In this short post I want to set out my case for the moral justifiability of 51% attacks against proof of work cryptocurrencies. In the past, a 51% attack was a theoretical construct that most people didn´t seem to think would be practically achievable or lucrative. This has now changed, as hashpower can be rented on sites like Nicehash and Mining Rig Rentals for a few hours at a time. The attack delivers the attacker two prominent opportunities:
-You can orphan blocks of ¨legitimate¨ miners. This essentially means that whatever work was produced by legitimate miners during your attack became worthless. Mine a secret chain of two hours worth of blocks, release it and you orphaned 2 hours worth of blocks by your competitors. By the time most of the miners have noticed their blocks were orphaned in an attack, their nodes will have been automatically mining on your own chain for a while and it will be too late for them to do anything about it. The amount of money they lost would be equivalent to the amount you had to spend to produce your chain. Because mining is an industry with tight margins, the economic impact on these miners can be very big. The cost may be sufficient in case of a very long attack, to persuade them to quit their endeavor and get a real job.
-The more important opportunity is that you´re able to double spend your coins. This is potentially, incredibly lucrative. How lucrative it is tends to depend primarily on the inflation rate of a cryptocurrency. A low inflation rate means relatively little ¨work¨ is done to maintain the security of the system. A high inflation rate on the other hand, turns the cryptocurrency into a very poor long-term investment. As a consequence, most cryptocurrencies face declining inflation rates, that delay the problem of their ultimately unsustainability into the future. The bank of international settlements explains this issue here
When it comes to the moral justification of a 51% attack, we first have to ask ourselves why proof of work is morally unjustifiable. There are two main reasons for this:
-Proof of work has an enormous environmental impact, that ensures future generations will have to deal with the dramatic consequences of climate change. There is no proper justification for this environmental impact, as it delivers no clear benefits over existing payment systems other than the ability to carry out morally unjustifiable actions like blackmail.
-Proof of work is fundamentally unsustainable, because of the economic burden it places on participants in cryptocurrency schemes. Cryptocurrencies can´t produce wealth out of thin air. The people who get rich from a cryptocurrency becomes rich, due to the fact that other people step in later. In this sense we´re dealing with a pyramid scheme, but the difference from regular pyramid schemes lies in the fact that huge sums of wealth are not merely redistributed, but destroyed
, to sustain the scheme. The cost of the work to sustain the scheme is bigger than you might expect, because the reality is that relatively little money has entered bitcoin. JP Morgan claims that for the crypto assets at large, a fiat amplifier of 117.5 is present, as a purported $2 billion in net inflow pushed Bitcoin’s market capitalization from $15 billion to $250 billion. You have to consider that the Digiconomist estimates that $2.6 billion dollar leaves the Bitcoin scheme on an annual basis, in the form of mining costs to sustain Bitcoin. The vast majority of retail customers who entered this scheme ended up losing money from it. In some cases this lead to suicides.
The fact that proof of work is morally unjustifiable doesn´t directly lead to a moral justification for a 51% attack. After all a sane society would use government intervention to eliminate the decentralized ponzi schemes that are cryptocurrencies. There are a few things that need to be considered however:
-Governments have so far failed in their responsibility to address the cryptocurrency schemes. Instead you tend to see officials insist that proof of work might suck and most cryptocurrency is a scam, but ¨blockchain technology¨ will somehow change the world for the better. Most libertarians who saw these schemes emerge insisted that it´s stupid to participate in them because the government would eventually ban them and round up the people who participated in them. This didn´t happen because of the logistical difficulty of suppressing these schemes (anyone with an internet connection can set one up) as well as the fact that suppressing them would lend credence to the anti-government anarcho-capitalist ideology on which these schemes are based. Goverments might say ¨these schemes facilitate crime, ruin the environment and redistribute wealth from naive individuals to scammers¨, but anarcho-capitalists would insist that governments have grown so tyrannical that they want to ban you from exchanging numbers on computers.
-Because cryptocurrency is fundamentally an online social arrangement, governments have very limited influence over the phenomenon. Binance seeks to become a stateless organization, not subject to the jurisdiction of any particular government. Just as with regular money laundering and tax evasion that hides in small nations that can earn huge sums of money by facilitating these practises, governments are dependent on the actions of individuals to address these practices. Whistleblowers released the panama papers and the tax evasion by German individuals through Swiss bank accounts. Through such individuals, the phenomenon could be properly addressed. In a similar manner, cryptocurrency schemes will need to be addressed through the actions of individuals who recognize the damage these schemes cause to the fabric of society.
