Odd Lots - History Has Some Ominous Warnings for Investors in Initial Coin Offerings

Episode Date: November 6, 2017

You can't go a day without hearing about ICOs or Initial Coin Offerings. By taking advantage of a regulatory gap and buzz surrounding cryptocurrencies, companies are raising millions of dollars by launching their own coins. But what's the point of these coins? What are they supposed to do? And what are the pitfalls? On this week's podcast, we talk to Elaine Ou, a blockchain engineer at Global Financial Access and a Bloomberg View contributor about the economics of ICOs, and how previous attempts at creating similar markets ended up as failures.See omnystudio.com/listener for privacy information.

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Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, and wherever you get your podcasts. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal.

And I'm Tracy Allaway. So Tracy, you know, there's this really big story in markets these days and in finance and it's tech. And we kind of haven't been covering it very much. I'm scratching my head because I feel like we've been covering a lot in markets. Do you mean on odd lots or? No, yeah, yeah. Sorry, on the podcast. Like every time I tweet that we have like some new episode, there's like this one topic out there.

They're like, when are you guys going to talk about X? And you must have gotten it, right? I think I have an inkling of what it is. But didn't you do a whole episode on this by yourself and I wasn't there? Yeah, we did. It's true. So I guess that sort of ends the suspense. It was a good effort, Joe.

Good effort. We had like the whole bubble series, of course, remember that? Yeah, of course. And every time we're like, oh, and today we're talking about another bubble. And someone on Twitter was like, oh, you're finally going to be talking about tokens and initial coin offerings. And every time we did it, they're disappointed. But it is true. You know, we've written and there's been a lot of Bloomberg coverage about initial coin offerings,

but they've become such a phenomenon. And so many people are talking about ICOs and tokens and cryptocurrencies that is kind of like, it feels like we have to talk more about them on odd lots. Okay. I've been trying to avoid the topic. In fact, I did such a good job of avoiding it that when you did that whole episode of ICOs, I wasn't even there. But for our listeners who don't know what they are, who've been living under a rock, I guess,

give us a recap of what exactly we mean. Well, basically everybody by this point has heard of like cryptocurrencies and if they don't understand them like, you know, Bitcoin and so forth. But what we've seen an explosion of in the last year, really, is organizations and companies trying to launch their own coins. And so launching some new network with the idea that you would buy this coin and buying the coin would fund the creation of a new network. You would have to use the coin to use the network. And if everyone want to use the network, then the coins would rise in value and everyone could make a fortune. at least that's sort of the idea. And we've just seen, you know, day after day, it feels like there's dozens of these new coins being launched. And the question is, is this a new funding paradigm? Is this a new way that markets will incentivize the creation of new platforms and networks? Or is this just a bubble slash a get rich quick scheme and there's really nothing there? And it feels like this is one of the biggest debates happening right now.

Yeah, more like I see, uh-oh. Ha ha, ha, ha. I've been saving that. one. No, but there's, in all seriousness, there's a subtlety here because you're talking about initial coin offerings, which are often these sort of new digital coins that are attached to the Ethereum blockchain network. And there's also tokens, which are usually a sort of system created to exchange services, basically. So there's two different things as they currently exist. But they all have a similar sort of goal, which is to get people interested and create this big network effect, as you mentioned. Totally. And they all have some of the same language and ideology about decentralization and subverting existing organizations and stuff like that. So there's a lot to

dive into. Today we have a guest. I'm very excited to talk to. We're going to be talking to Elaine O. She is a software engineer at Global Financial Access. She is a contributor to Bloomberg view. And she has been following the initial coin offering and cryptocurrency space. herself for many years, both on her blog and in her career and stuff like that. And I think it's a perfect person to talk about some of the technical aspects and the economic aspects of initial coin offerings and sort of hopefully guide us to an understanding of whether there's something real here or whether this really is just sort of a get rich quick scheme or a bubble that will all come crashing down. I remember some of Elaine's really early work on this topic. So I'm very

excited. Without further ado, Alaino, thank you very much for joining us. Thanks, Joe. What are our initial coin offerings or tokens? Like, if someone asks you, how do you describe what's going on right now? A token is basically a native asset in a network protocol that is used to, I guess, represent some transferable value. So break it down a little bit further. You say a network protocol, a native asset. What does that mean specifically? Like, and sort of spell it out a little bit more what's been going on. In simpler terms, it's just an imaginary thing that people are selling to raise lots of money in hopes of building a future product. That's pretty simple, isn't it?

