An introduction to corporate financing with cryptocurrencies

Blockchains, distributed ledgers, smart contracts, dApps, ICOs, … The buzzwords around digital currency are heard everywhere, but they are sometimes difficult to decipher. In this article, we explain everything you need to know about the latest cryptocurrencies and corporate financing trends to make sure you stay on top of the game.

Digital currencies are everywhere these days. The most famous one, Bitcoin, has surged more than 170% since the beginning of 2017.[1] The cryptocurrencies’ total market capitalization has surpassed the $100 billion mark.[2] Whilst some people are preparing for a bubble, others remain convinced of its value. Of course, this price increase might just be speculative, but it could also reflect a change in investors’ attitude towards cryptocurrencies. What if they were now seen as a tool to fund legit startups instead of criminal activities? Let’s investigate the latest hype: Ethereum, a new platform using blockchain technology, and the possibility of Initial Coin Offering (ICO) it enables.

 


Bitcoin price year-over-year increase[3]

 

Ethereum: More than a cryptocurrency?

The rising star in the world of cryptocurrencies is Ethereum. Like Bitcoin, its technology is based on a blockchain or distributed ledger. Ethereum, however, aspires to be more than just a cryptocurrency.[4] Most notably is the addition of decentralized applications, or dApps. Using a decentralized network of computers around the world, these apps could be used to communicate without a “middle man”. On top of that, all the participating computers get rewarded with a small amount of Ether, Ethereum’s cryptocurrency, in return for using their computing power and hardware.

Ethereum’s smart contracts are another interesting feature. They allow users to execute a contract on the platform’s blockchain with just a few lines of code. One way this could be used is to design contracts that automatically make one party pay another party if several conditions are fulfilled. This way, none of the parties can manipulate the contract, as the code is completely agreed upon and cannot be altered. One form of these smart contracts is already being used by Barclay’s to trade derivatives.[5]

ICO: Disrupting Silicon Valley?

Initial coin offerings are the latest trend in the world of cryptocurrencies. The concept gained popularity after the launch of Ethereum, which was also done using an initial coin offering. It is a new way of raising funds which combines characteristics of an initial public offering (IPO, hence the name) with attributes of crowdfunding.[6]

On May 31, 2017, tech startup Brave Software raised $35 million in less than 30 seconds.[7] A few weeks earlier in April, another startup named Gnosis raised millions in only 15 minutes, valuing the company at almost $300 million.[8] Both accomplished this with an initial coin offering, or ICO for short. Other remarkable cases of ICOs are EOS, that raised $200 million, and Tezos, that raised more than $230 million.[9],[10]

How does it work?

ICO are fairly straightforward to use. First, a company issues a new coin or token, using the same technology as other cryptocurrencies (like Bitcoin): a distributed ledger or blockchain. During the ICO, a portion of the company’s coins can be bought in exchange for coins of another currency, often Bitcoin (BTC) or Ether (ETH), but sometimes also for fiat money. ICO tokens can have several types of functionality or characteristics. Some ICO coins closely resemble shares, giving owners voting rights and/or the right to a part of the profits. However, other possibilities exist: an interesting example is Storj.io, a cloud storage company. Using Storjcoin, the tokens issued during their ICO, users will be able to buy storage space on their platform.

As companies issuing these coins are mostly startups, it is often uncertain when the investors will be able to use their coins. Nevertheless, initial coin offerings already helped tech companies raise $1.3 billion in 2017, and that number is rising fast.[11]

After the ICO, the new coins can also be traded on secondary markets. Coin investors bet that the company will have successful projects in the future, which will in turn appreciate the value of the coins they purchased.

Is it safe?

Unfortunately, not all initial coin offerings have been a success. In April 2016, a decentralized venture fund called the DAO raised $150 million using an initial coin offering.[12] Hackers found a weakness in the code and exploited it, stealing about $60 million in the process. On top of that, numerous cases exist where fraudsters stole investors’ money using an ICO.

 

Bitcoin and Ethereum[13]

 

To regulate or not to regulate?

This new method of financing provides startups with an alternative to angel investors or venture capital. However, there is one important issue that remains unresolved. The legality of the ICO remains a grey area, as it is still unclear if and how it will be regulated. In the United States, the Securities and Exchange Commission (SEC) has issued a report stating that tokens from the DAO’s initial coin offering are in fact securities and thus, subject to federal law.[14],[15]

In any case, regulation is needed as ICOs are troubled by fraudulent companies looking to make fast money of this new hype. On top of that, startups doing an ICO could be the target of legal cases, as the sale of securities in the US must be approved by the SEC.

The EU’s stance towards ICO is even more uncertain.[16] The FSMA, the Belgian financial markets watchdog, tells us that “currently there is not yet an official opinion of the FMSA on ICOs”. Furthermore, they consider this matter on a European level. In cases of filings, the FSMA statutes for compatibility with the existing laws. The question here remains: does the ICO classify as a security?[17] To protect investors, securities are tightly regulated and require the company to issue to right documentation. Thus, if the coins issued in an ICO are classified as securities, a legal and administrative hurdle would be imposed on companies wanting to do an ICO.

***

Although you will probably not yet use Bitcoin to buy groceries next week, one thing is certain: cryptocurrencies are here to stay. Blockchain powered means of exchange can be much more than just a currency. The technology has proven itself to be incredibly versatile. Its possible applications are incredibly diverse. ICOs are making it easier for companies to raise money and more accessible for investors to finance projects. Ethereum is not just a cryptocurrency, but a platform with dApps and smart contracts that could change the way we do business. Tech companies are starting to catch up, and it is just a matter of time before the rest of the world does too.

 

Authors: Etienne Goffin and Toon Vanderschueren

 

 

[1] https://www.coindesk.com/price/

[2] https://techcrunch.com/2017/06/07/what-the-hell-is-happening-to-cryptocurrency-valuations/

[3] https://www.coinbase.com/charts

[4] https://ethereum.stackexchange.com/questions/45/how-would-i-explain-ethereum-to-a-non-technical-friend

[5] https://www.coindesk.com/barclays-smart-contracts-templates-demo-r3-corda/

[6] https://cointelegraph.com/explained/ico-explained

[7] https://www.coindesk.com/35-million-30-seconds-token-sale-internet-browser-brave-sells/

[8] https://www.coindesk.com/ethereum-ico-irrationality-300-million-gnosis-valuation-sparks-market-concerns/

[9] https://futurism.com/tezos-just-finished-the-worlds-largest-ico-hitting-more-than-200-million-worth-of-cryptocoins/

[10] https://hacked.com/ico-eos/

[11] https://www.ft.com/content/1a164d6c-6b12-11e7-bfeb-33fe0c5b7eaa

[12] https://cointelegraph.com/explained/sec-ruling-on-the-dao-and-ico-explained

[13] http://blog.manigo.com/wp-content/uploads/2017/06/Picture1-3.png

[14] https://www.sec.gov/litigation/investreport/34-81207.pdf

[15] https://www.ft.com/content/e9c2ab09-0d94-3935-a780-1a2af79e4725

[16] https://www.coindesk.com/icos-eu-will-slow-giant-regulate-tokens/

[17] http://www.livebitcoinnews.com/will-eu-define-ico-crypto-tokens-new-asset-class-following-proposal/