The PERILS of joining the DIGITAL CURRENCY GOLD RUSH
Standards urged to restore sanity, reduce risks of investing in ICOs
Exio Coin’s home page, while it existed, was light on details, but had a heavy sense of urgency.
It featured a tagline (“The self-evolving cryptographic currency”), a vague claim (“World’s First Cryptocurrency to be Officially Endorsed by a Sovereign Nation”) and a link to a white paper. It also prominently featured a countdown clock, with large, boldface digits tracking the days, hours, minutes and seconds left until the reader would be able to purchase the cryptocurrency.
As recently as Sept. 4 — three days before an initial coin offering, or ICO, was set to begin — Exio Coin was presenting itself as the investment opportunity of a lifetime. The cryptocurrency’s team in a press release said it was “widely expected to be the largest ICO of 2017” — an impressive claim given the year’s largest had raised US$250 million.
But such claims are all too common in the wild world of ICOs, which have skyrocketed in popularity in 2017 and raised US$2.7 billion to date.
Proponents say ICOs give ordinary people an opportunity to invest in new blockchain technologies that will drive change on a comparable scale to that brought about by the internet. But the lofty valuations and ease of setup are also attracting scammers, pranksters and fraudsters, so much so that the cryptocurrency sector’s more sober voices are calling for standards to rein in irresponsible players before they bring the US$196-billion market crashing down.
“There’s a lot of rambunctious craziness that’s happening. It may or may not be intentionally shady,” said Miko Matsumura, a limited partner of the ICO Fund at San Francisco-based blockchain investment firm Pantera Capital and founder of the ICO Governance Foundation. “But it’s certainly not providing much security, comfort, safety, reliability, trustworthiness to people who are participating.”
Regardless, people keep dreaming up new ICOs for attract giant sums of money and many investors don’t bother doing even cursory homework.
For example, a simple Google search would have quickly cast doubt on Exio Coin’s claims.
On Sept. 1, Forbes published a story revealing Exio Coin’s website had plagiarized from Tezos, a cryptocurrency that actually had one of the largest ICOs of 2017 at US$232 million. Today, Exio Coin’s site has been taken offline — and the token it copied from is in trouble, too.
Participants in the Tezos ICO filed a class-action lawsuit in California in late October, alleging they were defrauded by organizers who violated U.S. securities laws. Lawyers for Tezos have said they believe the lawsuit is without merit.
Sid Kalla, a cryptoeconomic expert and researcher at Smith+Crown, a cryptofinance analysis company, said many investors appear to be motivated by a fear of missing out, rather than acting on a full understanding of the fundamentals.
“Investors are not doing their due diligence,” he said. “There’s greed in the market.”
Even ICOs that appear to be jokes — think Jesus Coin (“decentralizing Jesus on the blockchain”), PonzICO (“Let’s just cut to the chase”) and Useless Ethereum Token (“No value, no security, and no product. Just me, spending your money”) — have raised significant amounts of money.
Others sound like they could have come from the mind of a comedy writer, but appear to be serious, such as: Dentacoin, a blockchain-for-dentists venture; Cobinhood, which was endorsed by actor Jamie Foxx; and a cryptocurrency being planned by the creator of the Dilbert comic strip.
In exchange for their contributions to such ventures, founders running ICOs promise to issue units of a new cryptocurrency to investors. That cryptocurrency is a digital asset that can’t be copied and whose ownership is verifiable using a shared, immutable ledger called a blockchain.
The cryptocurrency can represent many different things. Often, it’s essentially a stand-in for shares in a startup, with investors betting the cryptocurrency will go up in value as the company grows.
In other cases, a cryptocurrency is necessary to use a product or service being sold by the startup. An example is Filecoin, which allows clients to store digital documents on a decentralized network and rewards people with its cryptocurrency for renting out unused space on their hard drives.
Regulators in Canada and the U.S. have issued warnings that any ICOs found essentially selling shares in a company will be considered securities, with all the attendant rules and disclosure requirements. In Canada, private companies can only sell shares to registered securities dealers or accredited investors, who must meet certain wealth thresholds.
But it’s often unclear whether an ICO is selling a security or not. The websites of many ICOs reassure investors that they’re not purchasing securities, though regulators may decide they disagree and pursue enforcement action.
The biggest ICOs have raised hundreds of millions of dollars, and investors who feel that money isn’t being wisely spent will have little recourse.
Jeff Ennis, entrepreneur-inresidence and chair of the blockchain task force at law firm Fasken Martineau DuMoulin LLP, said the global nature of these businesses will make it difficult to determine who is responsible for enforcement if things go badly.
“Who has jurisdiction? Is it where the issuer is? Is it where the investor resides?” he asks. “Which police force is going to go chase them?”
Even if the startup running the ICO is honest and operating in good faith, the massive sums of money they attract make them a target for scams.
Chainalysis, the Bitcoin antimoney laundering software provider, estimates that US$150 million of the US$1.6 billion raised by ICOs this year — or about 10 per cent — ended up in the hands of cybercriminals.
Technical glitches and poor security practices can also vaporize millions of dollars in a flash. On Nov. 7, a developer claimed to have accidentally deleted a library of code used by the Parity Ethereum wallet, freezing US$280-million worth of funds.
As a result, many people in the sector are calling for standards in the name of restoring sanity and reducing the risks of investing in ICOs.
For instance, Matsumura’s ICO Governance Foundation is preparing a system that would facilitate the voluntary filing of disclosure documents for ICOs, similar to the U.S. Securities and Exchange Commission’s EDGAR database.
Matsumura said such a system would be good for both investors and the cryptocurrency sector. “The natural result of more selfregulation is more trust. And more trust means more capital,” he said.
Impak Finance, a Montrealbased ethical investing cryptocurrency, has decided to take things a step further in terms of regulation and trust. The company was the first to obtain approval to sell and manage a security from all 10 Canadian provinces before launching its ICO in August.
Impak Coin raised $1.5 million — likely far less than it could have if it hadn’t complied with rigorous know-yourclient, suitability and antimoney laundering standards. But Paul Allard, Impak’s president and chief ecosystem officer, said it was worth it, with banks from around the world calling to work with the company after the sale.
“We did piss off a lot of cryptocurrency geeks that just wanted to pump and dump and speculate,” Allard said. “And that’s okay.”
Kyle Kemper, executive director of the Blockchain Association of Canada, cautioned against making regulatory compliance too onerous for ICOs. He said regulators should err on the side of encouraging innovation, even if it means a few bad actors get away with unsavoury activities.
“If Bitcoin was launched right now, would it be allowed?” he asks. “We’re never going to be able to protect everybody. There are always going to be people who get around it, people who get hurt.”
One thing the cryptocurrency community generally agrees on is that the current bull market won’t last forever. Indeed, it’s frequently compared to the dot-com bubble of the 1990s, when investors were throwing money at any company claiming a vague connection with the internet without looking too hard at its business plan.
Many of those companies went out of business during the crash of the early 2000s. Most of the companies raising money through ICOs in 2017 probably will, too, rendering their cryptocurrencies worthless.
But believers think a small handful of them will survive, eventually growing to be as big and powerful as Google Inc., Facebook Inc. and Amazon. com Inc. are now. If true, the investors who pick those winners today will be handsomely rewarded for holding on.
Matsumura said ICOs are analogous to the annual city-wide pillow fight held on Valentine’s Day in San Francisco. Like the pillow fight, ICOs are silly, excessive and confusing, but, for the most part, the people participating can afford to waste a little time and money on something frivolous.
“Mostly, nobody is being materially harmed as yet,” he said. “I think as we start to scale this phenomenon, it’s going to get much more serious.”