Cryptocurrencies have finally reached the euphoria stage. First it was just bitcoin, the pioneer in the digital currency era, but now initial coin offerings (ICOs) are coming out of the woodwork.
ICOs are not exactly initial public offerings for cryptocurrencies, but are something of a derivative of traditional IPOs. The idea is to offer an established cryptocurrency, such as bitcoin or ethereum, in exchange for a new digital currency backed by the established one. The new digital currency then serves as a sort of security for the startup, backed by the value of the original cryptocurrency but with the added dimension of value dependent on the success of the company that offered the ICO.
In other words, an entirely new stock exchange platform is being developed free of SEC regulation using cryptocurrencies as its base.
There are two ways to look at this: one in terms of volatility and the other in terms of stability. First, volatility. In one sense, ICOs both feed and are fed by the rise in the value of the cryptocurrencies that underpin them in a positive feedback loop. The more ICOs on offer, the more people will buy existing cryptocurrencies that back them, supporting the prices of these digital currencies. Just as well, the higher the price of digital currencies, the more people will be willing to invest in ICOs.
The catch is that while traditional IPOs are dependent on the success of the company on offer, they are also dependent on the value of the currency that underpins them, though much less so. Dollars, typically, have a much more stable value than traditional though speculative IPO securities.
With ICOs, the value of the new security is dependent on the success of the company in question and the value of the cryptocurrency underpinning it. This gives ICOs two heavy sources of potential volatility. Even if a company that gets initial funding from an ICO succeeds, investors could still lose out if the currency underpinning the ICO crashes. This is very similar to real estate flipping during the peak of the housing boom. There is no telling if the current crypto-boom will end anytime soon because the market cap of digital currencies compared to traditional currencies is still tiny notwithstanding the tremendous advances in value since bitcoin was invented.
The second way to look at this phenomenon is from a stabilizing perspective. Startups funded through ICOs give the underlying cryptocurrencies something more objective with which to assess their value. If these companies succeed, then the tokens, or crypto-backed “stocks” that make up their market cap, give the currencies that underpin them some sort of value anchor. If a crypto-backed company offers real goods and services, makes profits and offers dividends, then the currency underpinning that company has objective value on an equity basis.
We may be a bit away from the crypto pseudo-stock exchange stabilizing the prices of the cryptocurrencies use, but longer term, this seems to be the direction finance is headed. ICOs may be volatile now, but the more companies that succeed after an ICO, the more stable the values of these digital currencies will be in terms of purchasing power.
Disclosure: No positions.
