The Securities and Exchange Commission clamped down on cryptocurrency firms last week in a major way.
The regulatory body issued dozens of subpoenas (some groups estimate more than one hundred) to companies that conducted or advised on initial coin offerings (ICOs).
Check out our H2 hedge fund letters here.
Notes readers aren’t surprised, as I’ve long warned that the scammy ICO market is one of the biggest bubbles I’ve ever seen.
Before discussing the fraudulent nature of the space, a bit of background on ICOs…
A lot of people view ICOs as an asset class like stocks, bonds or real estate. But that couldn’t be further from the truth.
Initial coin offerings are simply a funding scheme. Companies looking to raise money will post a white paper on a website, post some pictures of their “C-suite executives,” and set up a Twitter account… that’s basically it.
The goal is to raise funds by issuing “tokens.” These tokens typically serve as pre-paid credits that can be used within the ecosystem of the company raising the funds. In other words, you’re not actually getting equity in the company… you’re buying a gift card.
Think of it like the in-game credits you would buy (with real money) to get ahead in the old Facebook game, Farmville. Outside of Farmville, those credits are worthless.
With almost no information, and the obvious, inherent risks to buying a prepaid service, investors are supposed to evaluate if there’s a valid, secondary market for these tokens.
In the face of these many flaws, prices of these ICOs would soar. Not for any fundamental reasons… simply because we were experiencing a massive bubble fueled by hype.
And the prevalence of outright fraud caught the attention of the SEC.
One company called Prodeum was allegedly developing a blockchain for agricultural commodities.
Prodeum raised $11 million through an ICO. Then the founders (who were likely made up in the first place) disappeared without a trace. And the only thing left on the company’s website was a single word – “penis.”
Despite the many warning signs, companies have still raised nearly $9 billion to date through ICOs. And a lot of that money has simply disappeared.
Bitcoin.com recently completed a study of the 902 ICOs that took place last year.
Of those, 142 failed at the funding stage.
Another 276 failed after either taking the money and running or simply failing as a business.
So a full 46% of all ICOs last year have already failed.
But it gets even worse…
An additional 113 ICOs, according to Bitcoin.com, are “semi-failed” because the founders have ceased communications with the public or because the community of users is so small there’s zero chance of success.
Once you add in these “semi-failed” firms, 59% of last year’s ICOs are goners.
Think about that failure rate… it’s astounding. And that’s in one year’s time.
I’m certain that percentage will only increase.
The vast majority (90+%) of cryptocurrencies and ICOs will fail for one simple reason… they have ZERO utility.
People forget, but when you participate in an ICO, you’re actually investing in a business. And that business has to provide value in order to justify its existence.
Let’s look at a couple of the more useless offerings of the past…
Skincoin allows you to get new “skins” for guns in video games. It raised $3.3 million.
There’s also a TrumpCoin meant to “support President Trump and his vision of making America great again.” I have no idea how that’s even a token, but TrumpCoin was worth $3.38 million at its peak.
I seriously doubt there will be much demand for Skincoin or TrumpCoin over the long term. And the fact that these types of coins are on their way to extinction means the market is working.
And while I’m no fan of government regulation, operators in the crypto space are welcoming more regulation… because it gives them clear rules and guidelines to follow as a business. Some lawyers have said the SEC’s recent round of subpoenas was meant as an invitation to have a more open dialogue with these firms.
Of course, I could think of a better way to start a conversation.
But once there’s a clear delineation of what’s legal and what’s not when it comes to crypto and ICOs, more mainstream players and investors will get involved. And that will lead to a larger, less volatile marketplace.
But ultimately, the value of these tokens is driven by demand.
And in the long-run, demand has to be driven by some sort of utility. The coin must present some special benefit that other coins and tokens don’t have… and that people will actually NEED.
I’ve been talking a lot this year about avoiding big mistakes. Luckily, the ICO market is an easy one to avoid.
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Article by The Sovereign Man