Initial Coin Offerings – Snake Oil or Saviour?

2017 was the year that Initial Coin Offerings (ICOs) hit the technical business press, and cryptocurrency stepped out of the shadows. It’s been a remarkable ride: in June, when finalising details of my novel Bitcoin Hurricane, the publisher asked whether Bitcoin was well enough known for the book to sell. By Christmas, at every signing I was met with people asking whether this lighthearted scifi thriller would help them to understand cryptocurrencies. The rapid rise in the value of Bitcoin, followed at a discreet distance by Ether, made overnight millionaires (I managed a new laptop and a decent holiday). The search is on for the Next Big Thing. Ripple? Litecoin? Bitcoin forks of every hue? Plenty of money is heading towards Tokens, and the gold rush has started.

What is a token?

In a Wild West scenario like emerging cryptocurrency, there is plenty of real value to be found – and plenty of snake oil, too. Ethereum in particular is an exciting platform, designed for developers to make groundbreaking new decentralised software applications. One of the many useful features of Ethereum applications is the ability to settle transactions within individual systems using tokens which are linked to the main Ether cryptocurrency. It’s cheaper than paying bank charges for using real money, and gets over the headache and volatility of cross-border currency conversions. It reduces risk to the user by minimising the personal and banking data that is exposed to the network. And for anyone who intends using one of these new Ethereum applications, it could be an advantage to have some relevant tokens already in the bag.

Initial Coin Offerings fund software development

Suddenly, there is an economic advantage to potential users to stock up on tokens before the system goes live. The value of the linked cryptocurrency, Ether, is rising against our fiat currencies (the dollar, pound sterling etc). Locking some investment away in a token could pay handsomely when a new system is launched successfully. Software developers have not been slow to recognise this.

If users are ready to pay before the system is launched, this is a potential source of finance for the development process.

The name coined for these token sales is Initial Coin Offerings, or ICOs. It’s a fancy title for what is, effectively, unregulated crowdfunding. In the United Kingdom we have an established investment crowdfunding market managed by the likes of Crowdcube or Seedrs. Businesses who want to raise money must produce solid business plans and investment decks before being listed. Potential investors must demonstrate that they are going in with their eyes open. The whole process of investment crowdfunding is regulated by the Financial Conduct Authority, because the chances are that the business will fail, however good their intentions.

Selling tokens seems a whole lot easier. All that’s required is a White Paper outlining the plans for the new venture, and the curious will come. It makes sense to developers, who realise that the speed of technological change is leaving a lot of traditional investors behind. While the $3.2 billion raised in ICOs in 2017 is a drop in the ocean compared with traditional funding, it has served to finance very specific types of software development. As a result, the industry’s understanding of blockchain technology and its potential has advanced at an unprecedented pace. So far, so positive. But this is the Wild West. For every great concept funded by an ICO – and there are hundreds – there are snake oil salesmen ready to take your money for worthless tokens.

The need for regulation

It is still all too easy for a fraudulent Initial Coin Offering to raise funds. How do you distinguish between intentional fraud and pure business bad luck when the development fails, leaving your tokens worthless? Unlike traditional equity investment, where you secure a share in the business, there is no security for tokens. The United States Securities and Exchange Commission has been quick to step up. It established a Cyber Unit to investigate and prosecute fraud in ICOs, and closed one recent sale down. In the United Kingdom, the Financial Conduct Authority has warned investors to be wary, and has declared that it may look to regulate token sales in the future.

Still want to join the gold rush?

There are hundreds more Initial Coin Offerings in the pipeline. Some will be pure gold: the vast majority will be fool’s gold or straight-up snake oil. Ultimately, responsibility lies with you, the investor, to go in with your eyes open. Good luck out there!