-The very nature of a 51% attack means that it primarily punishes those who set up and facilitate the cryptocurrency scheme in the first place. The miners who pollute our environment to satiate their own greed are bankrupted by the fact that their blocks are orphaned. The exchange operators are bankrupted due to double-spend attacks against the scams that they facilitate. When this happens, the cryptocurrency in question should lose value, which then destroys the incentive to devote huge sums of electricity to it.
Finally, there´s the question of whether 51% attacks are viable as a response to cryptocurrency. There´s the obvious problem you run into, that the biggest and oldest scams are the most difficult to shut down. In addition, cryptocurrencies that fell victim to an attack tend to move towards a checkpoint system. However, there are a few things that need to be considered here:
-51% attacks against small cryptocurrencies might not have a huge impact, but their benefit is nonetheless apparent. Most of the new scams don´t require participants to mine, instead the new schemes generally depend on ¨staking¨. If people had not engage in 51% attacks, the environmental impact would have been even bigger now.
-51% attacks against currencies that implement checkpointing are not impossible
, if the checkpoints are decentrally produced. What happens in that case is a chain split, as long as the hostile chain is released at the right time. This would mean that different exchanges may get stuck on different forks, which would still allow people to double spend their cryptocurrency.
-There are other attacks that can be used against proof of work cryptocurrencies. The most important one is the block withholding attack. It´s possible for people who dislike a cryptocurrency to join a pool and to start mining. However, whenever the miner finds a valid solution that would produce a block, he fails to share the solution with the pool. This costs money for the pool operator, but it can be lucrative for the actor if he also operates a competing pool himself. In the best case it leads to miners moving to his pool, which then potentially allows him to execute a 51% attack against the cryptocurrency.
-It´s possible to put up a 51% attack bounty, allowing others to do the work for you. This works as following. You make transaction A : 100 bitcoin to exchange X, for a fee of 0.001 BTC. Once this transaction has been included in a block, you immediately broadcast a conflicting transaction with another node: You´ŕe sending those 100 bitcoin to your own wallet, but you´re also including a 50 bitcoin fee for the miners. The miners now have a strong incentive to disregard the valid chain and to start mining a new chain on an older block that can still include your conflicting transaction. Provided that pool operators are rational economic agents, they should grab the opportunity.
-Selfish mining in combination with a Sybil attack allows someone to eclipse the rest of the network, while controlling less than 51% of the hashrate. Your malicious nodes will simply refuse to propagante blocks of your competitors, thereby giving you more time to release your own block. Selfish mining will always be possible with 33% of the hashrate and as far as I can tell there are no pathways known currently to make the scheme impossible for people with 25% of the hashrate. This potentially makes a 51% attacks lucrative without having to carry out double-spend attacks against exchanges. Although double spending is a form of theft, it´s not clear to me whether a selfish mining attack would get you into legal trouble or not.
The dreaded 51% attack is a morally justifiable and potentially lucrative solution to the Nakamoto scheme
Today Bitcoin Gold (BTG) has a MC of $2,630,984,532, each are worth $156.47. In the past 24hrs the price has outperformed most jumping almost 50%+.
BTG hard forked from Bitcoin on 24 October 2017, and has survived for months now.
Here was the Coinbase official stance on the matter from last year: https://support.coinbase.com/customeportal/articles/2892196-bitcoin-gold-faq
You can see a list of all the major exchanges and wallets that have now implemented support for BTG here which include Bitfinex, Binance, Shapeshift, Ledger, Trezor etc https://bitcoingold.org
GDAX Coinbase's exchange is still tagged as "future".
Todays spike is a strange one as there has been a fair amount of community cynicism over BTG in the past.
Some of the controversies outlined on its wiki included post-mining, bonus taking, secret mining code and wallet hacks. https://en.m.wikipedia.org/wiki/Bitcoin_Gold
That said when you think about the amount of money being retained by large exchanges such as coinbase from all the forks such as BTG, it ptobably eclipses anything BTG has done value wise. In fact BTG has probably posted more updates than Coinbase on the BTG funds they're holding.
The obvious reminder is always retain your private keys yourself, keep them in a hard wallet away from the exchanges or you'll always run the risk of not being able to benifit frim the growing number of hard forks.
That said, I think many newcomers, particularly using gateway exchanges to buy gateway crypto's have just got to grips with concept of Crypto and buying it.
I can understand how then buying hardware wallets and transferring crypto to them could be a daunting task.
