ICO Series: The state of a bubble - Episode 2
Where do ICOs come from? And why has it gained traction now?
ICO stands for Initial Coin Offerings. The term has recently been made famous after several new ventures raised $50M+ in only a short amount of time. In this series, we will explore the market’s recent fascination with ICO by explaining why it exists, how it works, from where ICO players are emerging, who these main players are, and why the ICO market may be the next bubble. This second episode is where we will deep dive into the building blocks of ICOs — technologies such as Blockchain and Ethereum, etc.
Several innovations have led to the emergence of ICOs. The main one is blockchain technology. But what is it? As described by Don Tapscott, co-founder and Executive Director at Blockchain Research Institute, “the blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”
Blockchain and the collaborative spreadsheet analogy
Imagine you have a Google sheet that everyone has access to. The same spreadsheet is duplicated thousands of times and these copies are hosted across a network of computers, meaning it is stored in more than one single location. This, in addition to continuous “syncing” of these copies, prevents file corruption because majority of servers in the network will know if the spreadsheet has been altered. Everyone can suggest entries into the spreadsheet, but entries have to be validated by a consensus among all the users of the spreadsheet. The spreadsheet becomes then a decentralized, distributed, incorruptible database — or ledger. This analogy describes a basic picture of what blockchain is.
Why is blockchain technology interesting in our internet world?
The internet does not provide a trustworthy infrastructure for assets and value transfer. For this reason, intermediaries such as banks — but also Paypal, Ebay, Uber, AirBnb, etc. — are needed to make sure both parties in a transaction oblige to some pre-specified terms and conditions. This is the case for money transactions but also, to some extent, for any transaction having to do with an exchange or contract of value.
Blockchain technology deletes the need for a middleman by creating an “incorruptible” database of contracts.
Once a contract between two parties is added to the blockchain ledger, it can’t be undone. Previous hackings have been linked to human errors, vault password hacking, and vulnerability in codes, but never by breaking the consensus between servers, given the network has now reached a significant size.
New opportunities to develop blockchain applications
The first application of blockchain is Bitcoin — a currency where banking intermediaries are noticeably absent due to consensus. However, many other applications emerged when people realized that blockchain could be valuable for things other than financial transactions. Coders then decided to create protocols that would facilitate the development of other blockchain applications. Ethereum was created for that purpose. It is an open source blockchain project providing developers with the tools to build decentralized applications. It made blockchain accessible to everyone — or at least to coders. After the release of Ethereum, people started to find new applications of the technology: file storage, sharing economy applications, IP protection, supply chain tracking and… crowdfunding.
ICOs are blockchain applications, mainly built on Ethereum protocols, and allows companies get the funding required to start their business.
Ethereum opened the way to the ICO boom, and one of the first ICOs was the launch of Ethereum itself. People were able to get Ethers (Ethereum cryptocurrency tokens) in exchange of bitcoins. These ethers would be used to transact on the new blockchains applications.
What is going on in the ICO space?
ICOs became famous last year with the launch of “The DAO” — The Decentralized Autonomous Organization. The DAO was a smart contract system built on Ethereum and its purpose was to jumpstart a community managed venture fund. They raised $160M by gathering 12.7M ethers. In June 2016, users exploited a vulnerability in the code to enable them to siphon off one third of The DAO’s funds to a subsidiary account. DAO was later unlisted from all exchange platforms.
It has recently accelerated with massive $50M+ ICOs. For example, Bancor, a protocol enabling liquidity for new cryptocurrency tokens* has attracted more than $150 million in just three hours.
* with the explosion of the number of cryptocurrencies, there is a need to make them liquid enough to facilitate trading.
Overall this year, $1.3B+ has been raised through ICOs.
Another metric of ICOs success in the market is the number of ICO sales concluding each week. According to Smith and Crown data, there were 2.75 sales a week from January to May.
Why has it gained so much tractions recently?
In our point of view, there are two sides to this story. On one side, the technology simply became mature enough. Infrastructure has been developed and big efforts have been made to democratize and open the technology to more and more developers. On the other side, the volatility of cryptocurrencies makes it attractive to investors. When people saw first investors gained gigantic returns with the first ICOs, more and more people decided to join the game. When you consider that ICOs are under not well-defined regulation, you can see why there has been a large influx of capital, with investors trying to gain their piece of the pie. (See Episode 1 to understand better why ICOs have short term gains).
ICOs and the threat of being regulated
The latest news in the space might slow this harried pace of investing. On Tuesday July 25th, the Securities and Exchange Commission concluded that tokens offered and sold during “The DAO” initial coin offering were securities. Their message was a gentle warning to the industry and market participants that although the SEC will not pursue any charges or findings of violations:
“The federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using US dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.”
