Opportunity or Trap?
For seemingly every expert making bold claims that cryptocurrencies are the future of finance and are capable of "freeing humanity from tyranny," there's another expert decrying the rise of bitcoin and the like as nothing more than an unstable "bubble" built on hype and bound to pop.
Perhaps the strongest criticism levied at crypto companies, however, is that they're massive scams — that they don't deliver anything of material value and are intentionally designed to make money for those at the top by taking advantage of those at the bottom.
Case in point: "In my view, digital currencies are nothing but an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it," Howard Marks, Co-Chairman of Oaktree Capital Group.
So, who is right? Is crypto a legitimate new type of finance system or a modern take on snake oil, one peddled by supposed tech revolutionaries instead of seedy profiteers? In order to answer this question, it is important to first understand how token launches (sometimes called "ICOs" or "Initial Coin Offerings") work in relation to IPOs (Initial Public Offerings) — to understand how crypto startups are funded in comparison to other companies.
Understanding the Terms
When a private company decides it wants to start raising funds from the public, it has what's known as an initial public offering (IPO). For a certain fee, interested investors can purchase shares in the company. Those shares make these investors, by law, part owners in the company and entitled to dividends if the company makes a profit.
The IPO process is typically facilitated by a team of experts — lawyers, accountants, underwriters, etc. — and it is overseen by the Securities and Exchange Commission (SEC), a non-partisan agency of the federal government with two primary objectives:
- Ensure that the companies raising fund are telling potential investors the truth about their business, including any potential risks to investing
- Ensure that the people facilitating the process, such as stockbrokers and exchanges, put investors' interests first and treat them fairly and honestly
To meet these objectives, the SEC will require that a company register before their IPO, submit their financial statements to be audited, and meet a number of other requirements. In theory, the SEC acts as an unbiased third-party in the IPO process, ensuring that everything is aboveboard.
One very important point to note is that basically all brokerage firms require investors to meet some qualifications before they can participate in an IPO. Generally, you have to have a certain amount of money or a set number of transactions, which means that a vast majority of society is not able to participate.
This is the big difference between an IPO and the launch of a new blockchain token — token launches put the power, and the responsibility, in your hands.
Instead of venture funding, many blockchain startups have a token launch or an ICO. It is important to note that many individuals operating in the blockchain space, and other experts, prefer the term "token launch" instead of "ICO." This is because some blockchain tokens/transactions do not qualify as "investment contracts," meaning that they are not considered securities, and so the term ICO (given its similarity to IPO) may be confusing.
"A Securities Law Framework for Blockchain Tokens" sums the problem with the term ICO, noting that tokens have many different applications and utilities:
There are many different types of blockchain tokens, each with varying characteristics and uses. Some blockchain tokens, like Bitcoin, function as a digital currency. Others can represent a right to tangible assets like gold or real estate. Blockchain tokens can also be used in new protocols and networks to create distributed applications...some tokens, depending on their features, may be subject to U.S. federal or state securities laws.
But, and this is the notable thing, not all tokens will have these features and be subject to security laws. With this in mind, for the purposes of clarity, we will be referring to the launch of a new blockchain token as "token launches."
As Balaji Srinivasan, board partner at the venture capital firm Andreessen Horowitz, explained in an essay on Medium, the fundraising process that drives some token launches is a bit "like a Kickstarter on steroids."
To raise funds through a token launch, a company will sell a certain percentage of the total amount of their crypto upfront. Purchasers of these crypto coins are not legally part owners in the company, and they don't earn dividends if the company prospers. The success of their investment is based on the market value of the coin. In other words, as long as they can sell their cryptocurrency for a value higher than what they paid for it, they can make a profit.
Unlike the IPO process, token launches are unregulated. Companies aren't required to adhere to a path set forth by the SEC or any other government agency, which means there is no third party ensuring that either side is telling the truth or meeting any certain requirements.
Token launches do tend to follow a certain format, however, and it starts with the company's founders writing a white paper providing details on their startup. This paper can be any length or format, but it will usually include the company's strategy and goals, as well as their plans for funding (the amount of money they hope to raise, the per-token cost, the duration of their token launch, etc.). Ideally, these white papers should provide a comprehensive business plan for interested parties.
If the company does not meet their minimum funding goals, the money is returned to the would-be supporters and the token launch is considered unsuccessful.
Risks vs. Rewards
According to one crypto investment expert (who agreed to speak on the condition of anonymity), the token launch process can benefit both investors and innovators looking to get their projects off the ground.
