Betting on the Blockchain, or When the Status ICO Broke Ethereum

Networks, markets and an economy of “attention.” What happened, how it works, what it means, and why it got messy.

I closely watched my first “Initial Coin Offering” (ICO) the other day. By many accounts it was a clusterfuck. Which I guess is about right:

Measured by some accounts, particularly Status.im’s Ethereum wallet, it went pretty well. It’s hard to say exactly how well, the network is still jammed up as I’m writing this. And Status.im are working on an official statement, but early estimates put them over $150 million raised in a day from upwards of 20K unique addresses. Of course, seems like it could have been more.

Before I ramp up here, this is definitely an “in the weeds” kind of post. It’ll be hard if you don’t already know a bit about blockchain stuff. Luckily a couple weeks ago, we had a Zengineering Podcast episode about blockchain technologies and their impact in the future. There we dig into the tech underlying everything I’m jumping off from here. If you get lost in the technologies discussed below, maybe bookmark this article and give that episode a listen first.

Okay. Strap in.

What’s an ICO?

An “Initial Coin Offering” or “ICO” is a first offering of any new crypto-currency. Offering is just a nice term for “sale.” In most cases you’re trading one cryto currency, like Bitcoin (BTC) or Ether (ETH), for a different one, in this case Status Coins (SNT.) The headlines tend to talk about ICOs in terms of “gold rushes” because it sounds exciting. And, they are exciting, as the tweet above may lead you to believe.

An ICO, like an Initial Public Offering, or “IPO” in a traditional stock market, is usually (when not a scam) an effort to raise money for the continued growth of a company or a project. Facebook sells shares of ownership in their company in exchange for the billions of dollars they hope it will raise so they can keep growing. Same deal with an ICO. It gets a bit weirder with the ICO, but the important ‘why,’ is that it’s about raising money.

The gold rush analogy isn’t wholly inaccurate but by that standard an IPO on the NYSE is also a “gold rush.” Yet you don’t tend to catch headlines about the “Facebook IPO Gold Rush.” Certainly not with the same sensational tone. The “rush” part is pretty normal. The market opens for trading, the Facebook stock is available, and a whole bunch of people buy some. The price fluctuates based on how many people are interested, how much they are willing the pay, and any number of other factors that whole news networks exist exclusively to talk about.

So nevermind the “rush” part. That’s just how this stuff works even when there are a boatload of regulations in place. The regulation allow periods of careful study, and require all manner of disclosures and filings and blah blah blah, and this makes “investors” feel like they aren’t just speculating on the future success of a company and looking to make a buck off of a smart bet. We’ll get back to the regulations part of this a bit later. But first let’s talk about gambling, because that’s the thing at the core of this whole system that makes people squirm, and really the part of the ICO’s that deserve the “Gold Rush” title, not the system in general.

Making Bets.

I find it important to get something straight that people generally don’t like to be this blunt about: Investing is gambling in a ballgown. I say this as someone who has been investing in stocks since before I could drive. (My Dad helped before I was 18. Chill out.) Investing is dressed up to look like it isn’t gambling, but buying stock is just fancy betting. “Investing” in a company is giving a company money, in exchange for a piece of paper that says you own a share of the company. If the company does well that share is worth more, and you can sell it later and make a profit on your investment dollars. You can use any approach you like to choosing which companies you bet on, but you’re still betting that you’re right, that this company will grow, and that your stocks will increase in value. The New York Stock Exchange, that hulking behemoth, is just a marketplace where people (well, computers mostly these days) sell and buy their little pieces of companies all day.

Its important to realize that this is already “virtual” behavior. We’re not actually moving around pieces of companies. A company is just an idea. We used to move around pieces of paper meant to represent a portion of a company. Now it’s all ones and zeroes in computers. Either way, the important thing to realize is that the NYSE is already virtual, even when it was a room full of brokers shouting and waving pieces of paper.

Making bets… on Stuff?

Gold (the expensive shiny metal) had a much different IPO. It was first offered to the public because people started finding it in the ground, and also finding that other people would pay for the shiny things they could make with it. In this case the “gold rush” was human miners scrambling to different parts of the world to find gold in the ground, and this happened way before the virtualization, which also means it happened much more slowly. (This also happened with pretty much every other substance one can take from the ground to use/sell.)

