It’s an IPO, It’s an ICPO. No, Wait, it’s an ICO!

What Happens When Venture Capital meets Cryptocurrencies (approximate reading time: 10–20 mins)

Idea in Brief

Cryptocurrency 101

Block Chain

Using a peer to peer network, and a distributed server, blockchain is managed autonomously.

The entire transaction history is booked in the distributed ledger and is visible to everyone on the network but everybody can tamper the transactions.

Blockchain can be used for a variety of purposes e.g. For peer to peer payments.

If Sally pays Henry $10, Sally’s account in the Blockchain ledger will be debited and Sally’s account will be credited with $10. This transaction will be visible. Also, if Henry then pays John $10, the entire circulation of the $10 will be recorded in subsequent blocks.

Bitcoin & Other Cryptocurrencies

The first Bitcoin was launched by Satoshi Nakamoto in 2009 after conceptualizing the currency in 2008.

Ether & Ethereum

Like Bitcoin(BTC), Ether (ETH) is mined. So, you can mine cryptocurrency by essentially loaning your computer to global decentralized network. Unlike Bitcoin which has a finite supply (21 million) there are no limits on the supply of Ether. As supply goes up, the price declines unless users decide to hold Ether

Smart contracts are Turing complete (AI equivalent of parties to a contract agreeing to execute the terms of the contract) programs that execute a clause in a normal contract if certain conditions are met. Eg if you pay a Bitcoin using a mobile wallet, the parking meter allows you to park for one hour. The trust between your mobile wallet and the chip in the parking meter is established using a Blockchain.

Initial Coin Offering (ICO)

Incidentally, a subsidiary of RWE, one of Germany’s biggest energy and gas provider with 30 million customers and billions of revenue, has launched 100s of electronic vehicles (EV) charging stations all over Germany, connected to ethereum’s public blockchain.

“Describing the vision of a new enthralling future, RWE’s representative detailed how blockcharge would work. By using a computer chip in the charging station, a smartphone app to communicate with the interface, and a blockchain to manage and record all of the payment and charging data, a fully automated, worldwide authentication, charging and billing solution with no middleman is created. The app used is called Share & Charge.

Now imagine, you want to launch a similar project on the Ethereum platform and you want to use crowdfunding to do so. You resort to what’s called a ‘Initial Public Coin Offering’ or ‘Initial Coin Offering’ which is accepting money from investors in the form of Fiat currency or cryptocurrency and providing the investors with tokens (similar to a equity) in the project. Thus, this is venture capital using crowdfunding and cryptocurrencies. Ingenious and borderline ‘purely speculative’

An exchange provides liquidity to investors to buy and sell the tokens which could be Ether (ETH)

Relatively Riskier Investment

However, since cryptocurrencies are not subject to stringent regulations and they exist in a digital realm, there is always a risk that you can lose your money.

If you want to understand why people across the world and primarily Chinese investors are attracted to Cryptocurrencies, look at the charts below:

Performance of Bitcoin

Performance of Ether

Performance of Litecoin

Legal and Regulatory Challenges

The value of a typical token is based on the value of the project. If a token is similar in function to an equity share, then it’s a matter of distributing the profits as dividends and the growth comes from increase in the market value of the project.

But, the underlying technology behind the project is a Blockchain. Because the Blockchain is a distributed ledger with self authentication built in, a token cannot be classified as a financial derivative contract but if you peel the onion and understand that the holder of a token has no voting rights, there is some resemblance to financial derivatives.

Since a Bitcoin or Ether is essentially a rent paid for loaning out your computer or a currency bought by using your actual money on an exchange, it can create challenges in classifying and accounting in conventional books of account. Do you Mark to Market?, hold it as cash or investment? etc.

The Securities and Exchange (SEC) is yet to comprehensively regulate Initial Coin Offerings (ICO’s), there is very little doubt that human nature will propel speculation and fraud making it necessary for regulators to start regulating such forms of crowdfunding/venture capital.

The Mt. Gox Hack

The DAO Hack

  • Programmers wrote smart contracts to create the organization on the Ethereum platform.
  • To fund its initiatives, the founders of the DAO sought crowdfunding and issued tokens to the contributors. Tokens had no voting rights.
  • The DAO launched on 30th April, 2016, with a 28-day funding window. For whatever reason, The DAO was popular, raising over $100m by 15th May, and by the end of the funding period, The DAO was the largest crowdfunding in history, having raised over $150m from more than 11,000 enthusiastic members. The DAO raised far more money than its creators expected (source:coindesk)

However, a programming flaw allowed an unknown attacker to siphon off 3.6 m ether which resulted in a fall in the price of Ether from $20 to $13. In other words, DAO was vulnerable to breaches which should serve as a cautionary tale to investors.

Conclusion

As for Bitcoin, Litecoin, Ether and other Cryptocurrencies, its hard to say whether either will end up becoming a very stable store of value. Cash has not been replaced yet even though many predicted its demise.

Regulators across the world are watching and so are speculators and investors with a very high risk appetite. Till then, it’s an interesting saga in a financial renaissance.

For more information, please refer:

Writer @ The Intersection of Finance, Tech & Humanity. Stories of a Global Language: “Money”. Contributor @ Startup Grind, HackerNoon, HBR. Twitter@akothari_mba