Tuesday, July 25, 2017

Initial Coin Offerings

The FT's Alphaville blog has started a new series, called ICOmedy looking at the insanity surrounding Initial Coin Offerings (ICOs). The blockchain hype has created an even bigger opportunity to separate the fools from their money than the dot-com era did. To motivate you to follow the series, below the fold there are some extracts and related links.

So far the series includes:
  • ICOs and the money markets:
    how can you determine fair relative value or what the no-arbitrage condition for a multitude of crypto currencies should be if they bear no income potential whatsoever? They have no time value of money in the ordinary sense.

    If and when they do bear interest it is derived not from lending to a productive industry but to short sellers — and this is done at heterogeneous rates across varying exchanges and at varying risk. There is no uniform base lending rate. Everything is arbitrary. Worse than that, the lack of income equates the whole thing to a casino-style game of chance, with ongoing profits entirely dependent on ongoing capital inflows from external sources.
  • In the crypto world, you can get something for nothing:
    you have some cash, and I have a “token”. The token is worthless. It has no purpose or function. There’s a big label on the token that says, “this token cannot be used for anything”. And we exchange the two, and so I end up with your cash, and you end up with nothing, and for some reason you’re happy with the transaction. ... This is a pretty accurate description of an “initial coin offering” (ICO) that has raised $200m worth of cryptocurrency. The company behind it is called block.one ... In an earlier post, we likened an initial coin offering to a Kickstarter campaign. Investors hand over their money, and in return get some sort of access to the product when it’s finished. The access is granted by a token that can be used with the software being developed. Block.one’s initial coin offering is different. There’s a token, but it can’t actually be used for anything. This is from the FAQs:
    The EOS Tokens do not have any rights, uses, purpose, attributes, functionalities or features, express or implied, including, without limitation, any uses, purpose, attributes, functionalities or features on the EOS Platform.
    You might want to read that over a couple of times, keeping in mind that investors have spent over $200m buying these “EOS Tokens”.
  • From dot.comedy to ICOmedy…:
    mainstream media coverage of the crypto phenomenon has all focused on the similarities with the dotcom mania of the late 90s, which came to a head in the Spring of 2000. ... Sure, there was a mania, and stocks went to comical valuations, and thousands and thousands of people thought they had become overnight millionaires, only to discover they weren’t. Yes, it was tech-related and people were making fabulous predictions about how the world was going to change. ... But during the dotcom era it was clear that the world was changing, for real. Old skool, analogue businesses like Barnes & Noble were getting Amazon-ed. It was clear that all forms of business were already being revolutionised as the digital aged dawned. The trouble was that greed and a herd-like mentality sent the public markets potty for a time.

    The crypto craze is different. It has grown from fringe libertarian philosophy, preaching that any and all government is a bad thing, and that all our current systems where society is organised centrally will soon be replaced by loose ‘non-trusting’ digital networks and protocols that transcend the nation state. ... State sovereignty is not going to disappear. Democratic government is generally a good way for nations to organise their affairs. Dollars will buy you food and energy for the foreseeable.
  • What does a crypto startup do with $230m?:
    You’ve probably never heard of Tezos before. It’s a “new decentralized blockchain” that’s apparently better than all the other blockchains, and last week, it completed a $230m fundraising. ... If the sum of money raised was a guarantor of success, then Tezos would now be a sure bet. It’s the biggest ICO to-date. The platform is the brainchild of Kathleen and Arthur Breitman, who previously worked at Accenture and Goldman Sachs respectively. They have been developing it through their venture Dynamic Ledger Solutions since 2014 and if they can get the Tezos blockchain running for three months “substantially as described” in their marketing, they and the other investors in DLS like venture capitalist Tim Draper will make $20m.
    What they will do with nearly a quarter of a billion dollars isn't clear. Ideas include "Acquire mainstream print and TV media outlets to promote and defend the use of cryptographic ledger in society"!
Ether price
Leaving aside the daily multi-million dollar heists, of which last Sunday's was $8.4M from Veritaseum, there is the opinion of one of Ethereum's co-founders that the speculative frenzy in Initial Coin Offerings is dangerous:
Initial coin offerings, a means of crowdfunding for blockchain-technology companies, have caught so much attention that even the co-founder of the ethereum network, where many of these digital coins are built, says it’s time for things to cool down in a big way.