I think for those people, maybe lured in to crypto with the likes of Coinbase referral programs really deserve to get at least regular updates from exchanges that are not supporting forks... how, where, why and when.
Also this doesn't include Airdrops where new ICO cryptos are distributed relative to someones holdings of another Crypto such as Bitcoin or Ethereum... again Exchange hodlers are missing out.
Companies and stock brokers need to keep investors updated when issuing dividends to shareholders,
That helps investors to make the educated decision whither or not to keep their money in invested in that company or not for the longterm.
Exchanges should be doing the same for forked funds.
I think with ever new fork that emerges Coinbase are setting themselves up for future legal challenge of somesort, forcing them to go back and support/ distribute all the forked funds they are holding.
This was evident in the case of Bitcoin Cash as it was only rumors of legal action against them that really seemed to get them to up their game.
This is a the risky cloud that will hang over them, particularly when going out for more rounds of funding their growth, as it's a big question mark future risk investors.
They need to be proactive addressing forked funds, instead of just bottling up a future storm by ignoring them.
All in all forks aren't really Coinbase's fault, but their lack of updates are. They have warned people just to take their crypto off the exchange in the past, but when at the same time as they are priding themselves on and encouraging the sign ups of newcomers that maybe aren't as technically minded I don't think this is enough?
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We are more than proud that we not only promote but also share our knowledge with the students of the UBAI. Here you can learn how to do security token offering and initial coin offering!
Now I want to share some cool info on the purpose and role of tokens within the Blockchain ecosystem at the ICO stage.
Initial Coin Offerings (ICOs) History
Initial Coin Offerings (ICOs) are a means of fundraising for the initial capital needed to get new projects off the ground within the cryptocurrency ecosystem. More often than not, Bitcoin and Ethereum, are used to buy a quantity of project tokens. However, new projects are also being launched on alternative Blockchain platforms such as NEO or WANchain, wherein the “parent” chain’s tokens will be used to fund these ICOs. Pre-launch, ICO tokens are endorsed as functional currency in the project ecosystem. After a project’s ICO, it is available on exchanges, and then the market determines the value of those tokens. The main benefit of using the ICO funding system is that it avoids the prohibitive amount of time and expense incurred by launching a startup in the conventional method, by way of Initial Public Offering (IPO). The lengthy and costly process of ensuring regulatory compliance in different jurisdictions often makes the IPO format unfeasible for small companies. Thus, the ICO method of fundraising is far more attractive as a means of crowd funding for the project. But at the same time, an ICO is certainly riskier for the investor.
It is important to note the different stages of the token sale. Token prices generally escalate the closer the token gets to its listing date. Projects often seek funding from angel investors even before the date of the private pre-sale is set, though some ICOs do go straight to pre-sale. After potential initial investment has been sought from angel investors, pre-sale begins. Usually there will be a 15–30% discount from the public sale price. The main-sale begins after the pre-sale has concluded. At that time, normal everyday crypto enthusiasts, with no connections to the team, may buy into the project at pretty close to the ground floor price. Angel investors and pre-sale investors sometimes receive quite large discounts from main sale prices, but their tokens are locked up for varying amounts of time, to prevent dumping, or selling all their tokens for a quick profit at the time of listing. Today the vast majority of ICOs make use of the Ethereum blockchain and the ERC-20 token. The very first token sale was arranged by Mastercoin, a Bitcoin fork, in July 2013. Ethereum soon followed in early 2014, raising 3700 BTC in only 12 hours (equivalent to $2.3 million at that time, and just under $35 million today). Before late 2015 there were sporadic ICOs, with Augur, NXT and Factom all successfully raising funds. 2016 was the year that the ICO format grew to truly disrupt the Venture Capital industry. There were 64 ICOs in 2016 which cumulatively raised $103 million USD.
Tremendous Success & Why Real World Case Study
The ICON (ICX) Initial coin offering is an example of a project that reaped the rewards of a token sale done with precision of execution and clarity of vision. The project promised to build a world-wide decentralized network that would allow Blockchains of different governances to transact with one another without a centralized authority, and with as few barriers as possible. ICX offered fair and clear tokenomics, with 1 Ether buying 2500 ICX, and with 1 ETH costing approximately 250 dollars when the ICO began on September 18th. 50% of the total amount of tokens were put up for public sale, 400,230,000 out of a total of 800,460,000, equating to a fundraising goal of 150,000 Ether. One of the core reasons for the project’s spectacular success was the incredibly distinguished background of those involved, and the foundation the project had in many years of stellar achievement. ICON was originally a project developed by “The Loop”, a joint venture between DAYLI financial group and three Korean Universities. They lead the Korea Financial Investment Blockchain Consortium, one of the largest organizations of its kind in the world, boasting members including Samsung Securities. The Loop had already implemented Blockchain solutions for high profile clients well before ICX was born, including completing a KYC/AML authentication smart contract platform for Korea Financial Investment Consortium.
