Beware the Blockchain Bubble
Using blockchain-based digital tokens to fund startups smacks of a financial bubble, but some good might come from it, says Elaine Ou, a blockchain engineer at Global Financial Access, a financial technology company in San Francisco.
Initial Coin Offerings (ICOs) provide "a way to raise hundreds of millions of dollars without the hassle of registering with the Securities and Exchange Commission," Ou writes in a Bloomberg column.
Digital tokens are transferable assets that can be redeemed for future goods and services, just like Amazon gift cards or Chuck E. Cheese tokens. But in this case, the token peddler hasn't built anything yet, and plans to use the acquired funds to create the proposed service.
This crowdfunding model is similar to Kickstarter, with the added benefit of immediate liquidity and global access. Andreessen-Horowitz partner Balaji Srinivasan calls token sales "Kickstarter on Steroids." Given all the recent hype, they look more like Kickstarter on crack.
We wrote about Srinivasan's perspective this week: (See Blockchain to Blow Up Startup Investing.)
Early stage blockchain projects have raised more than $150 million since January, "an amount that makes venture capital investments look like a stingy tip jar," Ou says, adding more details on ICO investments and how they work.
i guess it's not a crime if you're upfront about it https://t.co/64YK0rOFL3— Sam Ro (@bySamRo) June 1, 2017
Ou praises a proposal by Albert Wenger of Union Square Ventures to use token funding to finance digital infrastructure, in the way that HTTP and TCP/IP were previously developed by publicly funded research.
"I can't emphasize enough how radical a change this is to the past," Wenger says. "Historically the only way to make money from a protocol was to create software that implemented it and then try to sell this software (or more recently to host it)." That often left the researchers who actually developed protocols out in the cold financially, as others developed the software -- such as web browsers and servers -- that popularized the protocol and reaped the profits. Selling tokens would provide a means for the original researchers to reap financial rewards from their work.
Other than funding open source development, Ou is skeptical of tokens as a fundraising vehicle:
All the buyers of tokens probably aren't doing it for charity. Some see it as a way to get in on the next Uber. The token's most attractive feature is its distinctness from the underlying transaction. Colorful casino chips make gambling feel like a game. A child dropping Chuck E. Cheese tokens into a skee-ball arcade doesn't elicit the same concern as a kid feeding buckets of quarters into a slot machine. It could be that the real value of a blockchain token is to preserve the illusion of gambling while actually financing a public good.
It's still unclear how tokens make money for their owners without falling into the category of regulated securities. Indeed, it seems just as likely that the distinction is bogus -- that ICOs are a Silicon Valley scheme to do an end-run around regulations that were put in place to protect investors and the economy as a whole. We've seen this kind of thing before with Uber and Airbnb.
Indeed, blockchain may be a "Trojan horse sent by radical libertarians to undermine the global financial system," writes industry analyst Jason Bloomberg in a list of eight reasons to be skeptical about Blockchain. Certainly, many bitcoin enthusiasts see that currency as a way of undermining, or at least avoiding, governments and central banks.
Other arguments against blockchain, cited by analyst Bloomberg: It doesn't solve a real-world problem; end-users don't want it; blockchain could actually increase transaction costs, even though it's designed to decrease those costs; it's too complicated; and performance is a problem. Also, while blockchain is designed to be "immutable" -- to make it impossible to change or delete transactions -- sometimes privacy and regulatory concerns require mutability.
A recent academic paper warns about Ponzi schemes riding on top of blockchain. "Ponzi schemes are financial frauds where, under the promise of high profits, users put their money, recovering their investment and interests only if enough users after them continue to invest money... Smart contract platforms like Ethereum have provided a new opportunity for scammers, who have now the possibility of creating 'trustworthy' frauds that still make users lose money, but at least are guaranteed to execute 'correctly.' "
Also, while the blockchain implementation underlying bitcoin has been tested for security, other blockchain implementations haven't been, which increases risk, writes journalist Jeffrey Kutler.
"Don't assume that just because it's called blockchain, and Bitcoin is so secure, it will be okay," says Uri Rivner, the head of cyber strategy for BioCatch, who made these points in a February presentation at the RSA Conference, an annual information security event in San Francisco. "The reality is, it's the Wild West."
In the long run, blockchain will prove very useful -- even revolutionary. Blockchain can minimize middlemen and the bureaucratic infrastructure surrounding multiparty transactions, in the same way that email eliminated the need for a nationwide postal service just to send a message.
But Blockchain needs to exist within the context of responsible regulation and business practices. The Wild Wild West needed to be tamed before it became productive.
What do you see as the future of blockchain? Revolutionary, niche technology or baloney? Take the Enterprise Cloud News poll and let us know.
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— Mitch Wagner Editor, Enterprise Cloud News
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