“People say ICOs are great for ethereum because, look at the price, but it’s a ticking time-bomb,” Charles Hoskinson, who helped develop ethereum, said in an interview. “There’s an over-tokenization of things as companies are issuing tokens when the same tasks can be achieved with existing blockchains. People are blinded by fast and easy money.”

Firms have raised $1.3 billion this year in digital coin sales, surpassing venture capital funding of blockchain companies and up more than six-fold from the total raised last year, according to Autonomous Research. Ether, the digital currency linked to the ethereum blockchain, surged from around $8 after its ICO at the start of the year to just under $400 last month. It’s since dropped by about 50 percent.
The frenzy around ICOs using Ethereum was so intense that it caused a worldwide shortage of GPUs, but:
Over the past few months, there has been a GPU shortage, forcing the prices of mid-range graphics cards up as cryptocurrency miners from across the world purchased hardware in bulk in search for quick and easy profits.

This has forced the prices of most modern AMD and certain Nvidia GPUs to skyrocket, but now these GPUs are starting to saturate the used market as more and more Ethereum miners sell up and quit mining. Some other miners are starting to look at other emerging Cryptocurrencies, though it is clear that the hype behind Ethereum is dying down.

Earlier this week Ethereum's value dropped below $200, as soon as the currency experienced a new difficulty spike, making the currency 20% harder to mine and significantly less profitable. This combined with its decrease in value has made mining Ethereum unprofitable for many miners, especially in regions with higher than average electricity costs.
As I write, it is back around $225. If you are minded to invest, the FT's Alphaville blog just announced a great opportunity.


19 comments:

David. said...

Today's post in the ICOmedy series is In ICO utopia, there is no division of labour in which Izabella Kaminska dissects the idea of decentralized decision-making, for example in DAOs such as this:

"holders of [name redacted] tokens will gain voting rights with the cryptocurrency. These voting rights, similar to any other democratic system, allow holders of [name redacted] to vote on future investments in other tokens, including new and upcoming ICOs. ... The benefit will be that the wisdom of the crowd will pick the best investments and protect [name redacted] holders against the bad judgement of any single participant."

Kaminska writes:

"We guess the logic here is that while trusting transparent, regulated and accountable professionals to make investment decisions on your behalf is bad, but trusting anonymous crowds, whose agendas and identities are unknown, must be markedly better."

David. said...

As predicted, the SEC has determined that coins and tokens are securities, and thus that ICOs are securities offerings subject to the law:

"The Securities and Exchange Commission issued an investigative report on Tuesday concluding that tokens offered and sold by a "virtual" organization known as "The DAO" were securities and, therefore, subject to the federal securities laws. The regulator is cautioning investors that offers and sales of "initial coin offerings" or "token sales" by "virtual" organizations using distributed ledger or blockchain technology are subject to the requirements of the federal securities laws. ... Participating in unregistered offerings may subject participants to civil or criminal enforcement proceedings. ... However, the SEC decided not to bring charges in this instance, or make findings of violations in the Report, but use the results of the investigation to caution the industry and market participants."

David. said...

Alphaville responds to the SEC's report on ICOs with three reasons why their offering is exempt.

David. said...

Ars Technica clarifies the SEC finding with the note that it probably means that coins and tokens that buy services are exempt, but anything promising a vote or a share in profits almost certainly isn't.

David. said...

Izabella Kaminska interviews David Gerard - its a wonderfully skeptical take on blockchain technologies and markets.

David. said...

Timothy B. Lee's Why the Bitcoin network just split in half and why it matters is a good overview of the Bitcoin fork, and how (if you believe the "valuations" from thinly traded markets) it created $10B in value out of thin air.