Real World Example of Failure & Why Case Study
The risk involved in starting your own company is huge. Over 75% of startups eventually fail, according to the Harvard Business School study by Shikhar Ghosh. The study’s findings show the rate of failure for new companies is roughly 50% after 5 years, and over 75% after 10. Shikhar Ghosh identifies the following issues as the most common factors in start-up failure: -Insufficient Market Demand -Insolvency -Wrong Team -Got beat by competition -Pricing/Cost issues -Poor Product -Need for or Lack of business model -Ineffective Marketing -Disregarding Customer desires The statistics concerning rate of failure for conventional business startups pale in comparison to the number of crypto startups that fail according to Tokendata. They are one of the most rigorous ICO trackers, recording 46% of the 902 ICO crowdsale projects initiated in 2017 as failing by the time of writing. Of these 46%, 142 collapsed before the end of the funding stage, and a further 276 had either “exit scammed” (took the money and ran) or slowly faded into eventual obscurity. With no shortage of failed and abortive projects to look into, we thought it would be more helpful to look into an ICO that was mismanaged and unsuccessful in terms of its execution, rather than being fraudulent, or terminally mismanaged.
Real World Example of Failure & Why §3
Tezos was designed as a “new decentralized Blockchain that governs itself by establishing a true digital commonwealth”. The project was a partnership between the husband and wife team of Kathleen and Arthur Breitman, and a Swiss foundation run by Johann Gevers. They had a novel idea of “formal verification”, a technique that mathematically proves the veracity of code governing transactions and heightens security of smart contracts. That idea was wholeheartedly endorsed by investors, resulting in $232 million USD raised in the 2017 crowdsale. Trouble arose after the Breitmans asked the head of the Swiss foundation they were in partnership with to step down. In Gever’s words, the Breitman’s were attempting “to bypass Swiss legal structure and take over control of the foundation”. The resulting 6 class action lawsuits that were spawned from the wreckage of one of the most successful ICOs of all time have yet to be fully resolved at the time of writing, though Gevers has stepped down and a new leadership team is in place. The Tezos Network has a prospective launch date of somewhere around Q3 2018. The debacle, though not terminal to the prospects of the Tezos network, provides a cautionary tale about the need for a clearly defined leadership structure and plan for the allocation of funds after an ICO. It is entirely possible that the Tezos project could have ridden the late 2017 market euphoria to sit near the top of the cryptocurrency hierarchy if boardroom strife could have been avoided.
Real World Example of Failure & Why §4
Projects often also “pivot” from one focus or project to another. More often than not, teams change the project name entirely, even while retaining the same core team, to try for a successful venture one more time. One such project is Chain Trade Token (CTT) which, while technically speaking, not yet a “deadcoin”, shows all the signs of shutting down operations within a few months, and “pivoting” into a new project. The CTT project aimed to be the “first blockchain-based platform for the trading of futures and options on food and raw materials (aka commodity derivatives)”. But through a combination of a non-existent social media presence, and a distinct lack of urgency in securing listings beyond decentralized exchanges, the lofty ambitions of the top-level team were left unrealized. The team has supposedly split their operations from solely Chain Trade, to a former business endeavors, and the Nebula Decentralized Exchange. The project leaders then offered a 1-for-1 token swap which has been accepted by the vast majority of CTT holders.
The ICO Process
Before even researching the particular strengths and weaknesses of any specific project in which you may want to invest, it is important to know the overall processes of the ICO crowdfunding method. This will allow you to avoid any potential pitfalls if you do decide to move forward and invest money into a particular idea or project. How does an ICO happen? Stage One: Token sale details are set: This takes place usually after release of the whitepaper, and the presentation of a project to prospective investors in forums and on social media. Stage Two: Whitelisting for private sale begins: The vast majority of all ICOs have instituted KYC checks for investors which usually involve uploading a photograph of your passport or driving license along with a selfie holding the ID. Did you know? Participation in ICOs has proven to be a regulatory nightmare in some localities. Most token sales restrict contributions from investors in China and the USA entirely, though accredited investors may participate in the USA in some cases.
