Unchained Exuberance
Twitter has recently announced that it is banning any ads related to cryptocurrencies, including those offering trading advice. Twitter follows Google which in turn follows Facebook, which banned ads promoting cryptocurrencies (including bitcoin, ethereum and ICOs) earlier this year from its platform. The virtual currency space is increasingly perceived as difficult to regulate from fraud and other scams.
It is both hilarious and unsurprising that bitcoin, initially intended as a safe storage of value similar to gold (due to its controlled money supply out of reach from central bank interests) has become the most speculative security, swinging wilder than any other forex. After all, the market trades on expectations and the range of these for bitcoin is extremely wide.
However let’s focus here on another controversial application of blockchain technologies known as Initial Coin Offerings, or ICOs for short. An ICO is a fundraising mechanism in which a company creates and sells its own crypto tokens in exchange for money. It is a somewhat similar idea to the Initial Public Offerings (IPOs) in which investors purchase shares of a company, as it is supposed that the money is destined to fund the firm’s projects.
ICOs are a relatively new phenomenon but have quickly become a dominant topic in the traditional venture-funding model. As an indication of its growth, by the end of 2017 the amount of money raised for technology companies via ICOs had already surpassed early stage venture capital (VC) funding.
Now let’s consider that there were actually less companies funded by ICOs, but the average funds raised by ICO were 3 times as high as the average in venture capital for early stage (6.4 vs 19.2) and a staggering 13 times higher in seed stage (1.4 vs 18.5). Compound this by the fact that most successful ICOs, including the larger ones, did not have any sales or even a prototype by the time of funding, and we can see a dangerous bubble forming here.
Sure, blockchain is a truly innovative system, a smart application of cryptographic ideas, but don’t fall prey here to the smoke and mirrors. It does not really matter if you are an expert in the public key infrastructure principles that underly blockchain. What really matters in any investment is to understand which kind of bet you are doing, and the technology is only a way to get there. What is the hypothesis that are you betting on?
Blockchain is all about distributed tokenization. We call them coins, coupons, securities or other names depending on context, but what matters is that the tokens in a blockchain system don’t need a central entity to guarantee their integrity; it is instead preserved by mathematics alone. That comes of course at a cost in terms of processing and storage costs, and bitcoin in particular (due to its POW methodology) may be one of the less “green” technologies in history, but it certainly allows for an unprecedented level of decentralization.
Now, does that makes sense? It certainly does, but I would argue than decentralization is relevant in many less instances than are taken for granted if you buy into the hype. Consider bitcoin for instance, marketed as the future of digital money, the best solution for internet transactions due to its distributed nature. The truth is that, albeit imperfect, credit cards are actually faster and more reliable for these scenarios precisely due to their centralized nature.
It is worth remembering that the Internet itself was born in the late sixties within DARPA, the research arm of the United States Department of Defense, as a decentralized communications system that could withstand the threat of nuclear warfare posed at that time by the Soviet Union, so that the network would still be operational even if it lost a considerable number of its nodes. However the changing needs of globalization have been a driving force for efficiency through centralization, and nowadays the loss of a single cluster can lead to blackout in entire countries. The same holds true even for cryptocurrency mining, which theoretically could be very fragmented but in reality is concentrated in a few massive mining farms because, well, it is more efficient that way.
Let’s go back to our original question in the context of the ICO’s, which allow to raise funds for a project by selling tokens without the need of a centralized authority (e.g. the Securities and Exchange Commission or SEC). Was that really a logistical problem before? Not really. What happens in practice is that blockchain technology is being used as a proxy to bypass the traditional requirements that these official bodies mandate in the sale of new tradable securities. So what is the hypothesis you are betting on? That countries will suddenly forget about their regulatory entities, give up their sovereignty and allow both unrestricted transnational flows of money and unlimited emission of new tradable securities.
Even for a staunch believer in globalization and technological progress like me that is a hard belief to swallow. I am convinced that blockchain will be transformational in a number of used cases where distribution is a key issue, but it will not be right here. Whether you believe that the existing protections benefit the consumer or the industry, most likely the governments will crack down on these experiments and bring them back under the restraint of the regulatory authorities.
The announcement earlier this week that the SEC has opened dozens of investigations related to cryptocurrency and ICOs sent currency prices tumbling, and there is more to come, because the absence of oversight has fueled a, pun intended, unchained exuberance of epic proportions. Anything with the “blockchain” sticker on it sells by the millions. The bellwether might be that of New York-based beverage maker Long Island Iced Tea, which saw its stock jump 200% when it changed its name to “Long Blockchain Corp”. Many other irrational purchase cases abound, like Dogecoin, is a cryptocurrency without any other relevance than featuring the Shiba Inu dog from the “Doge” Internet meme as its logo… but nevertheless reached a market value of US$2 billion.
The space is also rife with subtle and not-so-subtle scams. Take for instance the recent Eligma ICO. Marketed as “an AI-driven cognitive commerce platform” (whatever that means) there is nothing more behind than a whitepaper that adds cryptocurrency sugarcoat to worn e-commerce ideas. It seems that the blockchain potion can rejuvenate even such basic propositions as serving digital ads (whether uLike it or you don’t) without actually changing the underlying business model. And those who a few years back did not succeed transforming a failed talent marketplace into a “social professional network” that never took off, have now a chance for a third round by rebranding their brainchild as a “decentralized professional ecosystem”, powered by blockchain, and thus continue living large at the expense of gullible investors.
The absence of oversight on the blockchain ICOs has fueled an unchained exuberance of epic proportions.
Once they are properly formulated and regulated, ICOs will play an important role in the mix of financing options available and, in a similar fashion than crowdfunding, contribute to lower the overall cost of capital for a startup. However, they don’t really pose a threat to the traditional VC funding mechanism. With smart venture capital the money is only a fraction of the complete value proposition, because such an investment also comes with experience, contacts and hands-on commitment to success. For instance, at Conexo Ventures our strategy is solely devoted to select companies that can compete in the global stage and work together with the entrepreneurs to establish their presence in USA and accelerate their growth. As we like to phrase it, we pay you to internationalize your company. A perfect alignment of interests to make sure we all row in the same direction, westwards.
The real problem is that ICOs not only exhibit an absence of additional services or investor partnership with the project, but also seem to lack the ability to filter promising projects and display a worrisome irrational behavior that dumps insane amounts of money to dubious, half-baked ideas. In that sense if feels like the high tide of the XVII century’s Tulipomania, at which point you could buy an entire estate in the Netherlands with a single tulip bulb. A few months later, when the market crashed, the price of a tulip was that of a common onion.
It will hurt.
