Money for nothing?

Jul 13th 2017 |

Should treasurers looking to diversify their funding sources think about cryptocurrencies? The more tech-minded may have noticed that Bancor raised around $155 million in mid-June, which it claimed made it the second-largest fundraising in the blockchain industry. It's certainly a significant amount of money and, with 20 to 30 "initial coin offerings" happening a month, it may have caused treasurers outside the tech space to wonder whether ICOs had applications in the traditional corporate financing space.

In an Initial Coin Offering a company, typically a blockchain start-up, creates a digital currency which they sell to the public to raise capital for business development, with the "coins" being assets that take the place of the securities normally issued in a capital raising. Why would people buy a new, unproven digital coin? Well, in a small number of cases the "coin" or token so created actually attributes equity to a token so that ownership of the token gives you voting privileges and access to dividends. However, much more commonly, the asset created can be used to buy the products or services of the company raising the capital. Again, why would anyone want a sort of reward point that lets you buy the as-yet not created product whose creation the point is being sold to fund? One answer is that you want the product or that you believe the product will have huge value thereby driving the value of the "coin" up (so making the coin somewhat equity-like in that it will reflect the underlying success of the business).

The other answer is that the "coins" created in ICOs are quickly listed on cryptocurrency exchanges and can be traded for more established cryptocurrencies like Bitcoin. In other words, one investment strategy is simply to convert and flip as quickly as possible to profit from the heady froth in this new market. So far that swap has created extraordinary returns: if you'd bought $1,000 of Stratis' tokens at its ICO, at one point recently you would have been worth $1,109,120, for example. ICOs rely somewhat upon investor enthusiasm for blockchain and new tech startups. They are essentially a crowdfunded alternative to venture capital. They also depend on the sharp rise in the value of "traditional" cryptocurrencies. For example, Bitcoin market capitalisation has grown from $11 billion on June 5, 2016 to almost $47 billion USD in June this year. But a year ago Bitcoin was 80% of the entire market capitalization of cryptocurrencies, and now it's less than 50%, despite the price rises.

Some of this sounds a little like occasions in the retail bond markets where companies like Porsche, with iconic brands, could issue attractively printed bonds which buyers kept as souvenirs and never cashed. But is it a viable capital raising mechanism? The first problem is that right now, the market seems to rely on a desire to speculate on new technology. It's not clear at all that non-start ups, and certainly companies outside tech, would attract the same attention.

A potentially bigger flaw is regulation. Right now, ICOs are not regulated. Investors have few rights and get little or no information on the risks of their investment. Given the amounts of money being raised, the regulators are likely to take an interest, and if ICOs are subject to the same rules as traditional pubic market offerings, they will become more difficult and expensive to execute. The SEC has already stepped in to certain transactions and successfully sued on the basis that they are unlicensed securities offerings. The judgments against cryptocurrency mining firms GAW Miners and Zen Miner are the most high profile of these enforcement actions. Other US regulators are also showing an interest: the CFTC and the IRS have been actively investigating ICOs. It looks as though in ICOs it's not just buyer beware, it's borrower beware too.

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