How about this? Give us the history of ICOs, because it feels like they just sort of exploded into the public consciousness this year. But I'm sure, you know, someone actually came up with the idea at one point in time and they were trying to solve. a specific problem? There were a number of ICOs back in 2013, 2014. They weren't as prevalent as the ones today. Probably the most well-known ICO was Ethereum. They sold their ether tokens before ever building anything,

and they collected Bitcoin in exchange for their future ether. So the creators of Ethereum collected Bitcoin to create this new, you could call Ethereum a coin itself. Now what we've seen in 2017 quite a lot is people collecting Ethereum to create new tokens that ride on the Ethereum network. So explain how that works. And explain like if there are some specific ones like, you know, what do people actually propose they be used for? I think Ethereum raised 18 million. billion dollars worth of Bitcoin back when they were doing their token offering. And Ethereum runs basically decentralized apps. These are just little software programs that run on computers all

around the world. And the most popular app that people are running on these computers is a token app. And a token app is basically just a ledger that keeps track of who owns which tokens. So by sending Ether, which is Ethereum's native token, to one of these token apps, people receive an allocation of token in return. What are some of the more esoteric, or what's the word I'm thinking of, I guess unusual ICOs that you've seen? Because I remember a couple people mentioning specific examples like Synthorn, which is a tokenized synthetic rhino-horn, afrodisiac. I'm not even sure what that means. But if you go to one of the websites that lists all the active ICOs, you can find some really odd things on there.

People will basically do an ICO for anything that will raise money. I mean, there are ICOs for tokens that claim straight up that they're not getting anything in return. It's just an experiment to see whether people will send money to a blank token. Like there was early on the Ponzi coin. Then there was an F word token where basically you're just getting a token named the F word. Okay, but wait, there are some actual ones that sound fairly legitimate in which it appears that a new application or a distributed application might solve some problem and a token and a native token might be of value. So, for example, there are ones that offer a distributed cloud. storage. So we all know about, you know, existing cloud storage, but if you have stuff that's

maybe more sensitive and you don't want it all with companies, you can have it distributed across a network of computers, and then you pay them in that native token for the service of hosting your documents, which on the service sounds reasonably legitimate. What I want to understand is, how does, in theory, how does the token facilitate this? So if I want to, you know, store something very sensitive. Let's say I'm working, I'm some subversive organization and a, you know, in an oppressive authoritarian country. And I want to store my organizational documents across all these different computers so nobody can shut me down. Explain how, in theory, these ICOs or tokens could facilitate that. Well, a token is supposed to represent a transferable

asset with a market price. And in return for storing someone's files, the person would pay you in these file tokens. And since these file tokens can then be sold on the open market, you're getting compensated for storing someone else's files. So it's a sort of incentive engineering, although there are other services like BitTorrent that do offer decentralized file storage already. You mentioned BitTorrent, Elaine.

So on your blog, you came up with a really good historical example of a previous attempt to provide a sort of, of token-based service. Can you walk us through what that historical parallel was? Right. So in the early 2000s, there was a company called Mojo Nation. And the intention of Mojo Nation wasn't really to create a token for people to trade, but to incentivize people to share their extra computational resources. The tokens were designed to incentivize the sharing, but they ended up adding unnecessary complexity, and it was a distraction from the underlying service, which was offering extra storage space or CPU cycles.

So people, in theory, Mojo Nation was supposed to encourage people to share their extra CPU cycles, and then they would get paid in this token. But it didn't work, and as you say, the token added extra complexity. But then what came out of Mojo Nation or sort of the successor organization was actually a huge success. So explain that. When you create a transferable resource like a token, then people who have the tokens want the tokens to be scarce. And in order for a service to be widely adopted, I mean, you don't want the token holders to also want the tokens to be scarce. The reason why BitTorrent was so much more successful than Mojo Nation was, well, not just the simplicity,

but also they didn't try to introduce artificial scarcity with these tokens. The earliest version, people who uploaded files, were given priority in downloading other files. So it was sort of a tip-for-tat protocol rather than actual accounting and trying to transfer resources that they had gained. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report, delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories.

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Get the reporting and the context from Bloomberg's 3,000 journalists and analysts. We're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. So this really gets to the heart of the question, I think, which is that the theory behind all these. tokens is that if you create a monetary incentive to join a specific network, then people will give up their computer resources or something and then the network will form. But history shows us that at least, maybe not every time it works like this, but sometimes the monetary aspect of it can create a

level of confusion and difficulty and friction that actually impedes the creation of the network and undermines the goal. Right. You can see this happening with big. right now. Bitcoin is a payment system, although there are far more people hoarding Bitcoin than actually using it for payments. And I mean, that's okay. People see it as a store of value as well. But it's also something that makes Bitcoin less usable, the fact that people are hoarding it rather than spending it. Are there any ways for people running ICOs now to kind of overcome that fundamental tension between, you know, early adopters who want tokens to be scarce and the needs of creating a large network relatively quickly. I mean, the incentives are basically at odds with

each other. Part of having the initial token sale is that you distribute the tokens to people who will be evangelists for this service. But then it sort of turns into a pump and dump because these evangelists try to drive up the price and then they sell off their tokens. Right. This seems to be sort of the heart of why like people think that there's a bubble because what you have is the theory, okay, the tokens facilitate the networks, but when you look at it, it doesn't look like any real networks are being formed, but you do have a massive amount of speculation and trading and as you say, pump and dump.

