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Issuing digital tokens is a popular way for many start-ups to raise money, but two prominent names in the cryptocurrency space warned about the rise in fraudulent projects that offer little value to investors.
Initial coin offerings, or ICOs, are a fundraising vehicle where investors send some form of digital currency — usually bitcoin or rival token ether — to the start-up. In exchange, they get an entirely new token that can be used to redeem a service offered by the firm. It does not give investors an equity stake in the company and they have basically no rights.
Many of the sales are used to back "high-quality projects, but there have been a lot of copycat projects where people copy all the same materials (and) don't intend to deliver any value to the people buying the tokens," Joseph Lubin, co-founder of ethereum, told CNBC this week at the sidelines of the Singapore Fintech Festival.
Ethereum creates a blockchain-based platform on which developers can build applications. That ecosystem runs on its own digital token, called ether, which has become the second-largest cryptocurrency by market value — about $32 billion, according to Coinmarketcap.com — behind bitcoin.
Lubin — who is also the founder of blockchain software company ConsenSys — said many of the copycat companies issuing tokens were based out of China, which is why Beijing's ban on new token sales was an "appropriate approach."
"With China's political approach to things, and with the fraud that was rampant there, it made a lot of sense for them to pause things a little bit and get a better, deeper understanding of the ecosystem, and scare potential fraud perpetrators," he said.
Companies have raised at least $3 billion via coin sales so far this year, according to website Coinschedule, which tracks activity in the space.
Brad Garlinghouse, CEO of Ripple — the company behind the fourth largest cryptocurrency by market value — agreed. "I think a lot of what's happening in the ICO market is actually fraud, and I think that will (eventually) stop," he told CNBC, adding that many investors are now suing token issuers.
For example, investors have sued the organizers of the ICO for a company called Tezos that raised over $230 million. Reuters reported two lawsuits have been filed — the most recent one was filed this week and alleged that Tezos' organizers broke U.S. securities laws and defrauded and misled participants during the token sale, according to Reuters.
Garlinghouse said token issuers are currently operating in a "gray area," while waiting for regulation to catch up. In the long run, he said, that gray area will go away. The CEO pointed out that in the securities market, it took decades for rules protecting both investors and companies to be implemented — the same will happen with digital tokens.
"There are a lot of really fabulous things that get done with digital assets and blockchain technologies to reduce friction, to reduce costs, and enable things that weren't possible before. I think instead of focusing on those, we're distracted by what's going on in this gray area," Garlinghouse said.
Authorities in China, United States, Singapore, Japan, South Korea and elsewhere are looking into ways to regulate cryptocurrencies and the issuing of digital tokens. Some argue that having heavy-handed regulation could stifle innovation in blockchain as companies may need to set aside a larger portion of their budget for regulatory compliance.
Lubin said he disagreed. "I haven't seen regulators stifle innovation at all," he said, explaining that proponents of cryptocurrencies and regulators have similar interests: They are "attracted to more equitable systems" that are fair and efficient, they like consumer protection which is what decentralization "is kind of about and we have to work it out. We have to mature it."
He added that regulators needed to wrap their head around the details of how the technology works and "rationalize what it offers compared to what the current rules are."
Bitcoin, the world's biggest cryptocurrency by market value, has taken plenty of bad press from financial luminaries in recent months.
On Thursday, Morgan Stanley's CEO told CNBC that bitcoin does not deserve the attention it's getting. His Wall Street peer, JPMorgan Chase CEO Jamie Dimon predicted that if "you're stupid enough to buy [bitcoin], you'll pay the price for it one day."
Despite the skepticism, the cryptocurrency almost topped $8,000 per token on Friday morning Asia time — it started 2017 at only about $1,000.
Lubin said the cryptocurrency's preeminence is why there's been so much criticism — "people with an agenda like to jump on that," he said.
But, Lubin added that nobody was dismissing the token's ability to quickly move money around at a relatively low cost. Instead, people are "trying to figure out whether it's appropriate" for their own businesses.
Matthew Roszak, co-founder of Bloq — a company preparing to launch a cross-blockchain cryptocurrency called metronome — said some of the skepticism toward digital tokens is driven by fear.
"Innovation is sometimes scary," he said. "We saw this (in the) early days with telephony, internet ... I think a lot of folks are having their Kodak moment where, maybe, they don't really understand the magnitude of this technology."
Both Lubin and Garlinghouse, however, said their own tokens — ether and ripple — have bigger potential than bitcoin.
"I prefer to look beyond bitcoin," said Lubin. "The real excitement is building decentralized infrastructure for the planet, so ethereum is, by far, in a way in the lead on that and it provides internet of trusted transactions." The cryptocurrency, he predicted, will be the "foundation for the decentralized worldwide web."
Meanwhile, Garlinghouse said Ripple was solving a "multi-trillion dollar" payments problem. The company has over 100 financial institutions signed onto its network.
"If we're successful in continuing to go over 100 banks to 500 banks to 5,000 banks, and really change the nature of how liquidity is managed for banks and their customers, there's a really big opportunity," he said.
"I think there's no doubt we're in the earliest innings of a transformative evolution," Garlinghouse added.
— CNBC's Dan Murphy and Arjun Kharpal contributed to this report.