Stage Three: Private/Pre-sale states: Typically, 10% of tokens will be offered to early investors at a 10–30% discount. These select few investors will likely have a close association with the team. But not all projects have a pre-sale round, some go straight to public sale. Stage Four: Whitelisting for Public/Main sale starts: The same format used for pre-sale investors is used for public sale investors, though it is a regular occurrence to see main sale KYC checks closed early due to overwhelming demand. An investor must then register a contribution wallet address. That is the address used to send cryptocurrency from, to buy the ICO tokens, and then also into which you will receive your purchased tokens. This wallet address must be a non-exchange wallet, like Blockchain.info bitcoin wallet, or MyEtherWallet for ERC-20. You already understand from the prior lesson that making a mistake with your wallet address may mean you lose the tokens forever as well as the BTC or ETH you used to purchase them. Copying and pasting your cryptocurrency public key into the whitelist wallet form is the next task to complete. And then, as the investor, you wait for confirmation of successful ICO registration from the team.
Stage Five: Public sale starts: Commonly on a specific date, though sometimes for a specific period of time. If you are interested in participating in an ICO, it is important to make your contribution as quickly as possible, or you risk sending your ETH or BTC after the hard cap has been reached, resulting in your funds being sent back. This refund can sometimes take many days, or even weeks in times of high market activity. Did you know? In 2017 it was not unheard of to find ICOs that had originally scheduled their ICO period for many weeks, but then they met with such high demand that they could close their crowdsale in a matter of hours or even in just a few minutes!
Stage Six: Tokens are allocated to successful participant investor wallets, and trading can begin on some decentralized exchanges like IDEX, or EtherDelta in the case of Ethereum based tokens. Tokens will be sent to and received by the wallet addresses from which the investor contributions were made. Stage Seven: Tokens are listed on mainstream exchanges: The tokens will then be listed on the exchanges with which the teams have negotiated listing, prior to or during the sale. It can cost huge amounts of money to list on large exchanges like Bitfinex Bittrex, Huobi or Binance, so usually smaller projects will not be listed on top 10 exchanges so quickly. As tokens are listed on more and more exchanges, their price usually rises because more and more investors are exposed to opportunities to buy that particular token.
Evaluating a Blockchain Use Case
Evaluating a particular use case for Blockchain technology, and thus how successful an ICO project’s ambitions might be in a particular market, is not a simple endeavor. As demonstrated in the graphic below, Blockchain technology has nearly limitless potential to be applied to a great variety of business areas, but as an ICO investor, you are looking for projects that have the potential to deliver significant long-term success. In the currently saturated ICO environment, some use cases have more potential than others. Ascertaining which use case is likely to have long term success is a key distinction. Also, we must recognize that businesses and corporate entities may be overeager to experiment with this new Blockchain technology, whether or not usage of the technology is actually advisable or profitable for their particular purpose. The main questions to ask when analyzing specific solutions proposed by the project are: What are the problems posed and the solutions offered? Does this particular area of business need a Blockchain solution? That is, is a Blockchain solution in fact superior to the current way this particular business operates? Is the use of Blockchain in this specific instance feasible and applicable? What are competitors doing about Blockchain projects in this same area?
A Blockchain network provides a shared, replicated, secured, immutable and verifiable data ledger. The implication for use case analysis: Shared and replicated: participants have a copy of the ledger and many people can view it or work on it Secured: Secured through cryptography Verifiable: Business rules are associated with all interactions that occur on the network Immutable: Transactions (records) cannot be modified or deleted, therefore a verifiable audit trail is maintained by the network So, with all this considered, what should we look for with regard to a possible business use case that would be best solved using Blockchain technology? 1. Data exchange that has trust issues i.e. businesses transacting with one another. Trust must be established through a multitude of verification processes with regards to employees and products. These processes increase operational cost. Example: Digital voting. 2. Any potential business process involving data storage, or compliance and risk data that get audited. Blockchain solutions would provide the regulators a real-time view of information. Example: Supply chain solutions like VeChain or WaltonChain. The possibility of close to zero operational loss would of course be attractive to any business. 3. All kinds of asset transactions. A Blockchain network, with its tamper-proof ledger, validating traceable and trackable transactions, could save many different industries untold amounts of money. Example: Tokenization of assets e.g. Jibrel Network or Polymath
Purpose of Tokens
Within the cryptocurrency ecosystem, the definition and role of a token iswidely understood. They represent programmable units of currency that sit atop a particular Blockchain, and they are part of a smart contract “logic” specific to a certain application. In the business sphere, a token can be defined as a unit of value that a project or business venture creates to enable it to self-govern. And the business venture also allows token users to connect and collaborate with its business products, while facilitating the sharing of rewards to all of its stakeholders. A token can also be described in a more general sense as a type of privately issued currency. In the past it was solely within the purview of governments to issue currency and set the terms of its governance. With the advent of Blockchain technology we now have businesses and organizations offering forms of digital money over which they, not the government or central bank, have control of the terms of operations and issuance. Wide scale adoption of these mechanisms could fundamentally alter the global economy. This is like the creation of self-sustaining, mini-economies in any sector of business or life, via a specific token or currency.