Now there are marketplaces for stuff like gold that function just like the stocks I talked about before, traders call them “commodities.” Another big word, but it’s essentially the same game. People have gold, other people want to buy it. Early on we realized that it was a really big hassle to actually move all that gold around. Gold is heavy. As an answer we did the same thing we did with the companies in the previous section, we virtualized it. We made up a system of paper, and ultimately ones and zeroes, we could pass around instead.

So we’re back to fancy betting. You can bet on this stuff by trading in the market. If I think gold is going to go up in value because the world still wants to buy gold, or if I know a shortage is coming which would drive the price up, I can bet on it by trading some of my money for some shares of gold. Once it goes up I can sell it off for a profit. If I think the price of pork bellies is going to drop, I can sell all my shares on the market, wait until the price goes down, buy them back for less, and then wait to see if it goes back up again. (Sorry, I just wanted to wedge that Trading Places scene in there, but, you get the point.)

Making bets on… what… fake money?

This is where it gets weird, but it’s a bit easier if you forget about the “what” that you’re buying and just follow the bets. What are you betting on if you jump into an ICO and trade a bunch of money for a bunch of new crypto-coins? You might be betting on the coin itself. Like betting on gold. This is what most of the action on Bitcoin is as of now. This is a bet that something about that coin means that other people want to use it. Maybe it’s the security technology, maybe it’s the way it’s traded and spent, who knows, but your bet here is on the coin itself. This is more like trading for gold. You’re watching the market for how people will behave with gold. The thing you’re buying is a share that represents some stuff other people want, and so that share has value. It works the same way with crypto-coins.

In some ICO cases you might be betting on the company that’s issuing the coins. In fact they might even represent a share of the company just like stocks I talked about earlier. Because crypto-coins are flexible, like, computer program flexible, you can do all kinds of interesting things with exactly how that “stock” works, but the important thing to know is that there are some coins you bet on, in the same way you bet on stocks. In this case a particular coin represents a share of a company, and that coin will gain or lose value based on how that company is doing. If the company grows, and makes money, the value will increase. If the company tanks, so will its stock, here: the coin.

Some of the coins that pop up in an ICO can be sort of both, which is where the confusion continues, but let’s look at the example that prompted this post: Status Network Tokens.

Status and SNT: Betting on a Network

Status Network Tokens, known by the market symbol SNT, were first offered for “sale” June 20th, 2017. This ICO, like any ICO, was an effort to raise money. In this case the money was for the growth and development of Status.im, a company working on building an open source messaging and web platform on top of a SNT based currency network. Their central idea is to cut out the middlemen that currently control most web browsing and social media interactions by building that infrastructure on top of a peer to peer payment network. The SNT coins are a material part of how that system works.

And it’s important to remember that the idea of an open source project is that the code is freely available, anyone can work on it, improve it, so on. The source code is open. By contrast, no one but Facebook knows what’s going on with Facebook’s code. That code is intellectual property that Facebook owns. Which is how they’re able to exist and make money. It’s notoriously difficult to monetize an open source project.

As a way to understand, let’s look at how Status would function differently from Facebook. Currently I go to Facebook because I want to look at my friends’ pictures. Facebook makes money by showing me ads. Those ads are paid for by other people who want me to pick their service, or vote for them, or just know they exist, or whatever. But what they’re really paying for is my attention. And they’re paying that money to Facebook. Me, the Facebook user, I don’t get anything beyond the enjoyment of looking at my friends’ pictures even though It’s my attention for which the advertisers are paying. TV works the same way. If you’re not paying, you are the product, or, your attention is the product, really.

Conceptually, with a network like Status, people that want to advertise would pay me directly for my attention. They would pay me some SNT to get a message to me; to get me to see their ad. And it costs me a bit of SNT (paid to the social network) to be on the social network. The social network is making money directly off of my presence, from me, while I’m making money directly from advertisers for agreeing to let them show me things they think I might be interested in. There’s an SNT cost for every interaction on the network, and you can’t take part without holding at least some SNT. (Don’t worry, these are all micro-transactions. You don’t have to pay to text your friends, you just have to turn ads on while you browse for a few days.) They get into more layers in their official whitepaper if you want to dig deeper. But the real thing to know is that, theoretically, a system like this has created a digital commodity, to be traded and valued in real time, which represents something we’ve only every tracked and traded via contact and billing invoice: our time and attention.

