Break it into pieces: Blockchain, bitcoin, cryptocurrency and ICOs

As the year draws to a close, many sites are posting year-end wrap-ups and Top Ten lists, of various highlights of the year (or since its 2017, lowlights). Rather than take that path, we thought we would take a look at some important topics and peel them apart to their basic economic elements. Like everyone else, we have been watching the rise of Bitcoin with shock and awe. We have also done a few blockchain projects this year – so the topic is top of mind here at D2D.

The idea behind this type of post dates back to our time as financial analysts. Back then, we found that often investment themes blurred, confusing rational analysis through repetition, abbreviation and sloth. When that happened, we found the best approach was to break a thesis down to its component parts. This post is not intended as an explanation or introduction to the topic. Those are better done elsewhere (and in bulk quantity). Instead, we just want to pull apart the various threads around cryptocurrencies. Our goal is simply to express some basic principles, with which we can all hopefully make better decisions in the future.

As this posts’s unwieldy title suggests, the ideas of blockchain, cryptocurrencies and ICOs often get lumped together. We are often asked “What do you think about Bitcoin?”, or “Should we hold an ICO?”. We have learned to hesitate before answering this question until we get a better sense of what the person asking has in mind.

These three things – blockchain, cryptocurrencies and ICOs – are three separate strands. Each with their own future prospects. We think it is important to tease those strands apart.

First and foremost is the idea of a blockchain. To put it in the simplest terms possible, blockchain is just a way of storing data, a new form of database technology. Many people would claim it is one of the most important advances in databases in decades, and that seems like a reasonable argument to us. A blockchain can store data in a way that it is effectively impossible to alter the pedigree of that data. Once entered into the ‘database’, the ownership of that data can be tracked with certainty. This solved an important class of computer science problems so many people are now proposing using the blockchain for all kinds of purposes, and some of these uses may actually come to life. The important thing to remember is that blockchain is a very useful technological tool. As such it is very likely to stick around and be useful for a very long time.

Which brings us to bitcoin. Bitcoin is built using that blockchain tool. The two emerged at the same time, and so they are frequently uses as synonyms, but they are in fact very different. Blockchain is a hammer, and someone used it to build a chair called bitcoin. Bitcoin is a currency to its true believers, an asset on the IRS’s dotted lines, a lottery ticket for hype salesmen, clickbait on the attention playground, and a source of confusion to just about everyone else. For the sake of sanity, in this piece we will call it an investible asset, but keep in mind that there is an ocean of digital ink out there debating this topic.

The early proponents of bitcoin often had libertarian or anarchist leanings. Building a currency on a blockchain means that no one can totally control it (in theory). Blockchain is entirely decentralized, which means there is no central bank or government can manipulate (we mean manage) it. So it is easy to see the appeal to those early backers. Of course, since then the value of bitcoin has rocketed up, drawing in all kinds of interest. That means the bitcoin universe is now populated not only by anarchists but also slick salespeople and their cousins scam artists and conmen, not to mention money launderers and outright criminals. Bitcoin has become a very confusing topic. There is unquestionably an unsavory element around bitcoin now, but that does not necessarily mean it has lost its original purpose. We have no idea of what the value of a bitcoin should be. Obviously people buying (investing? gambling?) bitcoin today need to be very careful around it. That being said, it is unclear what the future of bitcoin is. We have heard smart people argue it is going to become the global currency for the next century, and we have heard smart people argue that is worth zero. Our point here is that it is a monetary instrument built on, but separate from blockchain.

This hold equally true for the other cryptocurrencies out there. After everyone saw the rise of Bitcoin, many others set up their own version of a digital currency built on blockchain. There are hundreds of these now, maybe thousands. Discussing all of them is way beyond our scope here, but we would classify them as variants of bitcoin. We suspect that many of them will survive, but it is impossible at this stage to say which ones or at what value. However, the rise of Bitcoin has drawn large amounts of capital to the space.

Which brings us to Initial Coin Offerings (ICOs). An ICO is a funding mechanism which lets people invest in and thus create cryptocurrencies. However, there is one important distinction here. There is no standard way to do an ICO (let alone regulation, a whole other topic). As a result, many ICO issuers are able to raise funds in the offering and use it for whatever purpose they see fit. This has drawn considerable interest from the private companies looking to raise money. Why go out and look for a venture, with all the hassles that currently entails, when you can tap into the tsunami of money washing over all things blockchain? Almost every seed stage company we have talked to recently has asked us if they thought they should hold an ICO to fund their company. And we understand the appeal, but here we urge very strong caution. It is clear that the SEC is going to start regulating all of these areas at some point. They may not have much luck regulating bitcoin, and it may take them a long time to get their plans in order, but the one area where they will almost certainly be able to crack down effectively is in the solicitation of investments. There is currently nothing illegal about raising money via an ICO, but almost certainly at some point down the road the ability to do this will become radically restricted, and those restrictions may well be applied to companies who have already done an ICO.

To sum up. We have blockchain, which is a very useful tool. We have cryptocurrencies which are built using blockchain, but with an unpredictable value/future. And we have ICOs, a fundraising mechanism that currently resides in a legal grey area. All important topics, but also discrete topics.

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