Fun Fact: Tokens of the particular Blockchain upon which the project is launched will usually have to be bought in order to be exchanged for ICO tokens, hence it is important for traders and investors to be aware of the schedule for upcoming ICOs. ETH is usually the token used for exchange because the majority of ICOs launch on the Ethereum Blockchain. But this is not always the case. During January 2018, two NEO token ICOs, both the Key TKY and Ontology ICOs, were being carried out, and this caused the NEO cryptocurrency to spike to its all-time high in excess of $160 USD. Since the product or project is more often than not in its embryonic stage at the time of the ICO crowdfunding process, the ICO token’s true function and purpose is in most cases yet to be realized. At the ICO stage the tokens can usually be grouped together into one of three categories. Knowing how to distinguish these categories involves determining the specific nature and function of the token around which the project is centered. The main and crucial distinction, is whether or not a token is a security, and therefore subject to securities registration requirements.
ICO Stage Token Categories
Howey Test: This is the test created by the US Supreme Court to ascertain whether certain transactions qualify as “investment contracts”. If they are found to fall within this classification, then under the Securities Act of 1933 and the Exchange Act of 1934, those transactions are considered “securities” and participants must adhere to registration and disclosure requirements. One of the most important and amazing considerations of the effect of Blockchain technology is that normal people with a computer science background are now empowered to make decisions and offer products and services that previously only licensed financial institutions were able to do. This is a very complex and complicated situation with serious ramifications for anyone involved. One thing to note well is that ordinary participants and actors in this arena can easily commit white-collar crime, violating serious securities laws, without even realizing it. If a token falls within the US legal definition of “Investment Contract” then you must adhere to US regulations. For that reason, many ICOs simply do not want to sell to US based investors, perhaps until all the rules and regulations are clarified.
The broad and varying definition of the term “security” is a regulatory minefield. This has always been true for traditional financial products, and now it is especially true for the as yet unregulated cryptocurrency market. In the case of SEC V. Howey, parameters were established to determine whether or not a particular financial arrangement could be classified as a security and thus be subject to securities regulations. Cooley LLP Fintech Team Leader Marco Santori has said, an arrangement is a security if it involves “an investment of money, and a common enterprise, with the expectation of profit, primarily from the efforts of others.” Investors have the option of accessing a huge range of security tokens through ICOs. Prime examples are the gold backed DigixDao (DGD) and CProp (still in crowd funding stage). A security token is fundamentally different from the currently available ICO project tokens in that it provides a legal and enforceable ownership of a company’s profits and voice in its governance much like common stock traded on any exchange. If security tokens are the next step in the evolution of crypto-finance, real estate, stocks, venture capital, and commodities can all be tokenized. The traditional markets could be fully connected to the Blockchain. Financial assets would available to anyone in the world, not just licensed or accredited investors. That is one aspect of Fintech, the financial revolution taking place today, as Blockchain technology clashes with traditional finance.
One exciting application of smart contracts on the Ethereum Network is the potential for startups to distribute equity tokens through initial coin offerings. That would reduce the hurdles that an average person has to face in order to take part in the early stages of a company’s development. And, democratic governance of a project could be conducted in a transparent manner through voting on the Blockchain. As of yet, few startups have attempted to conduct equity token sales for fear of falling afoul of the Securities and Exchange Commission (SEC) in the US. But many Venture Capital insiders are bullish on the prospect of equity tokens taking a central role in the crypto finance industry, when and as the legal issues are resolved. For example, the Delaware State legislature recently passed a bill enabling companies to maintain shareholder lists on the Blockchain. That is one major step to enable Blockchain based stock trading. Lawyers also generally believe it is only a matter of time before the regulations are clarified. Did you know? Important consideration: The Sarbanes-Oxley Act of 2002 made it unfeasibly expensive for smaller companies to be listed on exchanges, causing a halving in the number of IPOs between 1996 and 2016 (7322 to 3671). In 2017 there was an almost 5-fold increase in the number of ICOs, from 43 to 210, with the 2017 volume already being eclipsed in the first 5 months of 2018.
