In CNBC’s last feature, we explained what the blockchain is. Many start-ups are now building entire businesses on blockchain technology. But instead of turning to public stock markets or venture capital to fund their company, businesses are turning to cryptocurrencies.
In the past year-and-a-half, the so-called initial coin offering (ICO) has been on the rise. It’s a new method of funding for start-ups in which new digital tokens or coins are issued. That’s what we mean by tokenization.
There are over 1,000 digital tokens in existence, and this article will explore how an ICO works and how entrepreneurs are trying to tokenize business.
An initial coin offering is essentially a fundraising tool. Firstly, a start-up can create a new cryptocurrency or digital token via a number of different platforms. One of those platforms is Ethereum which has a toolkit that lets a company create a digital coin.
Then the company will eventually do a public ICO where retail investors can buy the newly-minted digital tokens. They will pay for the coins with other cryptocurrencies like bitcoin or ether (the native currency of the Ethereum network).
Unlike other fundraising methods such as an initial public offering (IPO) or even venture capital, the investor doesn’t get an equity stake in the company. If you buy shares in a public firm for example, you own a small slice of it. Instead, the promise of an ICO is that the coin can be used on a product that is eventually created. But there is also hope that the digital token will appreciate in value itself — and can then be traded for a profit.
ICOs raised $3.8 billion in 2017. But already so far this year, companies have raised in excess of $12.4 billion, according to CoinSchedule, a website which tracks the data.
Here’s a list of the biggest ICOs ever.
|ICO Name||Amount raised|
|1. Filecoin [Futures]||$257 million|
|2. Tezos||$232 million|
|3. EOS||$180 million|
|4. SIRIN LABS Token||$157.9 million|
|5. Bancor||$153 million|
|ICO Name||Amount raised|
|6. Status||$108 million|
|7. QASH||$105 million|
|8. Aragon||$73 million|
|9. Bankex||$70.6 million|
|10. TRON||$70 million|
One of the largest-ever ICOs was a project known as Bancor which raised $153 million in around three hours. The digital coin issued is called the Bancor network token (BNT) and it was built on the Ethereum platform.
A key aspect of Ethereum is the so-called smart contract functionality. Smart contracts are contracts that automatically execute when certain conditions are met from all interested parties. The automation can help to speed the process up, ensuring no mistakes along the way.
Bancor is creating a product that rivals cryptocurrency exchanges based on smart contracts. An exchange matches buyers and sellers and essentially acts as a middleman. But, Bancor’s network allows users to convert one cryptocurrency into another with low conversion costs and without fears of low liquidity. It automatically balances supply and demand and works out the correct conversion price of one coin into another.
It does this through what it calls “smart tokens” which can be generated through the Bancor network. These smart tokens or digital coins hold one or more other cryptocurrencies in reserve which means that it can always be traded. For example, if there was a digital coin that only had a few thousand users, it would be difficult to trade as there would not be a large pool of people wanting to buy and sell it. But if that digital token had a popular and large reserve cryptocurrency like ether then there would always be liquidity to trade.
But ICOs are not flawless. As a result of the large demand for BNT, the Ethereum network became congested during the coin offering last year, leading to delays for buyers.
CNBC spoke to Galia Benartzi, the co-founder of Bancor, and asked her about the ICO process and the company’s ambitions .
Why was an ICO the right route to go down?
At Bancor we believe the term ICO is actually a misnomer because it implies a similarity to an IPO. ICOs, or as we prefer to call them "Token Generation Events" (TGEs), are fundamentally different than IPOs in that an IPO is conducted by a mature company with a live product and revenue, while a TGE represents the birth of a new currency which powers a network.
We decided to launch a TGE because we had a design for a promising token — BNT, which could connect many tokens into a network — the Bancor Network — and make them instantly interchangeable, without needing to match buyers and sellers, without relying on volume or market makers, and without fees or barriers to listing. During the TGE, more than 10,000 users contributed to the project by purchasing BNT. These 10,000 BNT holders instantly seeded the network in a way that no traditional launch would have been able to do. This momentum is essential for a network's growth and a TGE allowed us to create alignment with early adopters in a way that increases the network's chance of success.