But the more interesting take is Matt Levine's Bitcoin Exchange Had Too Many Bitcoins. The Bitcoin blockchain doesn't support shorting BTC, but the market needs to be able to short it. So exchanges lend BTC and this led to complications in the split:

"But what if you owned negative bitcoins yesterday? What if, that is, you had borrowed bitcoins in order to sell them short? Well, in stock lending situations, the normal way that this works is that the short sellers (stock borrowers) have to come up with whatever is distributed on a stock. If you are short a stock and it pays a $1 dividend, you have to come up with $1. ... You could imagine bitcoin lenders taking the same approach: If you were short a bitcoin going into the fork, now you have to deliver one BTC and one BCH to your lender. Or not! In fact, when bitcoin distributed a pony of indeterminate value to its holders, Bitfinex decided -- not unreasonably -- that it would be unfair to make bitcoin borrowers come up with it. The value of Bitcoin Cash is uncertain and volatile, and forcing bitcoin shorts to go out and buy Bitcoin Cash to cover their shorts might create artificial demand for it and push up the price. So Bitfinex announced, last week, that short sellers would not have to come up with any BCH."

So, what happened? Go read Matt's column to find out.

David. said...

Prostitution is apparently the latest target market for "smart contracts" on the Ethereum blockchain. Note the customer-centric view of the deal. It might be a natural outcome of this.

David. said...

Kadhim Shubber sums up the risk factors disclosed in the "offering memorandum" for Filecoin's upcoming ICO as:

"Roughly translated into English, and taken together, that looks to us like, ‘You might not realise you’re being screwed over’."

David. said...

Izabella Kaminska reports that the vampire squid is hyping cryptocurrency as an investment class. She notes:

"This, of course, follows exactly the pattern of events which led to the great commodities bubble. This too saw Goldman declare commodities an asset class suitable for passive investors and fund managers. Once the marketing material drumming up the bull case was dutifully and loudly distributed, Goldman (and its competitors) then worked hard to marry passive investor flows with an industry geared up for producing stock for idle speculative reasons rather than real consumption or utility.

The bubble popped when supply caught up with over-investment and the scale of globally-hoarded commodities became obvious to the market. As soon as the rate of commodity appreciation failed to compensate for higher returns than less risky assets elsewhere, the opportunity costs for passive investors became too great. They pulled out, and commodity prices collapsed forthwith to levels that could be justified by fundamentals."

But in this case there are no fundamentals. Also:

"they’re predicting the price will surge in a frenzy of speculation, before going on to halve — while simultaneously disclosing that the Goldman Sachs trading desk “may have a position in the products mentioned that is inconsistent with the views expressed in this material”."

As always when the vampire squid is involved, caveat emptor.

David. said...

Childish security lapses at the infrastructure for the forthcoming Enigma ICO cost investors about $500K.

David. said...

Via msmash at /, Lynsey Barber reports that:

"The head of [Estonia's] innovative e-residency programme has said the country is considering what the issuance of "estcoin", the country's very own digital currency, would look like.

In a blog post, Kaspar Korjus said: 'Estcoins could be managed by the Republic of Estonia, but accessed by anyone in the world through its e-Residency programme and launched through an Initial Coin Offering (ICO).'"

David. said...

And for those of you tempted by the supposed anonymity of crypto-currencies, note that Third party trackers on web shops can identify users behind Bitcoin transactions:

"Independent researcher Dillon Reisman and Steven Goldfeder, Harry Kalodner and Arvind Narayanan from Princeton University have demonstrated that third-party online tracking provides enough information to identify a transaction on the blockchain, link it to the user’s cookie and, ultimately, to the user’s real identity.

“Based on tracking cookies, the transaction can be linked to the user’s activities across the web. And based on well-known Bitcoin address clustering techniques, it can be linked to their other Bitcoin transactions,” they noted."

The paper is here. Note that there are crypto-currencies with stronger anonymity properties:

"Zcash, based on the Zerocash protocol, and Monero, based on the Cryptonote protocol. Zcash is more computationally expensive but comes with more rigorous security properties. Of the two, Monero has more vendor support at the time of writing, but still far less than Bitcoin or even Litecoin, and primarily on hidden-service sites merchandising illicit goods."

David. said...

The Ecomonist's backgrounder on the dispute over the bitcoin block size is worth a read.

David. said...

The next entry in the race to separate fools from their money is a failing startup:

"So what does a chief executive do when things grind to a halt? Well, she or he either kick-starts growth; pulls a dramatic pivot out of the hat; finds someone dumb enough to acquire the company; or prepares for the slow or fast decline of the business.

