The Emperor’s New Coins: How Initial Coin Offerings Fueled A $100 Billion Crypto Bubble


Date: 01.03.2018

On April 24, Martin Köppelmann, 31, Stefan George, 29, and Matt Liston, 25, placed their laptops on a long wooden dining table ringed by high-backed wooden chairs and three-armed candelabra at their Airbnb in Gibraltar. It was an old-fashioned setting for a 21st-century moment. The three were about to launch a Kickstarter-style crowdsale, based on a concept they'd been developing for two years: a user-driven prediction market based on a coming "Cambrian explosion of machine intelligence" called Gnosis.

Their goal: raise $12.5 million. But instead of dollars, they would accept money only in the form of a new cryptocurrency, Ether, that didn't exist two years ago. It was a new form of crowdfunding called an "initial coin offering," or ICO. Supporters would not receive a finished product down the road, as in a typical Kickstarter project. Instead, for every Ether (or fraction thereof) sent to Gnosis' wallet, the "smart contract" would automatically send back a different type of money, a GNO coin, that would give people special access to the platform plus act as equity in the network.

Ethan Pines for Forbes

Theoretically, as Gnosis became more popular, demand for GNO coins (also known as tokens) would rise, boosting the shares of existing GNO token holders. The founders had designed their crowdfunding as a Dutch auction, which starts with a price ceiling rather than a floor. Within 11 minutes, Gnosis had raised the $12.5 million, led mostly by programmatic pooled "bidding rings," and sold only 4.2% of its allotted 10 million tokens. The final price, $29.85, gave their project--which had little more underlying it than a 49-page white paper and a few thousand lines of open-source computer code--a valuation of $300 million. In two months, GNO coins were trading at $335 each, and Gnosis was suddenly worth $3 billion, more than the market cap of Revlon, Box or Time Inc. Köppelmann's stake alone is, in theory, now worth about $1 billion. "It's problematic," admits Köppelmann, who stammers and sighs repeatedly, in seeming embarrassment. His best defense for the valuation: There's a lot out there that's far worse.

That's pretty much all you need to know about the great cryptocurrency bubble of 2017. The market capitalization for these virtual issues has surged 870% over the last 12 months, from $12 billion to over $100 billion. (This number is a moving target, though, since a 30% daily market plunge or gain isn't out of the ordinary.)  That's more than six times the rise in stock market capitalization during the dot-com boom from 1995 to 2000. A lot of this total gain comes from Bitcoin, the original digital asset--created out of an artful blend of cryptography, cloud computing and game theory--which is up 260% in 2017 alone. The total value of Bitcoin now exceeds $40 billion, despite years of shady characters, fraud, theft and incompetence (including the Mt. Gox meltdown, which took almost $500 million with it) and despite the fact it has no intrinsic value--not even the promise of a central government or a precious metal mined from the ground.

But the second movers are growing much faster and doing something more interesting. Rather than a mere currency--which is largely used for speculation--these so-called "crypto-assets" intertwine businesses and tokens. The fuel here is something called Ethereum (whose currency is Ether). Like Bitcoin, it's based on blockchain technology, essentially a secure, decentralized, constantly updated ledger system. But while Bitcoin allows you to transact only in Bitcoin, the Ethereum network allows for software programs. In other words, Ethereum-based currencies can actually do things.

So suddenly anyone with a digital idea can launch a coin to go with it. There are now more than 900 different crypto-currencies and crypto-assets on the market, with another launching pretty much every day. On June 12, Bancor, which plans to create a new reserve cryptocurrency, offered 50% of its total tokens and raised $153 million in under three hours, setting the record for an initial funding amount. The very next day, an entity called IOTA listed a token designed for Internet of Things micropayments and immediately fetched a value of $1.8 billion. A week after that, a messaging platform named Status launched its coin offering, raising $102 million. (see: Not So Tiny Bubbles: The Top 25 Crypto-Assets)

In a gold rush, it's good to be selling the pans. Ethereum's value has skyrocketed more than 2,700% in the last 12 months, to $28 billion, or $300 per token. Of course, on the way there it has flash crashed to 10 cents and hit as high at $415. Bitcoin has been historically just as volatile, trading from $31 to $2 to $1,200 to $177 to its recent $2,500, as armies of day traders (see: Return Of The Daytraders) try to time something that has all the predictability of a roulette wheel.