However, given that this area is still a regulatory nightmare for people planning to issue security and equity tokens, many projects attempt to ensure that the tokens within their specific model fall under the definition of Utility Tokens rather than securities, so as to avoid the SEC regulations altogether. If a token is imbued with a certain functionality and use within the Blockchain infrastructure of that particular project, the token can avoid being labelled as a security, and thus render SEC regulations inapplicable. Just this week in fact, the SEC made the long-awaited and momentous decision that Ether was not a security. In the words of William Hinman, director of the Securities and Exchange Commission division of corporate finance, “Putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.” This means that Ethereum, in fact, fails the Howey test, which is exactly the decision the crypto world wanted. Hinman said, “When the efforts of the third party are no longer a key factor for determining the enterprise’s success, material information asymmetries recede,” Hinman said. “The ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful.” We will now cover various use cases that projects have been adopting up to now in order to get their tokens classified as utility tokens rather than securities.
Some coins portray themselves as a company with tokens being held in a way that is analogous to voting shares of a stock. One coin held is equal to one vote. This form of token utility has a major flaw in that so-called whales (people with huge amounts of a particular cryptocurrency) can manipulate any poll conducted. The cryptocurrencies Aragon and Lykke are examples of projects that have written voting rights into the structure of their code. In-App Reward: Another common tactic to evade the security label has been the addition of in-app rewards to the functionality of a particular token. The Basic Attention Token (BAT) is the unit of currency for use with the project browser named “Brave”. The BAT is a unit of account for the advertisers, publishers and users of the platform. Filecoin, the cloud storage project that raised a record $257 million through their ICO, pays other people or companies for use of their spare storage space. Some of the many rights afforded to token holders in various Blockchain projects are described by the graphic below.
Token Roles Function
The token can be used as a mechanism through which user experience is enhanced, enabling such actions as connection with users, or joining a broader network. It may also be used as an incentive for beginning usage or for on-boarding. Examples include Dfinity and Steemit. Value Exchange: In its most basic usage, a token is a unit of value exchange within a specific app or market. This usually is made up of features that allow users to earn tokens through real work or passive work (sharing data, allowing use of storage space) and to spend them on services or internal functions within the specific market ecosystem created by that organization. Augur and KIK, amongst countless others, are projects that have implemented this functionality into their tokenomics. Toll: The token can also be used for getting onto the Blockchain infrastructure, or for powering decentralized applications run on that particular Blockchain. This ensures that users have “skin in the game”. Tolls can be derived from running smart contracts, paying a security deposit, or just usage fees. Examples include Bitcoin and Ethereum. Currency: Seeing as the particular platform or app is designed with a view towards functioning in synergy with a particular token, the token is an extremely efficient means of payment and transaction engine, resulting in frictionless transactions. This means that companies can become their own payment processors and no longer have to rely on the often unwieldy stages of conventional financial settlement involving trusted third parties in the form of banks and credit card companies.
Rights: Owning a token bequests certain rights upon the holder, such as product usage, voting, access to restricted markets, and dividends (e.g.: GAS for holding NEO). Though most businesses are trying to avoid fitting the definition of a security laid out in the Howey Test, the right to real ownership of a particular asset is sometimes granted as a result of holding a token, for example DigixDAO or Tezos.
Comparison to Traditional IPO and Equity Capital Raisings
Despite the similarity of the acronyms and the derivation of one from the other, Initial Coin Offerings and Initial Public Offerings are very different methods of fundraising. The distinction is not limited simply to the fact that IPOs are used in conventional business, and ICOs are associated with cryptocurrency. Through ICO’s, companies in their early stages issue digital tokens on a Blockchain and those tokens act as units of value for use within the ecosystem created by the project. They have many other uses, but it is also fair to say they are analogous to shares offered in an Initial Public offering.
In an IPO, shareholdings are distributed to investors through underwriters, usually investment banks. But in the case of ICO token sales, companies often do not even have an actual product to show. Often, all that there is a whitepaper, evidence of the partnerships involved and the particular social-media infrastructure they have established. IPO’s take place when a more well-established company floats shares on a stock exchange. The company would have a well-established history of success and significant reasons to expect a bright future. In the vast majority of cases, an ICO is used for a new company with no such history, just trying to get off the ground.
