The pitch is always “crypto is a massive opportunity and will revolutionize everything”. It appeals to investors FOMO (Fear Of Missing Out). There’s a little footnote that it’s a bit volatile & uncertain but what the heck – the upside is huge!!
So … yes, you can make a lot of money. Yes, you can make shitloads of money very quickly. But it’s disingenuous to focus so much on the upside and neglect the risks and downside. But then maybe that’s how the financial world works anyway!
Up until Feb 2018 everyone holding Bitcoin was making shitloads of (paper) money very quickly. HODL was the word: Hold On for Dear Life and never sell. It hit over 15,000 USD per bitcoin. Remember: there was no way to short (to bet on it going down), and it was pretty difficult to sell them. The more it went up, the more buzz it made, the more people wanted part of the action, and the only way to get exposure to Bitcoin was to buy some, helping to propel it even higher. Virtuous circle, bubble, whatever…
Then came Bitcoin futures: financial products launched to make it easy to trade Bitcoin. You no longer had to buy Bitcoins but you could buy a regulated financial product that tracked Bitcoins (but didn’t buy or sell actual Bitcoins). Rather than propel Bitcoin higher, it turns out that the investors trading Bitcoin futures were more inclined to bet on it going down (shorting it). As I write this (March 2018) we are 2 months into this. And Bitcoin is trading within a band 8000 USD to 15000 USD with lots of volatility.
Up to now I’ve focused on Bitcoin. There’s thousands of other crypto currencies (altcoins) which are either:
- Being marketed as a better/different/niche crypto currency than Bitcoin
- Being marketed as a blockchain project where they are a medium of exchange for a revolutionary platform which in most cases hasn’t been built or tested yet.
Most ICOs are the latter. And I think it’s useful to make the comparison with the internet bubble of 1999.
Back in 1999 the new platforms each promised to dominate a market. Each pitch was that there was market which was going to be revolutionized by the Internet because the old way of doing business was no longer suited to the the Internet world. We all know how that ended: bubble, carnage, but a real revolution and long term value creation.
Now in 2018 it’s the same but just replace “Internet” with “blockchain”. Back in 1999, a team would create a startup, pitch to investors who would throw money at them. Most of the startups got a few millions before they really had a product. Then they built a product and spent an unsustainable amount of money acquiring each customer. If it all went to plan, they IPO’ed as a cash-burning but high-growth company. It was a land grab: “there is a finite percentage chance that we’ll own this enormous market therefore we’re already worth billions”.
Behind this 1999 madness there was some control. Most of the cash was coming from VCs who drove a Faustian bargain with the startup founders. We will give you loads of money BUT you’re signing this legal contract saying:
- We get our money back and more before you get a penny (a.k.a. the Liquidation Preference)
- This has to go up in value or we take control (a.k.a. Preference shares conversion, Anti-Dilution). You’ve pitched us crazy growth figures – so we’ll give you eg. 18 months to either IPO or raise far more money from other investors, or we’ll take it away from you.
Netscape’s successful IPO in 1995 was the model: haemorrhaging money, high growth, land grab. Fast forward to 2018. Replace all references of Internet with blockchain. Except that if you dig deeper there’s some subtle but very significant differences:
- You are investing in a coin, not shares in a startup. Financial regulators (seem to) allow selling coins to anyone (provided it doesn’t give you shares in a business), but selling shares needs proper financial oversight and can only be done to accredited investors.
- This time round, Investors don’t make the Faustian bargain with the startup founders. The startup founders are completely in control. They create the coin, they sell the coin to investors, they choose whether the investors’ money goes into their startup or their own pockets.
Why do investors agree to buy a coin and not shares in the underlying business? The pitch is:
- This market needs a distributed ledger (a.k.a. blockchain) rather than the way it’s managed today. It will be more efficient.
- This distributed ledger will be oiled by its own crypto coin (which we’re selling to you now) and these coins should each have shitloads of value. I.e. rather than people buying and selling on our platform using US$ or Euros, they will buy and sell in our coin and somehow this coin will be valuable.
A Blockchain is a distributed ledger which enables “exchange of value without powerful intermediaries acting as arbiters of money and information” (so says en.wikipedia.org/wiki/Blockchain). Each blockchain implementation needs a crypto coin only if the blockchain is public. If the blockchain is a private run project (where access is controlled by some entity) then there’s really no need to have a coin. Here’s IBM’s explanation.
Outside pure speculation, it gets very complicated to work out just where the long term value is going to be – if there’s value in the startup business operating the blockchain, the crypto coin, both or neither.
For a balanced view on Blockchains, don’t listen just to crypto coin speculators. Another side to Blockchains are the technology groups working on blockchains for business – businesses who’s business isn’t making money from crypto ICOs. They are led by ibm.com/blockchain and hyperledger.org . The trouble here is IBM is still trying to sell you something: consulting instead of coins so it’s still a marketing pitch.
