Part of our job as your lawyer is to protect you from obvious harm. In our view, the biggest risk of harm is currently posed by the crypto-craze, and in particular ‘initial coin offerings’ or ‘ICOs’.
Before investing in a crypto-coin of any variety – you must ask yourself at least these two questions:
- Why does the promoter of the ICO argue they don’t need to comply with the capital raising provisions of our existing securities law (either in Australia or the US); and
- Who controls the total supply of the coins?
The first question has a relatively simple answer in the case of most recent ICOs:- the promoter of the coin argues that the coin is not a security (i.e. not an investment). Why? Because they are really a ‘gift card’ – a promise by the promoter to deliver something in the future. Deliver what? Usually the goods or services of the promoter. Sometimes this is physical goods, but more often than not, it is a digital service – many of which do not yet exist, (i.e. it is a promise to deliver a service if and when it is able to be delivered).
So in very simple terms, a coin or token under an ICO is like a single-supplier barter card.
That’s it. That’s what a coin or token is. A promise to deliver something in the future. It’s effectively an unregulated futures contract or derivative. Its only backing is the ‘promise’ of the issuer to deliver something.
In many circumstances it is even debatable if a coin or token is a legal promise. At least one promoter has told the SEC in the US that it was really a recognition of a ‘gift’ of money by the ‘investor’! Now that’s honest.
So in our view it is effectively theft – on a grand scale. Our prediction is that someone – of high-profile – will be charged in the US with fraud around an ICO this year.
So if a coin or token is really just a promise by the promoter to deliver goods or services in the future – how can the value of the coin trade on a secondary (still unregulated) market – and then go up in value 3, 5 or 10x in days and weeks? In order to understand the absurdity of this, we need to present an example.
Let’s say you are Kodak and the coin you are offering relates to the delivery of an ‘image’ from a ‘digital service’ that does not yet exist (yes, this is a real example). Does the value of delivering that image really go up 10-fold overnight? This doesn’t even factor in any risk that the promoter (Kodak) may not exist in 12 to 24 months time to deliver on the promise.
It is theft, and it is fraud. Plain and simple.
Now to the second question. Who controls supply?
This is a critical question that creates a real distinction between ‘gift cards’ (ie most ICOs), and a crypto currency or trust platform of any likely enduring value.
Bitcoin has self-imposed limited supply. This was a fundamental aspect of its algorithm. Furthermore, Bitcoin does not promise to deliver anything in the future. Finally, no one issued or promoted Bitcoin or ‘raised’ any money. You need to create your own Bitcoin through running the algorithm (or buying them from someone else). Yes the original creators of the algorithm may have mined some coins early on at a cheap cost. But no one gave them any money. Compare this with ICOs where a promoter hauls in $30m+ in cash (and/or Bitcoin) from the punters, and leaves the door open to either sell their goods and services the old fashion way (i.e. for cash) and also issue more coins in the future.
Because of its characteristic of mathematically limited supply, Bitcoin has become a way to ‘store value’ and potentially act as a medium of exchange (subject to transaction throughput limits). In other words, it has the characteristics of a currency or precious metal.
But like all currencies, it requires some magical juice – called ‘confidence’. Enough people need to believe in its value for it to work. People fundamentally believe in the US dollar because the people behind it have nuclear warheads and the IRS. This is despite the fact that these people have been debasing the crap out of the currency for the past 10 years, (because they control the supply of US$, and never promised not to print any more when it suited them…).
Chances are Bitcoin will endure – mainly because of its fundamentally limited supply, and the debasing of traditional currencies. But it is going to take an absolute pounding on the way through. Why? Because when the fog of greed subsides around fraudulent ICOs and they all evaporate in a storm of law suits and prosecutions, Bitcoin will cop collateral damage.
ICOs have been made possible by the unique and relatively long-term success of Bitcoin and trust platforms like Ethereum. But when the ICOs are exposed, they will likewise taint their confidence enabler – Bitcoin.
The governments of the world will also then seize on this opportunity to take Bitcoin down along with ICOs, because Bitcoin represents a genuine challenge to hierarchical currencies. It will be a super financial battle on a scale not seen for a long time.
Our prediction is that governments will attack Bitcoin at its weakest point – which is the same weakest point for all currencies – confidence. ICOs blowing up may just give governments what they need. (In a very similar way to how 9-11 gave governments the opportunity to take away massive chunks of our right to privacy.)
A further question (related to the supply question) is why don’t more people create Bitcoin-like offerings? Well some have, but the SEC in the US has indicated that it will crush anyone who it identifies as trying to do this. The SEC is much more confident that a promoter of a crypto currency is breaching US securities laws. This explains why the successful crypto currencies have been created anonymously.
But the most important reason you won’t find many real crypto currencies is because they do not involve punters passing cash to promoters. ICOs have developed because they enable people to sell something to someone (i.e. a coin) and take their money. The beautiful thing about an ICO for the issuer is that it costs effectively nothing to create the coin.
So – if you want to punt on sentiment and confidence, then by all means, go crazy with your ICOs, but do not delude yourself. You are not buying an investment, because if you were, it would already be regulated…
The information contained in this post was reviewed on 16 February 2022