So that’s the value of the SNT coin, and you can see then where it’s value comes from inside of their system. They need it to exist, and to be spread out. But it gets weirder. The whole Status.im system is built as a layer on top of the Ethereum public blockchain. That blockchain has it’s own currency called Ether, ETH, I mentioned it earlier. Right now you can trade US Dollars directly to ETH if you like. ETH is the currency used to buy things, do things, or make payments in apps built on the Ethereum blockchain. Because status is built on the Ethereum public blockchain it means that ETH also has value within the world of Status and SNT. You might have heard of ETH, it’s been making headlines as the Ethereum blockchain gets attention. Status and SNT are a whole network of transactions, where you make and spend SNT based on your behavior on the network. You’ll have a wallet, and you’ll see the numbers fluxuate, but you won’t use SNT to buy a cheeseburger. That’s what the ETH is for, and that exists a layer out from Status and SNT. If Status and SNT go away all at once your ETH is still good money.

Incidentally this is part of why the whole fucking thing is weird and hard to understand. ETH is the money used on particular network based on a certain public blockchain structure. As that structure gets more popular, and more apps (et al) use it to make stuff, the ETH gains value, and the whole system becomes more robust. So back to betting, what are you betting on when you buy ETH? You’re buying a commodity in the sense that it has a value on other open markets stacked against other currencies. Currently it’s hanging around $300 for one ETH coin. But you’re also, sort of, buying a stake in the whole ETH system. You now have a reason to promote ETH, and the Ethereum Blockchain, and apps built on that blockchain. SNT works similarly.

The Status.im ICO was about raising money to continue to develop their system. They did it by selling units of the very juice that they will use to run that system, the SNT coins. They were sold at a value of 10,000 SNT to 1 ETH. And that ETH can be traded for normal money, like I said, $300 to 1 ETH. Status.im sold a boatload of SNT, and got a boatload of ETH from investors in return. So as much as I explained earlier that you don’t use SNT to buy a cheeseburger, you could trade SNT on an open market for ETH, and use that to buy your burger. But what are those investors actually betting on?

Well, The SNT does not represent a share of the company, it has no voting rights, or any sort of control of what the company does. So the bet isn’t stock. Owning SNT doesn’t mean that you own a piece of the company. It doesn’t give you any rights, or any control. It just means that you hold some of the juice that the Status system runs on. Of course, the system needs that juice to run, so in that sense there is some control.

So the bet is on a commodity, like gold? Well, moreso, but still not exactly. Gold exists in the real world. Remember? It’s heavy. SNT doesn’t really kick back to something you had to pull out of the ground that you can store in a Fort Knox vault. So it’s not that. But it does trade like gold. Because of all the ETH poured into the ICO there will, pretty soon if not already, be a market value for SNT to be compared against every other currency from ETH to Bitcoin to American Dollars. If it’s tradable then there must be something there right? If it’s a scam, no, but if it isn’t then yes. There’s a network. What does exist (or will, if Status.im keeps to their promise,) is the Status network. And that network requires SNT to run. What SNT does represent is essentially ownership of a share of the network itself. By owning SNT you hold the possiblity of exitings as a node on the Status network. By owning and using SNT you create the possibility for an economy of SNT, and you yourself benefit from that economy existing and persisting, which then gives the SNT, and then the whole system, even more value.

This is the core value of crypto-coins used properly. They allow us to build economies of value around things that otherwise used to be very difficult to pin down rigidly, like time.

So where’s the bet? In the short term the bet is on the coin as a commodity, like gold. And so in that sense it’s a gold rush based on the promise of the Status network concept. In the short term we might see a lot of it turned around on open markets to the profit of investors. There it will have value because of all the ETH dumped into the ICO. Long term the bet is on the network itself, the way a stock purchase is a bet on the success of a company. Anyone buying and holding long with SNT right now is in it because they think it will hold value as an SNT economy stabilizes around the system that Status.im envisions. (If you missed the ICO, and this is how you feel about it, then the move here might be to wait until this “gold rush” panic passes. The price will drop, and you can just pick up some shares on an exchange.) But I think we’re finally there… you know everything you need to know to understand the clusterfuck that was the SNT coin offering, when so many people wanted to bet on SNT that it broke the Ethereum blockchain.