But now there’s another option: an initial coin offering (ICO), which lets you raise money from the public without having to sell any equity and dilute your existing shareholders. One startup heading down this path is Kik, a messaging app that has raised $120m from investors like Tencent and Union Square Ventures since its launch in 2010."

David. said...

Todays ICOmedy features Paris Hilton endorsing an ICO from Gravity4:

"Gravity4 “does not have significant experience” with blockchain projects"

And a warning that the SEC is serious about ICO fraud:

"On the DAO rulings, Morgan says the SEC had a high-profile case to assert that they do have a jurisdiction over these issues — especially in the case of issues asserting expectations of profit. That seems a fairly clearcut point, so it’s entirely befuddling as to why the ruling itself hasn’t yet been taken more seriously by the market. Or why nobody told Paris Hilton about it."

And so are the Chinese authorities:

"The People’s Bank of China said on its website Monday that it had completed investigations into ICOs, and will strictly punish offerings in the future while penalizing legal violations in ones already completed. The regulator said that those who have already raised money must provide refunds, though it didn’t specify how the money would be paid back to investors."

David. said...

Based on a report from the Bank for International Settlements, Izabella Kaminska discusses the idea of central bank cryptocurrencies and concludes:

"the only incentive central banks really have for introducing cryptocurrencies is in performing a giant monetary bait and switch. “Hey guys! We’re offering this amazing anonymous central bank currency which is as strong and stable as the dollar and yet just as anonymous as bitcoin!!! Come, all you illicit users of physical cash, come use our amazing new currency! We swear it’s absolutely anonymous and will never lead to prosecutions. Honest!!

Steven Knight said...

ICO's are such an interesting area and will probably bring with it more regulation down the track. One ICO i'm involved in is Texcoin.io which is a fintech thats looking to use the decentralised ledger to change the way that global trade occurs.

David. said...

The Economist's Free Exchange blog has a post entitled Manias, panics and ICOs:

"The ICO craze certainly appears to entail a departure from reasonable values. Such deviations can happen when taking the pessimistic side of a bet is difficult—shorting stocks, for instance (ie, selling securities the investor does not own in the hope the price will fall). In some accounts of the tech boom of the 1990s, the small float of many new tech stocks made shorting them nearly impossible; as issuance increased, however, bears could have their say, and markets tanked. Housing, too, is famously hard to short; in the global crisis those few financiers who found vehicles to bet against mortgage-backed securities eventually made a fortune. There are some opportunities to short cryptocurrencies, but essentially none for ICO tokens (something those intending to buy might reflect on, if reflection is their thing)."

David. said...

The latest ICOmedy piece points to Reuters' Special Report: Backroom battle imperils $230 million cryptocurrency venture:

"Just three months ago, a tech project called Tezos raised $232 million online in a wildly successful “initial coin offering,” in which new digital currency is parcelled out to buyers. At the time, it was the most money ever raised from the public in the white-hot cryptocurrency sector.

But the venture is now in danger of falling apart because of a battle for control playing out behind the scenes, Reuters has learned.

The acrimonious dispute pits Tezos’ two young founders – Arthur and Kathleen Breitman – against Johann Gevers, the president of a Swiss foundation the couple helped establish to handle the coin offering and promote and develop the Tezos computer network."

The report is full of gems such as:

"Kathleen Breitman told Reuters that participating in the Tezos fundraiser was like contributing to a public television station and receiving “a tote bag” in return. “That’s kind of the same thing here,” she said.

The fundraiser’s terms called the contributions “a non-refundable donation” and not a “speculative investment.”

If deemed a donation, and not a security, the funds raised might not fall under the remit of financial regulators in the United States. ... [VC Tim] Draper told Reuters that cryptocurrencies are commodities like pork bellies, and characterized acquiring Tezzies as a purchase rather than a donation. Asked this month how much he donated during the Tezos fundraiser, he replied via email, “You mean how much I bought? A lot.” ... According to the “Transparency Memo,” the new blockchain “must launch and operate successfully” for three months, then DLS’s shareholders – the Breitmans and Draper – are entitled to receive 8.5 percent of the fundraiser proceeds in cash."