Initial coin offerings: How to speculate on emerging digital currencies
(Hint: “It’s the economy, stupid.”)
Democratisation of currency issuance through blockchain technologies has given rise to frenzied speculation. Analysis of this new asset class should focus on economic drivers of supply and demand.
Speculating on the future value of currencies has generated wealth for many investors. In its’ simplest form, traders or speculators use one currency to buy another, speculating that the newly purchased currency will appreciate in value relative to the one sold. The number of currencies available for traders or speculators has been limited by very high barriers to entry. Creating and issuing your own tradeable currency required internationally recognized sovereign statehood and a central bank.
Those barriers are now gone and the creation, issuance and distribution of currencies has been radically democratized with the emergence of cryptocurrencies. As would be expected, we are now seeing a proliferation of currency issuances by seemingly everyone (and their Doge). At the time of writing there are an estimated 1800 different cryptocurrencies that have been speculated upon through initial coin offerings (ICO’s).
In an attempt to articulate ‘where we are’ in the evolution of blockchain, many observers have compared the current state of the industry with the early days of the Internet boom. The analogy is useful; it helps us conceptualize and communicate that we are witnessing the birth of a new foundational technology offering previously unimagined opportunities for individuals and society. Frenzied speculation to place bets ‘ahead of the curve’ is also to be expected, and it is reasonable to expect a similar pattern of boom, bust and recovery to steady growth as the early experiments are naturally selected out and the technology propagates and permeates throughout our personal, commercial and social lives. We have seen this movie before.
The best cryptocurrency investors understand that while the Internet boom analogy is useful in analysing the technology evolution it does not extend to the nature of the asset class itself. Despite continuous regulatory debate about tokens being securities or commodities or other, value investors and speculators in initial coin offerings are not buying equity ownership of the company or any right to a share in company profits. These are not stocks that will pay a dividend or — at least at present — provide quarterly earnings reports or guidance. The leading cryptocurrency investors understand that they are not investing in a business but rather speculating on the future vibrancy and growth of a new economy. The business model and revenue model of the cryptocurrency issuer are important, but only insofar as they are able to adequately support the development and growth of the underlying economy.
Take Singapore, for example. Singapore was a newly formed economic entity in 1963, following independence from Britain and separation from Malaysia. The new country established a new government and a new central bank. They developed an economic plan and then issued their own currency — the Singapore dollar — to serve as the medium of exchange in this new economy.
A currency speculator at the time would have looked at the economic plan of Singapore. They would have looked at the underlying assets (very few) and the government’s monetary, social, trade and economic policies. They would have considered the country’s soft assets (its people), the regional and global macroeconomic situation and established a hypothesis about the overall potential for productivity, trade and demand for the currency. If you concluded that the Singaporean economy had a reasonable chance of growth and success, you might have chosen to purchase some of the newly issued currency. If you had used 100MYR to purchase Singapore dollars purchased in 1963 you would have tripled your money.
In this example, speculators purchasing the Singapore dollar in 1963 would have been interested in the country’s expected budget surplus (profits) or deficit (loss). But they would have paid more closer attention to the country’s overall operating budget and economic policy to determine if they would support a strong currency. Cryptocurrency investors should also understand the issuer’s expected profits/losses. But more importantly they should review company plans and policies to ensure that interests are aligned such that the company will continue to invest in and support the infrastructure and activity that underpins the economy and currency strength. If the company expects to be profitable, cryptocurrency buyers should ask about the company policy for surplus cash. Will it all go to dividends and bonuses for shareholders and executives, or will a healthy portion be used to ‘buy back’ and ‘burn’ tokens (destroy them) and strengthen the currency by reducing overall supply? Prospective cryptocurrency investors should ask additional questions to gain deeper insight into the intentions of the issuer and the overall supply and demand in the economy. For example:
· What portion of the budget (in tokens, other ‘reserve’ cryptocurrencies and fiat) will be allocated to bringing new participants (token holders) into the economy?
· How much will be invested to stimulate continued demand for the currency?
· Who will use the currency, how will they use it and, most critically… why?
Speculating on based on the hype around a specific project or the perceived value of a business proposition is insufficient. Some of the tools used by equity investors can be useful for analysing the health and sustainability of the cryptocurrency issuer, and standard due diligence processes can and should be adapted to perform legal and financial risk analysis on the operating entity and the management team. Analysis of the market and overall competitive landscape are useful in estimating the uniqueness and competitive advantages of the product/service being offered. But establishing a strong thesis for cryptocurrency speculation requires the tools of economic analysis and an understanding of the issuers’ monetary and economic policy and the fundamental factors driving the currency’s supply and demand.
About the Author:
David Harris is an entrepreneur, investor and futurist with more than 15 years experience as a driver of technology adoption in greentech, bluetech and communications technology across Asia. He serves as a strategy and technology advisor to governments, non-for-profit organizations and industry leaders in China, Hong Kong, Australia and Singapore. David is a frequent speaker and panelist at international conferences and summits, catalyzing and contributing to global conversations about the circular economy and transformative technologies. He is from Toronto, Canada and works out of offices in Shenzhen, Hong Kong and Singapore.
