What’s an ICO?

– I guess it’s time to talk about ICOs.   Hey, it’s Jackson, thanks for watching.  I’ve been getting a lot of questions lately  about why Ethereum, in general, has been  going up exponentially in price  and just why the whole kind of, cryptosphere,  has been going up in price as well.  And so I wanted to just do a quick video  to kind of explain my hypothesis  and kind of what I’m observing  as to why this is all happening.

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What`s an ICO?

Now before we begin, I want to kind of give  a really basic understanding of what Ethereum is.  Ethereum is kind of like a cryptocurrency.  It has a cryptocurrency running on it  that powers the network.  But what it really enables that’s different  to something like Bitcoin is something  called smart contracts.  Smart contracts are just arbitrary kind of  blocks of code that can be run  if you pay for it in Ether.  Which is the currency on Ethereum.  And so, when you hear about a smart contract,  all it is, is really a bundle of these functions  which can be executed with certain parameters  and using Ether that you’ve sent to that address.

So, awesome! Ethereum sounds pretty cool,  is that why the price is going through the roof?  Not really.  The real reason the price has been going up  something like $100 every week for the last month  is really just greed.  Greed from developers, greed from investors,  greed from everybody in the speculative market.  And that’s not necessarily a bad thing.  People making money is how the world works.  But it’s the way in which that’s been happening  and the speed at which people have been doing  these ICOs. That is a little bit concerning.  So what’s an ICO?  And ICO is an Initial Coin Offering  and it goes by various other names  a token sale, a token generation event,  really those are all just names that people  come up with to try and skirt around  the kind of negative connotation that ICO has.

In some reasons they think it’s gonna  get them out of legal strife potentially in the future.  But really what an ICO is, is it’s similar  to how a startup would raise money in the real world.  The only difference is that these people are raising  that money through Ether, or Ethereum via a smart contract.  So the way that people participate in these ICOs  is they’ll get a bunch of Ether,  which is the currency of Ethereum,  and they’ll send it to a certain contract on the network.  It’s just an address.

Similar to like a public address  which we covered in my previous video.  And when they send it to that contract,  that contract runs a function which says,  “Okay, because that person has sent us two Ether,  I’m going to assign them 6000 of whatever coin.”  Or whatever token. Whatever name they wanna give it.  And that function to do that is written  into the smart contract.  And so that’s how this whole thing is being created.  Almost as a sub-token on the Ethereum network.  Now I wanna take a minute here and say,  this isn’t our first rodeo when it comes to ICOs.  ICOs have been around for quite a long time.  And really it’s just come in the form  of companies taking donations or crowdfunding  in the existing forms of cryptocurrency.

For example, there was actually a company called Neo & Bee  which you might have heard about, do some Googling.  And they actually ran on a platform called  Havelock Securities which was literally a platform  where you could buy securities or invest equity  and get equity in a company based on Bitcoin.  That company went belly-up, there was an arrest warrant  for the creator of it, big drama.  What I’m trying to say it that this is not  our first rodeo. There have been many ICOs over the years  one of them being Mastercoin, they did an ICO  to do their token distribution.  Another one that’s kind of less favorable  in the community and, not really an ICO,  but GAW Miners and their hashlets and paycoin,  they launched a coin that was really just  a token to facilitate their Ponzi scheme.  And they would actually sell a product  that didn’t exist, these “hashlets,”  or cloud mining power.

Total Ponzi scheme, blew up in their faces,  but the creators of it made off with  a bunch of money that they pumped up in their paycoin.  I believe the guy that created that, Josh Garza,  has been arrested by the SEC and all sorts of things.  But another one that a lot of people  might not know about, or might not know  was a token sale, was Ethereum itself.  Ethereum, the way they issued the initial coins  on the network, was through doing a crowdsale.  You could buy the first Ether on the network.  So if ICOs aren’t a new thing,  why are we seeing this flurry  of new ICOs and token sales hitting the market?

ERC20

Well the answer is that Ethereum makes it really easy  to run an ICO.  And it’s really kind of seen a huge uptick  since the introduction of something called ERC20.  And so ERC20 is really just a fancy buzzword  for a standard format that people can use  and clone, copy, to create their own tokens on Ethereum.  And so because it’s so easy and a standard to copy,  there’s been a lot of people that can just  fire up an ICO in a couple of minutes.  There’s actually a couple of websites out there  that’ll let you generate an ICO or generate a token  on Ethereum with no coding required.  And so because of that, people can get in on this  really quickly. Whereas, previously, if you were  running an ICO, or a token sale, on something like Bitcoin,  you had to go out there and you had to do a lot of selling.

You had to go out there and tell people,  “I’m building this new platform,” like,  traditional venture funding.  And then there was no automatic way to collect  those funds or distribute the IOU.  You were really just putting their name  in a spreadsheet, taking some Bitcoin from them,  saying, “Hey, one day, you might get something back  on this.”  Something that is more tangible about Ethereum ICOs  is that when you send the Ether to the contract,  the Ethereum network does recognize and many wallets  out there because of the ERC20 standard,  will recognize that you got whatever coin,  or whatever token shows up in your wallet.

