For ICOs, Smoke, Sizzle, Or SoS?

The 1960s TV show “Lost in Space” featured a robot that would stand pat, robot arms akimbo, shouting in its robot voice, “Danger, Will Robinson, danger!” The filming was crude, the presentation abysmal, with the robot just a step or two up from tin cans joined together.

It worked. The makeshift oracle more often than not kept his flesh-and-blood charge safe from whatever dangers were lurking in the shadows.

Hmm. Technology issuing a warning to humans? Take that concept, run with it a bit and consider that the most modern of technology, cryptocurrency, is ringing alarm bells as stark as the ones that blared from black-and-white TV sets four-plus decades ago.

Put another way, and punning on the Bard: Skeptics might say a ruse is a ruse is a ruse.

Lowbrow and highbrow references aside, it’s worth looking at the rise of initial coin offerings (hereafter ICOs), which have been grabbing headlines as of late.

At this stage in the game, the smoke and sizzle might seem to outweigh the steak.

Yes, cryptocurrencies have grown in stature and in the public mindset for sure, stretching across and far beyond bitcoin and Ethereum. Bitcoin, of course, looks like the rollercoaster ride that is the stuff of dreams for some and nightmares for others. At a recent price of $4,472, the cryptocurrency has backed off highs of about $4,800. The total cryptocurrency market sports a market cap of more than $170 billion as measured in late August.

Of that tally, bitcoin holds $77 billion in market cap, and Ethereum at $400 a share has $35 billion, said late last week. But those two currencies are only the headline pair of a pantheon, which now includes the likes of Dash and NEO, to name just a couple of others.

Small wonder that the act of bringing new coins to market has become big business, with ICOs at the forefront. Want proof? All sorts of firms are getting into the act. The chat application firm Kik said this past week that it would look to raise $125 million through an ICO this month, with a token sale to begin Sept. 12.

On its face, the ICO is a simple way to raise funds. The transaction is one where a company will offer up new currencies — very new ones that haven’t been traded yet at all — in exchange for the ones you’ve got in hand. The funds are typically earmarked for a new cryptocurrency project or to bankroll ongoing operations.

Think about it as the reverse of the old bird maxim: You’re trading the fluttering wings in hand for the two pairs beating, yet unseen, in the bush. The coins themselves, as you likely know by now, are simply digital issues, typically debuting (or eventually to debut) on distributed ledgers, which are immutable and indelible.

A Few New (Digital) Wrinkles

A few wrinkles here: The tokens, or coins, may change hands, but they have typically never conferred ownership rights. This is a big departure from the notion that has traditionally underpinned the stock market for centuries, and Initial Public Offerings (IPOs), from which ICOs take at least some cues.

On the traditional exchanges and through a traditional IPO, where public issues are floated on the NASDAQ or the Dow, for instance, when one buys a share of stock, they are buying a sliver of ownership.

Gather up enough slivers, and you have a real piece of the action, with enough of an equity stake that you can make your voice heard with company management, so much so that you can help steer strategic direction (that is, if you’re a multi-million dollar or billion dollar fund with, in some cases, millions of shares in the portfolio).

Conversely, investors scrambling to get hands on tokens, with knowledge that ownership is not in the offing, simply are betting that higher prices and good returns are in the future. A few other key differences are in place, namely that the ICO is open to the public at large, while IPOs are typically geared toward experienced, accredited investors.

How hot has the market been? To date, in 2017, Coindesk reported that $1.3 billion has flowed into ICOs, against a timeline that saw $1.7 billion raised from 2013 to 2016. Recent ICOs show names as exotic as Opus and Bitbounce and Blockcat, as noted by The amounts raised can be significant, as Filecoin raised at least $250 million last month and Tezos grabbed $232 million this year in an ICO. Bancor raised more than $150 million.

But who is actually buying these ICOs? The fact that there is really no regulation in place (more on this later) means that crowdfunding for cryptocurrencies bypasses scrutiny that other types of offerings must endure. The upshot is that just about anyone with a (digital) dollar and a dream can play. The downside is that fraud can be tough to avoid.

Along with the lure of riches comes the lure of scams. Last month, thieves ran off with $500,000 in an Enigma ICO, directing unsuspecting buyers to a so-called “pre-sale” offer ahead of the ICO, which funneled funds into the bad guys’ cryptocurrency wallets. And in July, a heist stole $7 million during CoinDash’s ICO.

The scams have been persistent because of the relative absence of regulation, since traditional securities sales get oversight, but as mentioned, these are not traditional security sales. The hallmarks are the buzzwords like crowdsale that accompany the offers, and the model for the ICO has been likened to crowdfunding activities, where money can come from just about anyone to fund a project.

The lure right now may be the unregulated, somewhat Wild West nature of the ICO, where initial value is determined by the company itself (rather than by, say, investors subscribing to the issue, as is a hallmark of an IPO even before shares are actually traded).

The excitement lies in the fact that ICO holders can see strong gains in a short amount of time. As noted by the site in explaining some of the processes, once the ICO is done and the tokens issued, those tokens are then listed on exchanges. Upon listing, the tokens themselves can be traded among buyers and sellers. What drives the value up? If the tokens work as promised across platforms, then adoption increases; and ostensibly, as adoption increases, so will the price, as success breeds excitement. Thus, the person who “bought in” at the ICO level gets to reap some head-spinning gains.

In one sense, then, you are putting (again, digital) dollars to work where the payout may be huge or it may be nothing, which brings to mind the lottery. Or you are betting that someone is going to pay up down the line for something that you own (but do not confer any special investment rights to them). That brings to mind, at least a bit, Tulip and other manias that have marked other wild acts of price momentum.

Speculation, then, trumps investment. But looming in the wings…

Enter the Regulators

In several shots across the regulatory bow, the SEC has suspended trading in at least one publicly listed bitcoin firm, with a temporary suspension of First Bitcoin Capital, based in Canada. The suspension truly is short-lived, as reported, with the freeze taking effect on August 24 and lasting until Sept. 7. Other firms that have been suspended, all with minute market caps, include Strategic Global and Sunshine Capital. Talking up impending ICOs, said the SEC, set the stage for the pump-and-dump scheme.

But even before that, and in direct (at least early stage) scrutiny of ICOs, the SEC said in July that tokens offered and sold last year by DAO, a “virtual” organization, were indeed securities and not surprisingly are therefore subject to securities laws.

In a July report, the SEC said that “issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies. Those participating in unregistered offerings also may be liable for violations of those same securities rules.”

In China, the market is so heated that regulators have been discussing any number of options, including limiting the size of the offerings or even suspending ICOs altogether. Canada has said that many tokens should be treated like securities.

The August ICO of Filecoin brought with it news that the deal had been structured in part by a law firm, Cooley LLP. This offering was open only to accredited investors (where recent income exceeds $200,00 annually). And yet the offering exploded, with $187 million raised in short order.

Beyond the legal wrangling over whether the cryptocurrencies are securities or not, the SEC scrutiny might be giving new issuers pause — or at least food for thought — over who can shoulder the risk. The risk is, of course, losing all.

But as long as the less-seasoned crowd keeps piling in, with hopes of bling, and laying themselves bare, possibly to hacking, we’ll borrow another line from the “Lost in Space” robot:

“That does not compute.”