The Clusterf*ck

I woke up early on June 20th to watch the fun. It paid off. SNT’s ICO was the single largest burst of activity on the Ethereum network to date. That spike on the right there 👇 is transaction submissions on the Ethereum blockchain for the SNT offering. The x-axis is in increments of 10K.

I’d only known about the ICO for a few days. Long enough to read the whitepaper, watch a few videos, and try to get a quick sense of the community around it from Reddit/Slack/Twitter. I knew they were doing all of this on Ethereum, and that there seemed to have been a last minute wave of interest that even caused the founders to push the ICO by a couple of days to make sure they had a good process in place to handle a “gold rush.”

On Ethereum things like this are controlled by “smart contracts,” which, for my lawyer readers, is kind of confusing. They aren’t contracts. They’re automated instructions triggered by an action, say receiving some ETH. All you really need to know about the SNT contract is that it was a system meant, and promised by the Status.im team, to allow people to freely exchange ETH for SNT for a certain period. Because it’s all programatic the idea is ETH in SNT out. Send some ETH to an address, get some SNT back, verified and stored via the Ethereum blockchain.

Because of the nature of the system, and the Status network I explained in previous sections, they can’t have these coins consolidated too much or the system won’t run. Everyone needs some SNT or it doesn’t work. It’s not in the company’s interest to let fewer people take part in this network. The more SNT out there, the more people who can use it to text their friends. So they built in an automatic check system to break up large block purchases and spread the availability as much as possible. This kind of the opposite of what typically happens right now with an IPO on a stock market. Facebook doesn’t care how much their stock is consolidated as long as they’re protected from takeover.

This stuff is all new stuff. I explained all the contracts and everything above like it‘s an established system that works, but we really had no idea. It ad never been tried before at any kind of volume. Which is why I showed up to watch.

The end result was a whole bunch of grumpy people on the aforementioned Reddit/Slack/Twitter feeds, and a company with hundreds of millions of dollars in ETH. If your plan is to have a big base of people that want to use your system, grumpy folks are not your friends. It’s unclear what caused the clusterfuck I watched yesterday, but for the mad ones the experience was something like this: show up at the time expected, ETH in wallet, follow the instructions, get no reply…. wait… refresh…. wait…. try again…. wait…. no reply… wait… for hours… ultimately with no successful transaction. All the while more and more ETH being shown as traded for SNT successfully. Some of it in suspiciously large chunks, some of it earlier than seemed to be within the rules. So it’s working somewhere, and in some cases for what seems like some “whales” getting special treatment.

When it comes to why this happened there’s been a lot of shouting, and conspiracy talk, and scam talk, and failure to read the blog posts where Status explained some things (which is not meant to excuse their lack of transparency.) But the one thing that is for sure is that the Ethereum network broke under the transaction load that interest in this company and their product generated.

Breaking the Blockchain.

Okay. “Broke” is the wrong word. It didn’t go anywhere. Ehtereum is plugging along just fine today. But it is fair to say that the system jammed up. With only so many pipes, and too many transactions trying to get through them at once the network had to invalidate, and bounce, numerous transactions. Others got stuck pending for hours, only to be bounced. And also some got through. At least hundreds of millions. It’s hard to say how many got bounced. (But maybe that info will show up over time.) Transactions were turned away at such a high rate that many people spent all day trying again, like pulling a lever on a slot machine, still failing to get a jackpot. It made a lot of people pretty grumpy, but it didn’t break the system.

It did break a lot of secondary services, however. Tools used to actually prepare and submit the transaction to the Ethereum Blockchain did break, and crash, and freeze and go down, or however else you want to think about something actually breaking in the digital world. Some of these services got a bit snarky about it. 👇 (Which for my money is a bad look.)

When I break it down this way it sure does sound like a “gold rush.” It certainly was an explosion of behavior on the Ethereum network. An unintentional DDoS attack in some cases. It’s also worth noting that we’re not just talking about the ETH to SNT system jamming up. The whole Ethereum network was jammed. People that just wanted to do normal Ethereum stuff that they did without a hitch the day before were also getting jammed up. But I’ll come back to that bit in a second.

