Missing and stolen money, made up rules, and frequently with no justification for the use of blockchain. How long will the benefits outweigh the risks for cryptocurrencies?
It was once said that that the only certainties in life are death and taxes, well there seems to be an addition – cryptocurrency controversy.
The latest issue to hit the much vaunted market is that almost $400 million of the $3.7bn raised in initial coin offerings has been lost or stolen, according to EY research into ICOs.
The figure, which equates to more than 10% of funds raised, is attributed to factors such as phishing, which is seen as the most common form of funds theft, with the report saying: “Its popularity is attributed to its simplicity and effectiveness. Hackers steal of up to US$1.5 million in ICO proceeds per month. Scammers either request a funds transfer to their wallet or swindle private keys to investors’ wallets.”
Not only are large amounts of ICO funds being lost or stolen, but the report also found that the white papers behind the ICOs “lack a clear explanation of the businesses reasons for blockchain and token currency.” The result is that many projects never move from being just an idea to actually being implemented.
In essence, there’s very little justification in most cases for the use of blockchain; “Projects try to attract investors by introducing blockchain in new markets. White papers contain many clichés that attract inexperienced investors, with no reasonable justification for blockchain use,” the report said.
The point of an ICO is to raise funds for a project that is based on blockchain technology by selling digital coins. It can in theory circumvent the process of venture capital investments – which the EY report shows is less than half than what ICO’s have raised.
Similarly, the hype around this technology has created a wave of companies changing or adding to their name the word “Blockchain.” The Chair of the US Securities and Exchange Commission said at the Securities Regulation Institute that: “I doubt anyone in this audience thinks it would be acceptable for a public company with no meaningful track record in pursuing the commercialization of distributed ledger or blockchain technology to (1) start to dabble in blockchain activities, (2) change its name to something like “Blockchain-R-Us,” and (3) immediately offer securities, without providing adequate disclosure to Main Street investors about those changes and the risks involved.”
Jay Clayton continued by saying that the SEC is, “looking closely at the disclosures of public companies that shift their business models to capitalise on the perceived promise of distributed ledger technology and whether the disclosures comply with the securities laws, particularly in the case of an offering.”
The hype around blockchain isn’t without warrant, but blockchain has only proved to be useful in a limited number of cases, with EY saying that it’s useful in cases of a large number of transaction participants, participants are independents – and there is no trust, existing centralised intermediary is worse than blockchain because of cost, security or lack of trust, in addition to other use cases.
EY does say though that there are several examples of when it is not useful, for example when speed is essential, when there is a need to provide “the right to be forgotten”, there are changes in contract terms, and there is a requirement of anonymity/confidentiality, in addition to other reasons.
Then there comes the issue of hacking. Thanks to the speed and size of the ICO market, and the absence of a centralised authority, hackers are attracted to the “information chaos.” The problem is exacerbated by project founders focusing on attracting investors and not prioritising security, and unfortunately these threats hit both the projects and investors through the substitution of wallet addresses, accessing private keys, stealing funds from wallets and stealing funds from exchanges.
The hacking issue for crypto exchanges is particularly potent, with the exchanges having an average of $2bn in hacking losses, compared to $1.5m of typically insured funds.
Given the propensity for shoehorning in blockchain wherever it may seem mildly appropriate, and the exchanges security weaknesses, it should come as no surprise that most regulators are moving from simply ignoring ICOs to banning them, or “regulating them in accordance with the nature of the token.” Whilst market players are trying to introduce their own rules to the ICO market.
The report issues a damning take on ICOs, saying that they have become “a synonym for hype, unjustified valuations and excessive risk.” However, there is a silver lining; blockchain still holds the ability to increase project transparency, decrease investor risk and develop into an “effective financing tool for quality blockchain projects,” said the report.
The Wild West that is cryptocurrencies is both exciting and terrifying, the cost of getting it wrong can be great, but so can the benefits of getting it right. For now, the benefits outweigh the risk and the market is thriving, but should a lack of regulation and a proliferation of hacks continue then this balance may shift.