So it looks like, you know, it's really, it appears for. from my side, as they say, the card is coming before the horse. There's no real there-there-there with any of the stuff. Yeah, and it's unfortunate because there are people trying to develop legitimate technology, but the legitimate ones are going to get lost in the noise and be seen as a scam just like the other ones. Are there specific applications or, like, uses for ICOs that you think are better suited to the format than others? Like, for instance, I met Yobi Benjamin randomly in Abu Dhabi last week. He used to be a CTO for City, and he's running an ICO that provides services or exchanges, basically video game services.

And something like that, I can see, you know, playing video games is kind of a fun thing that people do. It's not necessarily critical to your everyday life, at least for some people. So maybe something like that, a token makes sense. Well, ultimately, a token is going to, if a token is widely adopted, it becomes like a currency. And I mean, the reason why we have things like the US dollar or currencies in general is to solve for the coincidence of wants problem. And if something has or actually has a native token that has value, like you might as well just pay in, Bitcoin or ether. So is this essentially us going back to a bartering system, but I guess a blockchain

bartering system, it sounds like? Basically, yeah. When you hear people talk about a bubble or a new gold rush, they say, yeah, yeah, there's a lot of speculation. It's a big bubble right now, and it's probably going to burst. But something good will come out of this. And they point to the internet, the dot com in 1999 and 2000 say, yeah, that all burst. But then we got the broadband network and now of course, and of course many of the companies from the late 90s ended up being huge deals like Amazon being the most obvious example.

When you look at this space, do you think it's going to follow the similar trajectory? Is it safe to be that confident that something of value will come from all the speculative activity that we're saying? Well, most of the things that these tokens propose to build involve open source software. So there's that aspect in that people are building open source software that could, in theory, be used by future applications, even if the tokens themselves don't succeed. I mean, a lot of them are not building anything at all, so that's probably less valuable. It seems like an understatement. Joe alluded to this in our intro. How do you think the, the ICO story ends ultimately, then do all of these things prove to be, you know, if not outright frauds, then kind of useless endeavors? And while we're at it, how do you think Bitcoin ends? Because to your point, it's supposed to be a payment system with a big network effect. And instead, we have people who are keeping the coins because they assume they're going to rise in value. That's two big questions. Sorry. Yeah. I think the token sales will eventually

run their course. Even today, I think we have passed the peak and new tokens that are being launched these days aren't seeing the massive influx of capital that the earlier ones saw. As for Bitcoin, one of the biggest complaints about Bitcoin in recent months was that the transaction fees are really getting too high. And part of the reason for that is because transaction fees are denominated in Bitcoin and the price of Bitcoin has gone up like 5,000% this year. So it looks like transaction fees have gone up a lot when denominated in US dollars. But then in terms of Bitcoin, I mean, they've stayed fairly constant. One recent change in Bitcoin was they did a software upgrade that now allows for layer two transactions that, uh,

don't actually happen on chain, but people can make Bitcoin transactions with lower fees off chain and then do netting and batching on chain later on. So just to be clear that you think that the software is in theory going to be enabling, it might become more conducive to payments in the future. Yeah, I think they will get around that, even though, I mean, Bitcoin did see, I guess, a couple years of complaints where people felt that it was not that. usable. Right. All right. Well, Alano, thank you very much for joining us. I think that no doubt this is going to be a very widely listened to episode because I know there's just tons of interest in this

topic. We appreciate your perspective on it. Lano, software engineer, global financial access, and a Bloomberg view contributor. Thank you very much. Thank you, very much. Thank you, and Tracy. So, Joe, I managed to escape ICOs briefly, at least on the Oddlots podcast, but we cannot escape them in our day-to-day markets coverage. And I can't even escape them from my personal email account. So just last week, I got an invite for a presale in a ICO. I'm not going to say the name of it, but I will tell you that the private presale password to participate in this offering

is participate in success. That gives you an idea of the marketing. I don't think we need to say anything more than that. That more than anything else that in your private email, you got an offer for a presale, and that was the password. I kind of think that sums it up, doesn't it? Yeah, should we just leave it there? Are we done?

Let's leave it there. This has been another edition of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. And you can follow our guest, Elaine O, on Twitter at Elaine, except the L and Elaine is an I. So it's like EIA.

So, E.A. And you can follow our producer on Twitter, Sarah Patterson, at Sarah Pat with two T's. Thanks for listening. I'm Francine Lacqua, an award-winning journalist. And I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader.

decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts.