July 20, 2017

Breakingviews: Crypto-currency deals recall an earlier tech craze

by Breakingviews.

Technology startup funding may be bubbling again, but this time in a new form. Initial coin offerings, or ICOs, have taken off, raising $1.3 billion so far in 2017, according to Autonomous Research, six times last year’s total and nearly 50 times the market in 2014. The startups in question typically involve some new application for a crypto-currency like bitcoin or the use of associated blockchain technology. But the fundraising technique is untested and unregulated, while the beneficiaries’ ideas don’t have to be thought through. It’s a risky recipe.

ICOs are a bit like a cross between crowdfunding and issuing non-voting shares. A startup provides a white paper about its idea – which may or may not contain much detail – and issues eager investors with tokens, essentially versions of digital currencies, representing an interest in what it’s developing in exchange for liquid crypto-currencies that it can easily spend or turn into cash, like bitcoin or ether, the Ethereum project’s crypto-currency.

Investors hold the tokens they receive either in the hope they will rise in value – even bitcoin, for example, remains more a speculative phenomenon than a currency – or in anticipation of development success that brings an increase in the functional value of what the startup is doing.

Just last week Tezos – a startup that has previously used crowdfunding and is working on a new type of blockchain ledger – completed the largest ICO to date, raising over $230 million in bitcoin and ether. Gnosis, developing an Ethereum prediction market, recently raised $12 million in less than 15 minutes.

It’s an echo of the 1990s. Unproven management teams are receiving hefty funding based on little except a white paper and rarely any clear prospects of future profitability. Dizzying rises in the prices of bitcoin and ether, up more than 130 percent and 2,300 percent respectively this year, feed the frenzy. And in what should be a red flag for those using ICOs to raise money, it’s a market – unlike the early-stage initial public offerings 20 years ago, for example – that is not currently within the purview of the U.S. Securities and Exchange Commission, even though it looks a lot like the issuance of quasi-securities.

Unlike in crowdfunding, many investors expect large returns – even if they should be repeating “caveat emptor” to themselves as they peruse ICO white papers. When most of the startups in question fail, that could turn into a big problem, too.

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