ICOs, STOs, and The Crazy, Complicated World of Crypto Finance
By Victor Santos, CEO and co-founder, Airfox
Since the term “blockchain bubble” reared its head again last year, the world has been reminded that tech speculation is fully capable of dancing financial markets off a cliff.
As regulation in the crypto space evolves, security token offerings (STOs) have been touted as preferable to initial coin offerings (ICOs) as a blockchain-investment model, but clarity is elusive and analogies with the dot-com bubble are plentiful.
This Looks Familiar
In some ways, the comparison to the initial public offering (IPO) frenzy of the late ’90s is apt. At the turn of the last century, new technology propelled a massive business boom in web-based ventures like Amazon. It also propelled wild internet day trading, Pets.com, reams of pink slips, and $4–$6 trillion in shareholder wealth that swiftly evaporated into thin air.
It has not gone unnoticed that a snapshot of the NASDAQ composite index from the era looks awfully similar to recent charts of value fluctuation in crypto tokens. Like so many dotcoms of yesteryear, and with a nod to the famed Gartner hype cycle, crypto has plunged from peak speculation into the trough of disillusionment.
In both instances, excessive zeal for new technology was a huge factor in market volatility. Back in the 1990s, the internet was taking hold and any venture with a dot-com moniker soared in speculative value. The same could be said of “blockchain” investment just last year. With global business increasingly automated and online 24/7, cryptographically secure distributed digital ledgers (or blockchains) and virtualized autonomous transaction technology fueled the crypto craze. A 2017 surge in initial coin offerings (ICOs) showed rising enthusiasm for both digital crowdfunding models and unbridled excitement for all things blockchain-based.
ICOs continued to escalate into 2018, but existing high-profile cryptocurrency valuations plunged dramatically. Like crowdfunding on steroids, ICOs disrupted the traditional startup launch cycle. Wealthy venture capitalists were no longer the only ones supporting startups, but fraud was also rampant and plenty of crypto scams plagued the market. It was difficult to separate the wheat from the chaff, and there’s still a lot of genuine confusion.
It’s Complicated
It’s been virtual bedlam trying to differentiate between digital commodities, digital securities, and digital scams, much less mineable cryptocurrency tokens developed purely to generate value or utility tokens developed to facilitate transactions. As a result, the market is now skeptical of ICOs, new U.S. regulations have been enacted, and blockchain startups face greater scrutiny. But provisional paths to compliance with federal securities laws are expected to establish the regulatory certainty needed to keep the wave of innovation flowing, and the sector continues evolving to offer better structure.
It’s important to recall that the dot-com crash did not mark the end of the internet or web-based business, and the current crypto winter will not mark the end of blockchain. Subsequent to the ’90s bubble, there were years of stock market dubiousness and speculation. For example, the Chinese reverse merger fraud crisis led to more than 50 companies being delisted or halted from trading on Nasdaq or the NYSE in 2011 and 2012. Over time, stock markets matured and investor confidence was restored. Something similar will happen with crypto, it will just take time. In fact, the aftermath of this crash will solidify blockchain models that support pretty exciting new mechanisms for financial inclusion.
Finance Reformation
STOs represent a promising opportunity for offering virtual securities on the blockchain that is backed by an actual asset such as bonds, funds, equity, debt, or real estate investment trusts (REIT).
At scale, STOs could make markets more efficient and transparent. Estimates suggest that tier-one banks spend well in excess of $1 billion a year on compliance-related costs. This excessive business expense could be eliminated with the wide adoption of blockchain-based smart contracts, a strategy multinational investment bank Barclays is already testing. Additionally, a continuous, immutable, and automated index — that requires no middle men — would be a natural byproduct of security tokenization.
This would disrupt the way venture capital works (which, let’s be honest, hasn’t had a good shakeup in a long time). With the current VC model, it can take 8–10 years to confirm if a fund will perform. Limited partners invest in funds, giving money to general partners who take a management fee every year. Blockchain-powered indexing would automate and streamline performance indicators, so investors wouldn’t have to wait a decade to find out if a fund will deliver returns.
And venture capital isn’t the only investment arena ripe for a revamp. Perhaps the most exciting development to emerge from this “blockchain bubble” is a global fractional investment opportunity for democratizing fundraising for assets and access to these same high yield assets to any investor in the world.
Capital markets are geographically segregated, with illiquid markets for small-cap stocks and share prices that limit the pool of investors. But digitally tokenized securities can support fractional shares in a global scale, so you wouldn’t have to possess great wealth to generate wealth.
The idea is that you can securitize items of value (assets) and break that value into digital parts, without physically breaking the asset into parts. Picture a queen’s tokenized tiara, for example. Its whole value digitally represented can be fractionally bestowed to several inheritors without having its precious metals melted down and its diamonds pieced out. Similarly, tokenized real estate allows the purchase of a digital fraction of building or piece of land or a stake in a loan instrument with asset-backed security tokens.
The same process translated to business investment would mean that even “Average Joes” could invest in price-prohibitive but performant shares in Amazon, (Keep in mind, one Amazon share currently costs about $1,800.) Another example is enabling “rich people” high yielding assets such as private equity opportunities to literally anyone in the globe without investment or geographic restrictions.
The crypto sector is definitely complicated right now, but the underlying technology is solid and its implications are groundbreaking. For real correlation to the dot-com days, consider this: Pets.com may be the dark poster child of tech-fueled financial folly, but Amazon was also born of that age. After a 1997 IPO at $18 a share, Amazon surged to $89 per share in 2000 and plunged to just shy of $6 a share in 2001. Still, no one is calling its existence crazy now.