Early in the contribution period there were a couple of very large transactions that seemed to slip in under the rules. They’re explained here. But the fact that they’re explained there doesn’t change one place where I am comfortable saying that the Status team messed up: transparency. And in a system like the one they’re pitching a glaring failure of transparency can be a real problem.

A Transparency Problem is a Platform Problem

Status covered a lot of their bases. I’m a trained lawyer, and I’ve dealt with deals and contracts my whole professional life. I dug through everything, and I asked programmer friends to take a look at the smart contracts. Everything seemed ship shape to me. The only mention I found of these initial, very large consolidated purchases of SNT was in the blog post I’ve linked above. It wasn’t posted until the day before the ICO. It turns out a lot of people missed this.

In the stock world these initial purchases would just be “presale” behavior. The public wouldn’t really know about it either. But a public Blockchain is something new. With the transactions pouring in anyone that wanted to could check out the wallet address for Status and see how many transactions had cleared, and how many ETH they transferred. No way to tell who those transactions came from, but they were visible. This is how we know about the early transactions, and how we know that they cleared while violating some of the rules meant to slow the land grab. It’s hard not to notice a single transaction for nine million dollars worth of SNT. People noticed. And they all cried “whale.”

And what’s the problem with a whale? In this case, a whale means two things. 1. That the Status network will never work, as there aren’t enough SNT holders, or; 2. those whales will get to control the price of SNT on the open market. In that case they control the price of access to the Status network. Both of these options are pretty big problems for Status. Number 2 wouldn’t be a problem if Status already exist, and had a massive user base, like Facebook did before its IPO. This is why stocks work. But SNT isn’t a stock. SNT is gold. And if people didn’t at some point decide that gold was shiny and desirable, then gold is just a metal we pull out of the ground that isn’t good for too much because it’s so soft. Maybe we could wrap food in it.

The problem is that Status needs people to download their app, then they need people to use it. To use it they have to go buy some SNT. If it costs too much, people are out. If the app is too boring, people are out. If the buzz around the product is that you’re actually buying your SNT from a faceless company that snatched it all up at the start, therefore sort of nullifying the whole idealogical concept surrounding these distributed architectures, people are out. That last one could have been avoided through a bit of extra explaining.

To their credit there was nothing less than a shitload of explaining going on via their site and other channels. There were other failsafes as well. Just get a view behind the curtain of the whole thing I had to VPN around a geofence. (Nothing illegal, they were playing it safe as the SEC is kinda grey on where the hell all this fits in the US regulatory system right now.) I had to confirm a bunch of things, flick through without reading a ToS (maybe it was in there, but that’s not a good excuse), and sign some things. At some point in there it seems like a popup could have let me know about these early transaction. Not because there was any particular right I had to know, but because it sure does look shady. And shady is a pretty bad look on an open source project like this.

I guess there’s another option: maybe they didn’t care. Status has a lot of money. At this point they could advertise and try to make a push I suppose, but they’re playing in a crowded pool with Facebook, WeChat, iMessage, etc.. In that pool hundreds of millions of dollar will, at best, make the cute lifeguard smile at you. And the last option: it’s vaporware, and a giant scam. That’s also possible too, and is the start of a pretty important conversation about a werid future where these scams are doable on such scale.

The Weird Future

We’re used to the idea of the “gold rush.” We can get our head around it from a lot of angles. The image of the panicked prospector, the wise investor, and so on. The idea of getting in early resonates. But in this case it’s arguable whether “getting in early” mattered at all. Throughout this whole thing the value of SNT was set. 1 ETH = 10,000 SNT. Whether you got that SNT early, or right before the contribution period ended it got the same exchange rate. This is different from an IPO. Like I mentioned before there are usually presales we don’t know about with an IPO. That means that a bunch of rich people were allowed to buy stock, usually at a price under the price the stock will debut with on the market. Then, when a stock is finally offered to the public on the open market the price usually goes up from there, at least for a bit. The rich people gain a bunch of value, while the public dukes it out on a market that’s over the place all day, and for the weeks and months after. There It’s easy to see why the “whales” in the IPO are shady, and frustrating to people with no pre-sale access.

