers can create secure smart contracts, raised $232m in an initial coin offering in June this year – the biggest ICO to date at the time. Now it is to spend $50m of that money on venture-capital funding for companies looking to build on its platform, reports Crowdfund Insider. The investments will be disbursed via venture-capital partners and also through a “direct venture arm”, says Tezos. The rest will be put into stocks, bonds and precious metals to “ensure that our organisation is resilient in good times, and bad times”. Tezos attracted a great deal of publicity ahead of its ICO, and was backed by US venture capitalist Tim Draper.