But Hyperledger is a non-profit opensource project – they are not selling anything. So here’s an example from Hyperledger on how you could manage healthcare claims. Today when there’s a claim the information is sent between the doctors, hospitals, insurances etc. systems: there’s no one master copy of the whole file – the information is held all over the place. It’s inefficient, plenty of delays, nobody knows what’s going on. A Blockchain based solution would mean one copy of the claim’s data held on the blockchain and enable all the participants to edit, approve, pay, reject, bundle, and take any action they want (and are allowed to) on the claim. In theory it’s far more efficient than the system we have today. Easy to implement? In practice there’s massive effort to figure out how to build this and deal with the resistance of many participants to lose control of their part of the data & work flow. Great idea, lots of work and problems to solve. No mention of ICO, crypto coin, etc.
My guess is this healthcare claims project could be either a public blockchain or a private blockchain – either way each claim file would need to be encryption and access restricted. But who’s going to run it? Who’s going to do the work to build, maintain & police it? This is where I get confused. Is it really a startup opportunity backed by a crypto coin ICO (like some of these icobench.com/icos/health think)? Is it a consortium of the major players? Is it a non-profit NGO? Is it the government? How different would it really be from a well-managed centralized system? Does it need an intermediate (or several intermediate) steps to get there? How does it get to critical mass if the major players won’t play ball, or even if they are just moving at different speeds?
Here’s an interview (18 minute long) with Brian Behlendorf of Hyperledger putting the case for private blockchains.
For the public blockchain ICO approach the premise seems to be that the crypto coin will create strong enough incentives for people to use the platform and at the same time it will pay the operator (and whoever is running each blockchain node) to maintain and improve the whole platform. Everyone wins. Powerful stuff.
When many financial commentators are quoted that “raising money via ICOs is the future” they are being mis-quoted/mis-interpreted. Often they said “With regulatory acceptance, raising equity via ICOs is the future”. (eg. mangrove.vc/ico-report2017 ). They are not talking about the speculating on crypto coins which is being done today, but a future where the register of shareholders is a blockchain with smart contracts that can be bought and sold so that startups can raise money directly from investors. This can’t happen until there’s regulatory acceptance. When is that going to happen? Who knows…
Meanwhile back in 2018, the possible ways of making money on crypto are:
- Go for it: spray and pray, pump & dump, don’t worry. Rely on the value of crypto being propelled higher due to greater demand. At some point this is a “finding greater-fools strategy” and will lead to a crash. Maybe you are the fool …. There’s only one way to find out.
- Mining crypto coins – provided mining costs are less than the current tradable price of what you’re mining.
- Trade volatility (bet on it going up and down, buy and sell).
- Find the rare ICOs where there’s a proper project behind it with proper oversight.
Or throw your money at someone else. There’s now a whole bunch of investment vehicles that will take your money for a management and invest in a diversified way into the whole “crypto” space. Are they any good? Do they know what they are doing? Who knows. Nobody has a track record but they probably do more due diligence than individual investors are capable of.
What we do know is there are some hurdles for the whole crypto space to solve before it matures:
- Can Bitcoin be financially stable enough and flexible enough to be used as a currency? Here’s Varoufakis saying no – a currency needs to be managed by a government. Period.
- Has there been a whole load of mis-selling going on which will lead to a legal mess if/when the whole thing crashes down and people lose their life savings? Maybe…
- Can it be made hack proof? There’s a lot of work to be done here and who knows what happens when quantum computers come along…
- How to avert an environmental disaster? Mining is already using the electricity needs of a reasonable country.
- Do each of these markets actually need an open blockchain solution with a crypto currency?
- What new challenges does un-deletable public blockchain bring? eg. if it contains illegal content does it make it illegal to host a blockchain node?
Me: I bought a few of bitcoins in 2014 (the equivalent of buying Netscape shares just after their IPO). I sold most of it when the Bitcoin futures were launched and the prices stopped going up. I’m sad that I didn’t buy more in the first place. I’m happy that I didn’t buy more because the whole mining thing is an environmental disaster in the making. I’m not doing any ICO investing because I’m just not capable of due diligence on which ones are maybe interesting, which ones are being over-optimisitc and which ones are outright scams. They all look like pets.com in 1999 to me. And all the blockchain engineers and smart-contract lawyers I talk to all tell me there is a long, bumpy journey ahead to get this whole thing working.
So I’m missing out on the equivalent of Amazon, Ebay, Paypal for blockchain. Maybe I’m really wrong. Or maybe they haven’t been started yet. Or maybe they’ll never be started. Who really knows…
Update: here’s a very good explanation of smart contracts and their challenges by Jimmy Song: The Truth about Smart Contracts