So it’s a lot more tangible, you’re not just  sending money somewhere and never hearing  about it again.  But I hear you asking, “What has this got to do  with the price of Ethereum?”  Well, it’s all about supply and demand.  So, there’s been a crazy flurry of these ICOs,  some of them in the last week or so,  have raised upwards of 150 million dollars  in something like a minute, or 30 seconds.  And when this happens, the only way to  buy into these ERC20 contracts, or these ICOs,  is through Ether, or Ethereum.  So if these companies are raising 150 million dollars  in Ether, that’s locking that Ether up in that contract.

And so it’s taking that money off the market.  So what happens is you have this shortened supply  but there’s a ICO coming on the market  every single week.  And so people are getting really excited about this  and trying to buy up Ether.  And you know what happens when you have low supply  but increasing demand?  The price goes up and up and up  because there’s a shortage.  And this is what’s really happening.  This is what’s driving the bulk  of the Ethereum purchases and trade right now,  is people buying Ether to send to a contract  in the hope that they’ll get rich quick  off one of these ICOs.  And as this is happening, everybody’s in this  speculative, trading boom.

You have people that have this FOMO,  this Fear of Missing Out. I’m gonna miss out  on this amazing ICO, or I’m gonna miss out  on this other altcoin, even.  And so I think that’s why we’ve seen the whole market  kind of go up because people are desperately  throwing their money, and in often cases,  more money than they should be, throwing this money  at random ventures out there in the hope  that they’ll get rich quick.  This is where that greed aspect comes in it.  And I’m not gonna knock any individual investor,  if you have the money, and you’re totally fine  with gambling it or losing it,  your decision.

But I think the developers that are running  these things really need to take a look  at themselves and their companies and say,  “Is it right that we’re raising 150 million dollars  for our little startup?”  And that’s not to say there are not legitimate startups  out there with really cool tech doing ICOs.  One of the good examples is status.im,  I recommend you check it out,  it’s doing a kind of light wallet on mobile  on iOS and Android. And it really gives you  a full window into what they call “decentralized apps.”  They’ve been running hackathons, doing a lot of stuff  that’s tangible and you can actually play with,  which I like.

Another one is Civic, which is another ICO  that’s coming up. They’re doing KYC, Know Your Customer,  so background checks on individuals,  for security and verification.  But as I said, I think the real onus  is on the developers and these people doing these startups  that are doing ICOs, to say,  “Do we really need that much money?”  If you think about the typical seed round  that a startup here in the Bay Area will take,  it’ll be around half a million to a million dollars,  just to get them bootstrapped so they can get  some employees, get a small office,  and start building their product.

But these ICOs are raising 30, 50, 100, 150 million  dollars in 30 seconds. And many of them  don’t even have a tangible product yet.  And because of this whole, ICO, supply and demand thing  I was mentioning, it’s this self-fulfilling bubble.  Where every week there’s a new ICO that people  are putting their money into, driving down the supply.  And then more people are trying to buy Ether  to get into that ICO next week.  It could go on indefinitely, there’s no real kind  of precedent for this. And we don’t know  what’s gonna happen. And it could well drive  the price of Ether up 2x, 3x, who knows?

But I think many people in this space  can agree that it’s not sustainable.  Something is going to make this bubble pop  in the future, we just don’t know what.  There’s a few things that could do that,  and it’ll just take one of them.  The first is just an ICO gone wrong.  And this has happened before, there is a precedent  for this. It was called the DAO, the D-A-O.  If you just Google it, you can see the history,  but basically, it was one of the first, big  smart contract ICOs on Ethereum.  And they raised millions and millions of dollars.

But, the problem: there was a bug in the code.  And on Ethereum, “Code is law,” it’s “immutable,”  and so hackers got in, they exploited this bug,  and they stole millions of dollars.  That was actually the point at which we’d learn  Ethereum isn’t really immutable  because the developers forked the coin  and moved those stolen funds back somewhere else.  And that’s why we actually ended up  with Ethereum and Ethereum Classic  which you might hear about.  Ethereum Classic is a fork of Ethereum  which didn’t make those changes.  The purists, the Ethereum purists, wanted  to just keep everything as it was.  And say, “If people lost money, they lost money.”

Now the second thing that could potentially result  in the bubble popping, is just a lack of ICOs.  It might all peter out.  If there isn’t a new ICO every week driving down the supply  and increasing the price, then it could be kind of  self-normalized.  Do I see this happening? Not really.  Because I think it’s really the everybody wants  to get in on an ICO right now.  And I don’t see any signs of it slowing down.  Now the third, is network splits.

That could happen to Ethereum?

Something that could happen to Ethereum.  Now there’s upcoming changes with Ethereum coming,  so they want to switch to proof-of-stake.  We don’t really know when that’s gonna happen,  the timeline isn’t concrete.But another thing is, what if there’s another DAO situation?  What if there is another situation  where a buggy contract results in the loss  of millions of dollars?  Will Vitalik and the leaders of the Ethereum community  do another hard fork? And will that result  in yet another network split, where you end up  with Ethereum Classic 2, or something along those lines.  And the last possibility that I could think of  is the SEC coming in and saying, “You know what?  You guys are actually selling unlisted securities  to unaccredited investors.” And that’s totally possible.

