“I’M GONNA make a $hit t$n of money on August 2nd on the Stox.com ICO.” Written in July on Instagram, these words made Floyd Mayweather, a boxer, the first big celebrity to endorse an “initial coin offering”, a form of crowdfunding that issues cryptographic coins, or “tokens”. Stox, an online prediction market, went on to raise more than $30m, some of which seems to have gone directly into Mr Mayweather’s pocket. Other VIPs, including Paris Hilton, a socialite, followed suit and endorsed ICOs. But this source of easy cash may now be drying up: on November 1st America’s Securities and Exchange Commission (SEC) warned that such promotions may be unlawful, if celebrities fail to disclose what they receive in return.
The endorsements and the SEC’s attempt to rein them in are the latest episodes of token mania. Virtually unknown a year ago, ICOs are now more celebrated than initial public offerings (IPOs), the conventional way of floating a firm. Over the past 12 months $3.3bn has been raised in more than 200 ICOs, according to Coinschedule, a data provider—compared with only about $70m in the same period a year ago. This surge is one reason for the boom in bitcoin, a crypto-currency, which was worth around $7,500 on November 2nd. As Benjamin Lawsky, a former securities regulator in New York, put it recently: “Regulators have never seen a new financial product explode with the speed and velocity [of ICOs].”
Unsurprisingly, supervisors have stepped in. China and South Korea, where ICOs had become part of the local gambling culture, have already outlawed them. Many regulators in Western countries have by now made clear that they consider at least some of the coins (or “tokens”) that are distributed in an ICO to be securities, which need to be regulated as such, with all that this entails in disclosure and other requirements. Leading the pack, the SEC said in a report on the DAO, an ill-fated early ICO, that offerings of this kind need to be registered (or apply for an exemption). But big regulatory problems remain unsolved.
The most pressing open question is what a token really represents, says Peter van Valkenburgh of Coin Centre, a think-tank. Technically, the answer is straightforward, at least for those familiar with crypto-currencies. Tokens are mostly entries on Ethereum, a “blockchain”, or “distributed ledger”, copies of which live on many connected computers around the world—much like the one that underlies bitcoin. The Ethereum ledger, however, not only keeps track of a currency, called “ether”, but hosts what are known as “smart contracts”, programs that encode business rules. Investors send ether to an ICO’s smart contract, which generates tokens that can be traded. The ICO’s issuer can keep the ether, and use the funds to develop its project.
Legally, things are more complicated, says Kevin Werbach of Wharton, a business school at the University of Pennsylvania. The SEC, for instance, argues that the technology is irrelevant: when tokens are used to raise funds, they are securities. By contrast, champions of ICOs hold that, although they are initially used to raise funds, they also often have a function in the projects they finance and hence should be treated differently. In Filecoin, an online market for digital storage that raised a record $257m, the tokens will be used to pay or get paid for space on disk drives.
Source: The Economist