What have you learned along the process?
The industry has matured a great deal since Bancor held its TGE in June, 2017 and yet still has a tremendous way to go. We are learning more every day than ever seemed possible, as seemingly disparate fields from economics, history, psychology, system design, network effects, finance, law, ethics, sustainability and others converge in the blockchain space.
Some of the main learnings are actually in areas that the Bancor Protocol aims to shed light on. For example, in today's ecosystem, one of the main jobs of a token issuer is to plan for its liquidity, via costly exchange listings and market makers. We hope that in the future, token creator's will be able to focus on their networks, products and users, when liquidity is fair and free for all.
Where are you in the development of the network?
We are aiming to make cryptocurrencies accessible to a wide array of users, including those who are brand new to crypto. To this end, we launched the Bancor Wallet which allows users to log in from any mobile device or social messaging account (Telegram, WeChat, Messenger or SMS) and instantly buy and sell more than 100 tokens, without having to be matched in an exchange to a buyer or seller.
What will your tokens be used for?
All tokens on the Bancor Network hold an amount of BNT (Bancor’s Network Token) in their smart contracts. This links together each token in the Bancor Network, allowing tokens to be instantly interchangeable for one another at continuously calculated rates. As users buy BNT (or any token in the Bancor Network), it increases the liquidity of each token in relation to the others, creating more predictable and efficient token conversions for all users of the network. BNT is the hub network token for a decentralized global liquidity network that allows anyone to launch a viable currency with continuous liquidity based on its actual usage.
With any new technology, particularly where large amounts of money is involved, there will be scrutiny from regulators and scams. ICOs have seen both. But the new nature of these digital token issuances has meant that the regulatory landscape globally is fragmented with each country looking at ICOs in different ways.
The short answer: it depends where you are. It’ll be hard to go through every single country in the world, but let’s look at the major markets.
China, which was once a prolific market for cryptocurrencies, has come down hard on the industry. Last year, the People's Bank of China declared ICOs as illegal, warning people of the risks involved in investing in them. Shortly after, South Korea followed, banning raising money through virtual currencies.
In the United States, there are no specific regulations for ICOs, but depending on how the digital coin is classed, it may fall under the jurisdiction of the Securities and Exchange Commission (SEC). The regulator is in charge of overseeing trading in various financial products. If the SEC deems that a coin is a “security,” then the company behind it may have to register with the regulator.
The SEC has been very vocal however on warning people about the dangers of investing in ICOs.
“As with any other type of potential investment, if a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost,” the SEC says on its website.
The watchdog also issued a warning last year to celebrities who endorse ICOs saying that they may need to disclose information about the relationship with the company if the digital coin is deemed to be a security.
Elsewhere, in Europe, the European Securities and Markets Authority (ESMA) released guidance on ICOs last year. The regulator said that ICOs that qualify as financial instruments could fall under the relevant laws to do with anti-money laundering or investment legislati
Some countries are attempting to actually create new rules in order to bring ICOs into the regulatory fold. For example, the government in Malta recently approved three new bills related to cryptocurrencies and blockchain technology. One of those new laws aims to bring a regulatory regime to ICOs.
Similarly, in Abu Dhabi, the capital of the United Arab Emirates, the regulator has published guidelines on launching ICOs. Under the guidelines, companies wishing to execute an ICO must approach the Financial Services Regulatory Authority to see whether it will fall under the body's regulation. Companies will also have to publish a prospectus, just like a firm would for an initial public offering (IPO) on the stock market. Any market intermediaries, or secondary market operators dealing with ICOs must be approved by the FSRA.
“If you put a regulator’s lens on, regulators are saying ‘oh my gosh there is a concentration of crypto capital that is in these ICOs, these people aren’t in the financial system, what is happening to the money’,” Lawrence Wintermeyer, a principal at advisory business Capstone, told CNBC. “There is a huge concern retail people might be exposed to this.”
Many countries are looking into how to regulate ICOs but there’s clearly a disparity around the world. The lack of regulation however is a factor behind major scams — one of the biggest issues right now with ICOs.
