Are initial coin offerings a good way to raise startup funds or to invest in startups?

Initial coin offerings have come out of nowhere in 2017 to become the talk of Silicon Valley and Wall Street. Programmers raised over $2 billion in the first nine months of the year by selling their own virtual currencies to investors. That is nearly 1,000 percent more than the amount raised using coin offerings in 2016.

What is an initial coin offering?

Coin offerings are a way for start-ups or online projects to raise money without selling stock or going to venture capitalists — essentially a new form of crowdfunding.

The programmers raise money by creating and selling their own virtual currency, generally with rules similar to well-known virtual currencies like Bitcoin. The new tokens are usually designed so that they can be used only on a computing service the programmers are building.

Filecoin, which raised $257 million in the largest coin offering to date, is being designed to pay for storage on a global cloud storage network that the creators of Filecoin are promising to build. BET, another coin, is being designed to serve as the chips in an online casino its programmers are promising to build.

“Promising to build” is the operative phrase here, because in almost every case the services that will supposedly make these coins valuable have not yet been finished.

What does this have to do with existing virtual currencies?

These coins are generally inspired by older virtual currency systems like Bitcoin or Ethereum, with a cap on the number of coins that will exist — to provide a sense of goldlike scarcity — and a structure that allows them to operate entirely outside the existing financial and regulatory ecosystem.

Investors generally buy the new coins by sending the programmers Bitcoin or Ether (the virtual currency inside the Ethereum network). What’s more, many of the coins are stored, moved around and enabled by other Ethereum technology.

But the coins sold in coin offerings are meant to exist independent of Bitcoin and Ethereum, with their own free-floating value.

(For a more complete explanation of Bitcoin, click here, and for an Ethereum explainer, click here.)

Is there a relation to initial public offerings of shares in a company?

The name for coin offerings was clearly inspired by the initial public offerings that companies do to sell stock to investors. But unlike stock offerings, coin offerings are generally designed so that investors don’t get an ownership stake in the start-ups. If the coin does provide an ownership stake, the Securities and Exchange Commission has said, the companies must comply with all securities law. A few coins have done this, but most have tried to avoid it.

Investors can contribute as much or as little money as they want in these offerings, which are generally more like crowdfunding campaigns that new projects do on Kickstarter or Indiegogo.

Why would anyone pay for these coins?

Learn more: An Explanation of Initial Coin Offerings

 

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