The SEC take their stuff seriously  and any of these ICOs that are selling tokens  to people in the US, run some very big risks in doing so.  If they cannot prove, or beat something  called the “Howey Test.”  The Howey Test is a simple test  that they legal community look at to try and determine  if something is a security.  And the best way to get out of being deemed a security,  is to simply have a platform on which  the tokens you’re issuing can be used  as a way to purchase something.  So if I can login to your wallet,  and I can redeem something, and I can receive services,  a good example of this is like, Storj,  which is selling cloud storage, or decentralized storage  based on their token.  And so if I’m able to go in and use that token  to buy something, a service, then it’s obviously not  a security.

In addition to that, there’s a whole bunch  of exceptions the SEC has to deem something not a security.  I recommend you go and read about it.  I’ll link it in the video description  so you can go and check that out.  What I wanna stress, though, is that it only takes  one of those things to happen for this whole  house of cards to come crumbling down.  Because once the price crashes, investors lose confidence,  and then developers are deterred from creating  further ICOs, the whole thing comes undone.  And so everybody’s kind of on tenterhooks right now,  waiting to see which of these things  is gonna happen this summer.

What’s really interesting is that smart contracts  aren’t really being used in production  for anything on Ethereum right now other than ICOs.  And I think that’s really telling,  I think that’s not necessarily Ethereum’s fault  because it’s still a rather immature, newish technology,  and developers are still getting on board with it.  But it’s alarming that the first use case,  and the most widely adopted use case,  is raising hundreds and hundreds of millions of dollars  on the back of products that don’t even exist yet.  So we’re still in the Wild West.

And I think there’s a few kind of bits of advice  I can give to investors before you run in  and dedicate all your money to one of these ICOs.  The first is to watch out for any ICO  that doesn’t have a working product to some degree.  You’ll see a lot of white papers  that are full of kind of techno jargon and buzzwords.  But, take a look on their Github repo,  or see if there’s a way you can build the project  and run it yourself.  And that’s often very telling of whether  they have development resources backing up  these claims, or whether it’s just some kind of  moonshot idea that somebody’s come up with  and is trying to raise money for.

Now if you’re in the US, it’s actually really important  that you check there’s some sort of legal agreement  that you’re signing when you go through  and purchase these tokens.  This is really important for when the SEC  does go looking in the future.  You just wanna make sure everything’s above board.  And also, it protects you as an investor.  And lastly, a really good way of just kind of detecting  the shadiness level of these ICOs is  is their contract code open source and audited?

Now there are several companies out there  in the kind of block chain, smart contract space  who are doing auditing, security auditing,  of the code that runs these smart contracts.  And that’s really important because if there’s a bug  in the code, it could actually result  in you sending your Ether to them,  and never receiving the tokens you expected.  It could also result in all sorts of other things,  like the creators of the ICO being able  to go and issue tokens at will,  or take your tokens back, or do anything randomly.  So make sure that you go and check that the contract  code from what you’re sending your Ether to  is open source and audited by somebody with a reputation  that knows what they’re doing.

So that’s my advice for investors.  Watch out, be careful, and as people have always told you,  and I’m sure you’re sick of hearing:  Never invest more than you’re willing to lose.  Now for developers I also have some advice.  Take a look at the company you’re trying to build  and say, “Do I really need 150 million dollars?  Or do I just need kind of a classic seed round?”  And if you do, go and talk to cryptotraders,  go and talk to people that are already in the space  and see if you can raise that money legally,  and traditionally because you probably can.  And that money’s also gonna come with industry experience,  advice, and a whole bunch of other benefits  that you don’t get when you’re just soliciting  millions of dollars from random people on the internet.

So to wrap up, I think there is definitely a use case  for ICOs or token sales or whatever you wanna call them  in this space.  And I think that use case is probably a lot more niche  than we’re seeing kind of evolve right now.  It’s probably focused on services that are trying  to get really even token distribution out there  because they’re trying to do something decentralized.  Do I think that every single block chain startup  needs to do an ICO? No. I think doing them  is kind of irresponsible.

It artificially inflates  the price of Ethereum because you’re doing  that whole supply-demand thing that I talked about.  It also puts investors at risk.  These people might put money into your thing,  and then you’ll fail to deliver.  I don’t think any developer really wants  to kind of bear the brunt of that  or have to live with that.  And also developers, use smart contracts  for something other than ICOs.  I’ve seen a few good examples out there  for basic data storage and things like that  on Ethereum. But Ethereum is this playground  that offered all these promises  and you should go out there and do the development work  and take advantage of that, rather than just  writing really small contracts  that collect money from people.

Thank you, if you enjoyed the video,  subscribe and like below. I’m gonna keep trying  to make these on an almost weekly cadence.  And if you have any questions, reach out to me on Twitter  it’s @ummjackson, u-m-m-jackson.  And I’ll be happy to answer them in a future video.  (upbeat hip hop beat)

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What’s an ICO?