Of course, that hasn't stopped a slew of websites and Facebook groups from popping up, full of endless bragging of crypto-conquests, including token purchases financed with credit card debt. Or hucksters from trying to get people to put their retirement money in this stuff, via Ether and Bitcoin IRAs. Every new coin offering presents another chance to translate a flaky business into an absurd valuation.

These pioneers have certainly unlocked a better way to raise money and create a network effect. Why grovel before Silicon Valley venture capitalists or deal with federal regulators in the public markets when you can attach a token to your idea and have speculators throw money at it and then bid it up? These initial coin offerings have raised more than $850 million, from Brave Software's lofty "Basic Attention Token" (which sucked in $36 million in 24 seconds, at a $180 million valuation, on the promise of using blockchain technology to fix digital advertising's deep problems) to the more basic Legends Room (a coin that gives users VIP privileges at a Las Vegas strip club). [see:Cryptos In Wonderland: The 12 Weirdest and Wackiest Coins]

If this all sounds familiar, it's because it is. The same dynamics--companies with more concept than concrete, day-trader speculators, wild volatility, Dutch auctions, instant fortunes created out of thin air--were ubiquitous in the first internet bubble. As was collapse: In 2000, $1.8 trillion in internet stock market value evaporated, and unless you think a prediction-market concept is instantly worth $3 billion, history will repeat. Ether is both a building block and the future description of what's going to happen to most of this "value."

Still, we're past the tulip stage. Yes, that first dot-com bubble was ridiculous, but it also gave us enduring companies like Amazon, Google and eBay. And, yes, scores of foolish day traders and IPO junkies got crushed, but lots of smart, early players got very, very rich. That history is repeating right now, too.

To best understand how cryptocurrency works, think about videogames. You have a virtual world, and within this realm, you can often earn virtual currency, which can then be redeemed for rewards within the game--extra armor, more lives, cooler clothes. It's the same here, except that it's rooted in blockchain technology and (theoretically) you can either convert the play money into the real thing or deploy it for actual goods and services inside the entity that spawned it.

Many ICO descriptions even read like byzantine videogame rule books. For example, owners of GNO tokens in the $3 billion prediction market Gnosis have the ability to earn a second kind of token, WIZ, valued at $1 each, to pay platform fees. Ingeniously, the coins are earned by voluntarily "locking in" tokens for periods up to a year, which conveniently props up Gnosis' overall price.

It's a common model. Since most of these platforms cap the number of tokens, increased usage jacks up the demand for them and should, in turn, boost the price. This network effect, in which a service becomes more valuable as more people use it, mirrors the incentives of Amway-style pyramid schemes. Imagine if Facebook had a token and by merely convincing a friend to join you would improve the network and your "token" net worth.

"We are crowdfunding a new decentralized digital economy," says Chris Burniske, who recently left New York City's ARK Investment Management, the first public fund manager to invest in Bitcoin. Burniske classifies the emerging assets into three categories. First, cryptocurrencies like Bitcoin and untraceable digital cash like Monero and Zcash. Second, crypto-commodities, the putative building blocks of a decentralized digital infrastructure. Golem Network Tokens, for example, harness a network of computers that rent or lease computing power--so while you sleep, your computer could be used by an entrepreneur who needs to train her machine-learning algorithm, earning you coins in the process. An especially hot type of crypto-commodity: decentralized data-storage tokens, such as FilecoinSia or Storj, which compete with Amazon Simple Storage Service. The third category (and farthest off), crypto-tokens, promises to power consumer-facing, decentralized networks. Think Uber without Uber--a peer-to-peer network of riders and drivers (or driverless cars), earning and paying one another in the crypto-tokens needed to transact on that network. [see: How Crypto-Tokens Work: A Case Study] 

The entities raising money in these coin offerings are not always startups. Sometimes they're merely developers collaborating on a project and don't form a legal entity. And even when the group is really a corporation, such as the messaging app Kik, which is launching the Kin token, the organizers will claim that the crowdsale is not actually offering a share in the company, conveniently sidestepping securities regulations.

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