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Initial coin offerings: Tech's next bubble?
Last week, one of the final demons of the dotcom crash at the start of the 21st century was finally exorcised. The S&P 500 technology index, a gauge of the leading US internet stocks, passed the record that had stood since March 2000.
Seventeen years after the bubble burst, technology investors feel much of the promise of the internet that led to such outlandish valuations has finally been realised, albeit much later than they had thought.
But at the same time, many fear that a new bubble is forming, involving another technology that has huge potential but may also be dramatically overhyped: the blockchain.
Listen to one of its advocates and you will hear that the blockchain could be the most significant invention since that of the internet itself. It is best known as the technology that underpins the virtual currency Bitcoin, but its disciples believe its potential is far greater, and represents a profound shift in how information can be stored and sent.
Blockchain is essentially an online ledger, a record book of events such as messages or transactions. But unlike most data, kept in a physical location or on a computer server, it is stored and maintained by a network of its users. This allows a network - such as a financial service, voting system or property system - to run independently of any central authority, at almost no cost and with almost no capacity for fraud, since changes to the database must be verified by all of its users.
Its supporters say blockchain means a world without transaction fees or identity theft, one in which elections could safely be done online and legal contracts could be drawn up and signed immediately. And while not yet understood by the general public, it promises to use technology to make information and services easily and instantly accessible.
The blockchain technology was invented as part of Bitcoin in 2008. But in recent months a swell of investment, being enabled by a new way to raise funds, has created bubble fears.
The typical way for a start-up to raise money is to seek investment from venture capitalists, or alternatively turn to crowdfunding websites. In exchange for funding, founders will relinquish equity, with the investor receiving shares that they hope will appreciate. It is a well-worn and straightforward transaction, if often risky.
But blockchain start-ups are shunning venture capital backing in favour of a new phenomenon, the “initial coin offering” (ICO). It is similar in name to the initial public offerings that see firms list on public stock markets, but the two share few similarities.
ICOs are complex arrangements in which start-ups do not trade shares in return for capital, but instead exchange their own “tokens”, cryptographic units whose value varies from company to company.
Unlike shares, tokens offer no stake in a start-up or any voting rights, but a promise of access to the company’s services in future. As one report put it last week, they are like a casino selling chips to raise money so that the casino can open.
Nor do ICOs see start-ups raising dollars, euros or pounds - capital comes in the form of a cryptocurrency such as Bitcoin. Essentially, the process involves trading one financial substitute for another. If it sounds like a leap of faith, it is, but huge amounts are now trading hands via ICOs, at least on paper.
According to the financial analysis company Autonomous, $1.3bn (£1bn) has been raised via ICOs in 2017 so far. This compares to $222m in the whole of 2016, and just $14m the year before. Of the $1.3bn raised this year, around half has been in the last 30 days, and blockchain start-ups have raised more money through ICOs than via traditional venture capital backing.
The price of the virtual currencies funding them has also boomed. Bitcoin has risen to all-time highs, from under $800 at the start of the year to a high of more than $2,200 in June. Ether, the second-biggest cryptocurrency, rose from $8 to $400 in less than six months. This explosion has made millionaires out of those who invested early, and created a cycle of speculation that has only served to further increase prices.
Blockchain believers say investors are only now starting to realise its potential, but to many onlookers, the situation looks like a classic bubble, and a dangerous one to boot.
“Speculation and volatility across the crypto economy are rampant, and many participants are aware of both fraudulent practices and a growing bubble,” Autonomous Research said.
ICOs are largely unregulated, coming without the legal protections that apply to other funding, are often completed in minutes, and it is often unclear what the tokens that investors are getting for their capital are for. Many investors are not professionals, but merely enthusiasts keen to invest the gains made from rampant cryptocurrency speculation.
Last week, a blockchain start-up called block.one launched one of the biggest ICOs to date. The company, based in the Cayman Islands, claims its software will allow millions of transactions a second with no fees.
The fine print of the offer, however, stated that the tokens investors were buying “do not have any rights, uses, purpose, attributes, functionalities or features, express or implied”. Essentially, they were getting nothing. And yet, block.one raised $185m. Another offering for Coindash, an online exchange, went awry when its website was hacked, leading unsuspecting backers to send cyber criminals the $7.3m they meant to invest.
Charles Hoskinson, a co-founder of the Ethereum currency, called ICOs a “ticking time bomb”, warning that many of the tech companies raising funds were offering little of value.
Even many champions of cryptocurrencies freely admit the sector feels hot, and bears spooky similarities to the dotcom boom. “The bulk of the activity is still very much speculative,” says Miguel Vias, an executive at blockchain start-up Ripple.
But this has not dented enthusiasm. By 2010, 86pc of tech companies that went public during the bubble had failed, but the likes of Amazon and Netflix have come to dominate their industries.
“This is a transformational technology,” says Dias. “It’s the first innings of a very long game.”