"Token launches allow the broadest amount of participation we have seen yet," they explained. "They're a pure way to go from a creator of an idea directly to investors without a large number of middlemen. They allow investors to get in at an earlier level than an IPO. They allow anyone anywhere in the word to easily participate with very low minimum investments."
In this respect, token launches are all about total participation and democratizing power. Instead of just a few wealthy participants, anyone can participate in a token launch or even host their own token launch, allowing individuals in impoverished areas (or who are faced with other economic or social barriers) to participate in the global economy.
"Crypto is complicated, exciting, and the future."
Unfortunately, token launches also carry with them several inherent risks due to their unregulated nature.
"With token launches, people are able to raise large amounts of money with very little evidence they can deliver," the expert noted. This is mostly a matter of supply and demand. Crypto has the potential to deliver high returns, so investors are eager to jump into the market. Unfortunately, the supply of crypto projects isn't yet enough to meet this demand, which leads to investors who are more willing to take greater risks on companies with less evidence they can deliver on their claims.
"Investors are also willing to accept a longer lag between when they give their money to a token launch and when [the company] builds a product — another example of moving further out the risk spectrum," they continued. "This dynamic lends itself well to a Ponzi scheme, where a company does a token launch, promises a product in six months, builds nothing, and then uses the money raised to market and execute another token launch two months later."
Investors in OneCoin know the dangers of investing in crypto startups all too well. Founded by Bulgarian national Rjua Ignatova, the company raised more than $350 million before Ignatova and nearly two dozen of OneCoin's promoters were arrested for running a fraudulent business.
This, of course, is important to note: Just because token launches are not regulated does not mean that they are held to no standards and are free to do whatever they like. Those who act with malicious intent can still be held accountable, though this is admittedly a long and painstaking process.
After the arrest, Deputy Commissioner of Police (Crime) Tushar Doshi told The Indian Express, "It is clear that this is a Ponzi scheme,” but that fact obviously wasn't clear to the thousands of investors who put money into the operation. How were they supposed to know where OneCoin landed on legitimate-to-scam spectrum of business models before putting money into it?
The Point: Don't Invest Blindly
In the end, the expert consensus indicates that, although some cryptocurrencies and token launches are nothing more than schemes, there are a great many projects that are genuine and can (and have) delivered.
Indeed, some major financial institutions are already developing their own cryptocurrencies to ensure that they’re not left behind if the economy does undergo this major transition, and even JP Morgan is looking into ways to incorporate blockchain into their operations.
Furthermore, more than a billion people worldwide don’t have a way to identify themselves, and they can’t open bank accounts and participate in the traditional economy as a result. A cryptocurrency like bitcoin has no such barrier to entry.
With this in mind, according to experts, the best way for investors to ensure they don't fall victim to the crypto scheme is to do their due diligence. This is the big difference between an IPO and the launch of a new blockchain token — token launches put the power, and the responsibility, in your hands.
So, how do you safeguard yourself?
"Investing in token launches is a really hard business," the expert asserted. "I'd say the most important things are knowing the team and their business plan. If the team has a history of hopping from one project to the next, they're probably going to hop on your project. If they can't explain their business plan in a way that makes sense to you, they probably don't understand well what they are doing."
Following this advice could have prevented OneCoin's many investors from falling victim to the scam, as it raised many red flags online long before arrests were made.
As The Cointelegraph pointed out, Ignatova's qualification were inconsistent between her resume, personal websites, and OneCoin's website, and several of the company's directors had been linked to scam operations in the past. When combined with several other eyebrow-raising factors — the promise of huge returns, constantly moving goal posts, and a refusal to accept payment in crypto — the illegitimacy of the operation seems obvious in hindsight.
Of course, as previously mentioned and as evidenced by cryptocurrencies like bitcoin and ether, not every crypto will be a scam, and some can deliver remarkable returns. Over the course of eight years, bitcoin has increased in value from eight-hundredths of a cent to more than $4,000 per coin. Ether has seen its own value surge over the last year, and Ethereum is now the blockchain technology of choice for some of the world's biggest tech and finance companies, including Microsoft, JP Morgan, and Intel.
No doubt anyone who bought in when either of those cryptos was in its infancy now thinks the gamble was worth it. As our expert explained, "Crypto is complicated, exciting, and the future," so as long as investors understand that token launches, by their very nature, are riskier than traditional investments, investing in them can be a potentially rewarding — and highly profitable — experience.
This interview has been slightly edited for clarity and brevity. The term ICO has been changed to "token launch" throughout.
Disclosure: Several members of the Futurism team, including the editors of this piece, are personal investors in a number of cryptocurrency markets. Their personal investment perspectives have no impact on editorial content.