THE EMPEROR’S NEW COINS

WE’RE IN THE MID­DLE OF THE GREAT­EST BUB­BLE OF THE DECADE: $100 BIL­LION WORTH OF CRYP­TOCUR­RENCY WITH LIT­TLE IN­TRIN­SIC VALUE. A LONG-TERM SYS­TEM WILL EMERGE—BUT NOT BE­FORE A HAND­FUL OF VI­SION­AR­IES, AND HUCK­STERS, TAKE BIL­LIONS FROM THE GREATER FOOLS.

Forbes - - CONTENTS - By Laura shin

We’re in the mid­dle of the great­est bub­ble of the decade: $100 bil­lion worth of cryp­tocur­rency with lit­tle in­trin­sic value. A long-term sys­tem will emerge—but not be­fore a hand­ful of vi­sion­ar­ies, and huck­sters, take bil­lions from the greater fools.

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 old­fash­ioned 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.

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 re­peat- edly, 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 cur-

Why grovel to ven­ture cap­i­tal­ists or deal with reg­u­la­tors of pub­lic mar­kets when you can at­tach a to­ken to your idea and have spec­u­la­tors throw money at it?

rency—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 tech­nol- ogy, 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 cryp­tocur­ren­cies 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.

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 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 cryp­to­con­quests, 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).

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 Bit-

coin. 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 File­coin, Sia 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-topeer net­work of rid­ers and driv­ers (or driver­less cars), earn­ing and pay­ing one an­other in the crypto-to­kens needed to trans­act on that net­work.

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.

And the peo­ple back­ing this tech­nol­ogy aren’t naïve ide­al­ists. Ven­ture cap­i­tal stal­wart Tim Draper has backed two crypto-as­sets. Bren­dan Eich, of Ba­sic At­ten­tion To­ken fame, pre­vi­ously cre­ated Javascript and co­founded Mozilla. Tiger Man­age­ment alum Dan More­head founded Pan­tera Cap­i­tal to spe­cial­ize in these as­sets.

They’re chas­ing firms like Blockchain Cap­i­tal, founded by for­mer child ac­tor and videogame vir­tual-cur­rency en­tre­pre­neur Brock Pierce. He went as far as to fi­nance the firm’s lat­est fund with its own cryp­to­coin of­fer­ing, BCAP, os­ten­si­bly free­ing its would-be limited part­ners from the usual reg­u­la­tions, in­clud­ing lock-ups. He raised $10 mil­lion in six hours in April. Pierce avoided reg­u­la­tory scru­tiny by lim­it­ing his coin crowd­sale to 99 ac­cred­ited in­vestors in the U.S. and 901 in­vestors over­seas, where rules are more re­laxed. Once it launched, though, any­one could buy in. And they did; the fund’s val­u­a­tion has spiked, to a re­cent $17.5 mil­lion.

“My phone has been ring- ing off the hook,” Pierce says. “I have so many peo­ple com­ing to me say­ing, ‘Can I do this in my in­dus­try?’ ”

Olaf Carl­son-wee is a 27-yearold son of Lutheran pas­tors. He can barely write com­puter code, has no for­mal train­ing in fi­nan­cial anal­y­sis and has never man­aged money be­fore. This, of course, qual­i­fies him as the poster child for the cryp­tocur­rency bub­ble of 2017. Carl­son-wee’s Poly­chain Cap­i­tal, based in San Fran­cisco, has seen its as­sets swell from $4 mil­lion to $200 mil­lion in less than ten months, mostly be­cause of a se­ries of deft ma­neu­vers based on his in-

Ether is both a build­ing block and the fu­ture de­scrip­tion of what’s go­ing to hap­pen to most of this “value.”

nate un­der­stand­ing of crypto-as­sets.

For Carl­son-wee, it all started on a Min­nesota lake dur­ing his sum­mer va­ca­tion from Vas­sar Col­lege in 2011, as he stared at $20,000 in stu­dent-loan debt and $700 in sav­ings in the bank. While his two older brothers have be­come po­ets, Carl­son-wee was ob­sessed with math, games and imag­i­nary worlds from a young age. And af­ter read­ing about the un­der­ground drug mar­ket­place Silk Road and how it was en­abled by Bit­coin, he con­jured a world cours­ing with cryp­tocur­rency and even­tu­ally sank in al­most all of that $700 into Bit­coin, at prices as high as $16, only to see it drop to $2.

Un­de­terred, Carl­son-wee per­suaded his so­ci­ol­ogy pro­fes­sors to ac­cept a se­nior the­sis on Bit­coin and grad­u­ated from Vas­sar with a de­gree in so­ci­ol­ogy. Af­ter a stint as a lum­ber­jack liv­ing in a yurt on a com­mune in Washington State, he emailed his the­sis to Coin­base, the cryp­tocur­rency wal­let and ex­change, in 2012, and be­came its first em­ployee,

ON THE COVER: OLAF CARL­SON-WEE WAS PHO­TOGRAPHED BY ETHAN PINES;

GROOM­ING BY JAMES AN­THONY FOR ARTIST UNTIED

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