As I eluded to earlier, SNT will also start to flucuate like that starting whenever the contracts allow it to hit the open market. But for one little 24 hours period there was no flucuation and the “whales” in this context just got to grab and early chunk of coins at the same price as everyone else. And this is sort of a weird new thing. Sure, they got a lot of coins, but they didn’t have any option to sell them two hours later when the price had doubled. So yeah, it’s weird. It’s like having an offering of Facebook stock, but in a context where no stock ever existed before the IPO. Nothing to pre-sell because nothing existed. An ICO is the first creation of a digital representation of value where there was litereally nothing. Executed like Status.im tried to, this offering spreads the weath around, and precludes bullshit pre-sale market manipulation tactics. Maybe. But even that ‘maybe’ is strong, because it might actually be doable to offer a stake in a company, or a currency, or whatever, in a different way than we’ve ever seen in modern economies.

In a sense the fact of this difference means that the “gold rush” for SNT didn’t need to happen. The idea was to get as much SNT out there as possible to seed a network, it wasn’t to maximize a stock price and sell the allotted quantity at that price. Certainly volume does help with the value of SNT on an open market, down the road. And the fact that so much ETH went into the SNT primes the system. But even that’s messy. I’m not sure what the rules are on Status issuing more SNT and I haven’t thought through what that does to the system. I’m not sure how you might change things to avoid this, while still generating the buzz that an ICO can. Maybe they did everything right, and the answer is in shoring up the Ehereum Blockchain. Luckily that’s a distributed system, all we need to do is add more nodes and at the least that jam up piece won’t happen again.

It’s easy to see how a transparency gap, perhaps even a small one, creates a big problem for a project like this. But seeing the reactions and the feelings flying about on the web during the initial hours of ICO also calls attention to difference between an IPO, and an ICO. An IPO on most major markets carries with it a certain amount of forced transparency. There are just a lot of documents you have to file publicly before you’re allowed to offer a stock. Usually this goes as far as Facebook having to put “users could suddenly stop using our service for no reason,” under a section marked “possible risks.” (Seriously, they really did, I read the documents before I invested and again in business law class.) None of those protections exist in the ICO space. In that sense, it’s getting really wild west-y out there right now.

Like I frequently mention on Zengineering Podcast, this isn’t something we can put back in the box. This ICO was something of a clusterfuck, but it’s not the death of anything. More likely, it will push more people to set up Ethereum rigs to make some ETH off of adding a node to the system. Status pulled in a lot of money to work with, and demonstrated an awful lot of interest in their proposed means of digitally representing the value of attention, and time.

It’s hard to chase where regulators are on this one right now. In the US it’s certainly closer to the offering of an illegal security. But also, it’s unclear what it is exactly. It’s not stock. It’s not really cash in a traditional sense. We’ve never dealt with this. In the right context this is a way to launch your company, and get a crapload of money to do it with right up front. All without really controlling any intellectual property. This isn’t something that is going to go away as an option for getting started, and people will continue to refine the execution. In the US we came up with the idea for the SEC because there was a mess of problems with markets and trading. It seems like the only real problem with the Status ICO was a jammed up network, and a couple blips in transparency. And it sure sounds like the community is demanding (and producing) fixes and explanations.

But take a step back. There’s something totally insane to look at more broadly here aside from the specifics of how this particular ICO went down. Conceptually Status came up with an idea for a way to structure a network such that the underlying juice that makes the whole thing run is a commoditized, digital representation of attention. A commoditized, digital representation of time. They raised hundreds of millions of dollars with which to chase this idea. They did it without selling shares in their company. And they did it without killing the open source component by selling off the idea. Instead they offered anyone who was interested the chance to buy some time. To buy some of the actual underlying juice that will keep their economy of time running. People bought that time, and now Status is real, valuable, and open source.

Mind Blown. 👇

UPDATE — Read this tweetstorm:

If you’ve got any ideas, or if I missed something big let me know. I’m @thekerp on here and on Twitter. Also listen to the Zengineering Podcast episode about bitcoin, cryptocurrencies, blockchain, and distributed technologies. We talk about stuff like this all the time, but… with more giggles.