Another important difference is the expected return in exchange for the investment. Companies engaging in IPOs may offer participants dividend paying stocks which result in various levels of return depending on the success of the company after the shares are issued. An ICO however can offer no such guaranteed return. When buying tokens in an ICO, you do so with no promise of return. An investor who holds the tokens of a particular project does so with the promise, rather than an assurance, of future success. The main benefit to investors taking part in Initial Coin Offerings, compared to Initial Public Offerings, is the need for only basic Know Your Customer checks in the case of the ICO, compared to the costly, complex and time-consuming regulatory obstacles that must be traversed in an IPO. In the case of Initial Public Offerings, a business must obtain authorization from a number of entities before the act of “going public”. Prior to an IPO, companies are not obliged to disclose so much of their internal records or accounting. It is not so complicated to make a private company in the United States. But in the run up to going public, the company must form a board of directors, make their records auditable to the relevant authorities in one or more jurisdictions, and prepare to make quarterly reports to the SEC (or equivalent).
Relevant Factors to Consider in ICO process
When analyzing the chances of success for a specific project, and the likelihood of a favorable return on investment in the long term, it is essential to break down the project into its constituent parts, and evaluate the strengths and weaknesses of each part individually. An effective investigation and analysis would start with the team and white paper. Consider the stage the project is at,and VC investments in the project. That would lead to a good initial idea of the actual progress thus far. Next, evaluate the social media presence and the credentials of the community that has formed around the core team. If a compelling case is made by the team, (e.g.: via an in-depth dive into the use case), and the tokenomics, distribution schedule, potential competitors, as well as the team’s awareness of any future business or regulatory concerns all check out; then the ICO might present a good opportunity for investment. In the following slides we tackle each of these considerations in order so you will be able to evaluate an ICO’s worth and assign a grade for the success of each project.
Relevant Factors to Consider in ICO process
The Team First and most important, we need evaluate the background and experience of the team, the people involved in the project. Well-established developers, for example, will likely have LinkedIn profiles demonstrating their previous endeavors and occupations, from which we can judge their suitability to the project and the likelihood of the team’s success. The LinkedIn profile is a point of reference for professional accomplishments and official positions. But we can also learn more about a person from their personal accounts on Twitter, Facebook, and Medium etc. That is also a good way to follow along with the progress of the project. By investigating team members through as many means as possible, you will know how long they have been involved in cryptocurrency. If they have been around and active for a long time, they are that much more likely to be knowledgeable and capable of making better quality decisions in this business. It goes without saying that it is a huge red flag if it is too difficult to find information about the team members online, and worse still if the team members are anonymous.
Relevant Factors to Consider in ICO process
A good Whitepaper gives a detailed description of the project, the problems the team is going to solve, the timeframe projected, and methods to be used in the implementation of their ideas. If, in answering the question about what the project actually does, it seems the team is presenting ideas that are too complicated or advanced to understand, then you simply should not invest until you are satisfied you have been given the requisite level of insight to understand the concepts described. It is always possible that the whitepaper is nothing more than a salad of buzzwords and technical language intended to give the impression of competence while really doing nothing but obfuscate the truth. The whitepaper should clearly and concisely present the problems and the solutions needed. The whitepaper must give a solid and coherent answer as to who needs this project and why. Also, if the team have put no effort into explaining why a Blockchain solution is needed for this particular problem, or why such a solution is superior to its “real-world” equivalent, it is likely they are only in it for the money. We have more to say about red-flags later.
While 2016 raised a comparatively small amount in comparison to the proceeding years, there were a few specific projects that raised significant amounts of capital. These are respectable amounts of money, even by today’s standards, and especially impressive when contrasted with the immaturity of the ICO market at the time, and relative to amounts raised in traditional IPOs. Waves ($16.4mill), Iconomi ($10.6mill) and Golem ($8.6mill) were the three largest fundraisings of the year. 2017 was the year of the ICO whales. Hdac ($258mill), Filecoin ($257mill), EOS Stage 1 ($185mill) and Paragon ($183.16mill) were the largest that year. To be able to raise so much money, so quickly, in such a new market, using such a new mechanism is truly incredible. 2017 was the year that proved ICOs are for serious individuals and institutional investors as well. We have also had some phenomenal amounts raised so far in 2018. Telegram ($1.7bill), Dragon ($320mill), Huobi ($300mill) and Bankera ($150mill). Telegram might be the first mainstream example of an ICO, not only by raising close to $2billion, which would be beyond incredible and impressive even by traditional IPO standards; but also, because it is one of the first ICO companies to tangibly put a product in the hands of hundreds of millions of users, and successfully compete against traditional companies such as Facebook (MessengeWhatsApp), Microsoft (Skype) and Tencent (WeChat).
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