Initial Coin Offerings Going Way Beyond Small Change

Trends in crowdfunding and cryptocurrencies are converging into a mechanism catapulting cash-poor young companies and fashioning a new financing landscape.

Block.one and Dynamic Ledger Solutions — two software startups with no sales — raised more than $400 million in early July through so-called initial coin offerings, according to The Wall Street Journal. Tezos, Dynamic Ledger’s main initiative, drew $232 million, a record amount for an ICO, according to the website CoinDesk. The record had been $153 million, established in mid-June by Bancor, a startup developing a platform for launching blockchain tokens, the Quartz Media website reported. ICOs have raised more than $1 billion so far this year, up tenfold from last year.

Unlike initial public stock offerings, the coins usually do not convey ownership of the companies but are wagers on whether products will become popular, The Wall Street Journal noted. The coins, also known as digital tokens, act like supermarket coupons, entitling holders to buy a product or service that a company expects to offer. If a product bombs, then the coins could be rendered valueless.

ICOs’ lack of regulation is attractive to investors and company managers alike, although it means more risk than Wall Street equity or bond offerings. The Securities and Exchange Commission has not pounced on them so far but has warned people about dealing in cryptocurrencies such as Bitcoin, which is connected to many of the ICOs.

In a May 2014 advisory, the SEC’s Office of Investor Education and Advocacy said, “The rise of Bitcoin and other virtual and digital currencies creates concerns for new investors. A new product, technology or innovation — such as Bitcoin — has the potential to give rise to both frauds and high-risk investment opportunities. Potential investors can easily be enticed with the promise of high returns in a new investment space and also be less skeptical when assessing something novel, new and cutting-edge.”

ICOs are sometimes run through nonprofit foundations. Dynamic Ledger Solutions is using a Switzerland-based foundation that carries the name of its Tezos software project. Bancor, which has Israeli connections, also is attached to a foundation. That some of the foundations and ICOs are outside the United States and its sometimes-stifling regulatory environment may be no accident. The websites of companies operating in the ICO universe rarely list a base city for their operations, another sign they’d rather the authorities not be able to easily find them.

Block.one and Dynamic Ledger Solutions’ Tezos are attempting to create digital platforms using blockchain, the decentralizing software innovation that gave birth to Bitcoin. Indeed, the Twitter profile of Kathleen Breitman, cofounder of Dynamic Ledger, says she is “working on decentralized governance.” Coin offerings have helped fuel the rise of Bitcoin and another digital currency, Ethereum, although the coins sold in the offerings are not always those currencies.

Likened to crowdfunding campaigns that are uplifting shallow-pocketed developers in various fields, coin offerings have tapped large capital pools, sometimes from venture capital investors that have traditionally been out of reach for most young entrepreneurs.

Block.one, which was founded just this year, raised $185 million worth of Bitcoin and Ethereum, The Wall Street Journal reported. Tezos drew 65,627 bitcoin (valued at about $156 million) and 361,122 ethereum (worth about $76 million), CoinDesk reported. While lacking Wall Street prestige, the two recent coin offerings each raised close to the $219 million that U.S. companies on average raised through initial public offerings last year, The Wall Street Journal reported. By way of comparison, the much-watched IPO of Blue Apron Holdings, the New York–based meal-kit delivery company with $800 million in annual revenue, raised $300 million at the end of June.

New York–based block.one, which has just 35 employees, announced it is developing open-source software for EOS, a new blockchain operating system designed to support commercial decentralized applications. Among the goals is enabling blockchain users not to pay separately for every transaction or have to purchase a cryptocurrency.

The Tezos project could be instrumental in bringing about “a sea change as big as the internet,” Tim Draper, a Silicon Valley venture capitalist, told The Wall Street Journal. Draper is a coin investor and adviser at Dynamic Ledger and Bancor. ICOs look to be an impressive bootstrapping alternative to traditional financing methods and could have positive spillovers on the financing world as most of us now know it.