Investing in ICOs is risky business for a number of reasons. Often people are putting money into products that don’t exist yet. While this may not sound too dissimilar to say very early stage investing in other start-ups, the people placing bets on ICOs are usually unsophisticated investors.
These projects have high failure rates too. Already, hundreds of coins are dead, meaning the projects behind them were scams, a joke or didn’t materialize. Dead Coins is a website that lists all the cryptocurrencies that fall into those categories. So far, it has identified just over 800 digital tokens that it considers dead. These coins are worthless and trade at less than 1 cent.
And because of the lack of regulation, scams are rife in the industry. One example uncovered by CNBC earlier this year was a project called Giza which claimed to be developing a super-secure device that would allow people to store cryptocurrencies. Scammers in this case managed to raise more than $2 million in an ICO, and eventually run off with the funds without delivering any product. A bad actor or actors used a fake LinkedIn profile and copied pictures from another user's Instagram to create a false persona — and successfully drew more than 1,000 investors into the ICO project.
Investors are still trying to get their money back but because of the lack of regulation, there is very little consumer protection in the space.
Another high-profile scam involved a company called Centra Tech Inc. It was an ICO backed by champion boxer Floyd Mayweather. The U.S. Securities and Exchange Commission (SEC) charged the founders with carrying out a fraudulent ICO.
Even successful ICOs have their problems. Bancor, whose coin offering we detailed above, suffered a security breach that saw $13.5 million worth of digital tokens stolen.
Many experts in the field however have predicted that ICOs are here to stay and that they will become professional.
“Are there fraudulent projects? Yes. Are there ill-conceived sales that have not thought through potential regulatory issues? Yes. Are there poor projects that will ultimately fail? Naturally. However, amongst these there are many, many deeply innovative projects amongst which a handful will be gamechangers,” Richard Muirhead, founding partner at Fabric Ventures, an investment fund focused on blockchain projects, told CNBC.
“If 2017 was the year of ICO hype, then 2018-2020 will be the years of decentralized networks development which will be focused on shipping working code and building communities.”
Looking at the ICO space now, it’s clear that there’s a lot of problems but potentially a lot of promise. A comparison that is often used is that the current state of the ICO market and cryptocurrencies as a whole is akin to internet companies in the dotcom boom and crash in 2000 — a lot of noise, many companies will fail, but there could be major firms that survive and become big.
If ICOs do survive, it could pose a challenge to traditional funding methods such as initial public offerings, venture capital or corporate debt.
But beyond that, the whole idea of “tokenizing” a product via an ICO could also lend itself to traditional assets such as stocks, bonds or even currencies like the U.S. dollar. Robert Leshner is the CEO of Compound, a start-up that lets users earn money on their cryptocurrencies. He believes that real-world assets will eventually be tokenized which could boost security, the ability to move them globally, and create new business models.
“Real world assets, from government currencies like the U.S. dollar, to corporate bonds, to equity, can all be upgraded with these properties. Philosophically, the value of an asset should be greater when there is more utility, which is a strong incentive for issuers to tokenize real-world assets,” Leshner told CNBC.
He proposes two ways to do this. The first involves freezing an asset in the traditional financial system and creating an equal amount of tokens on a blockchain, with the ability to unwind the process if needed. A central bank, financial institution, or custodian is trusted with the administration, similar to how exchange-traded funds are created and destroyed. The second option is creating tokens that mimic the value of an asset.
“Tokenized assets will behave like safer, speedier, more useful versions of themselves, which investors will prefer. Once we head in that direction, there will be no going back,” Leshner said.
There are however a number of stumbling blocks to such a movement, the main one being regulation. Authorities across the world have barely begun looking at cryptocurrencies and ICOs, let alone the tokenization of traditional assets.
But advocates believe it is just a matter of time, likening the development of blockchain and tokenization to the way content was changed by the internet.
“Tokenization is to ownership as digitization was to content,” Muirhead told CNBC.
Design and code: Bryn Bache
Editor: Matt Clinch