Investments 

Beware the risks of virtual currencies

  • Learn about the history of Bitcoin and how ICOs work.
  • Comprehend how and why the virtual currency has grown and the hurdles it faces.
  • Understand the headwinds facing Bitcoin and the impact for wealth managers.
CPD
Approx.30min

Contrast this with a more traditional fundraising approach taken by R3, the bank-owned organisation behind the "Wall Street-friendly" Corda distributed ledger, a blockchain-like platform that boasts more than 90 banks as members. R3 took nearly a year to raise funds through the time-consuming, but orderly and regulated, avenue of Series A funding, raising $107m (£80.5m).

What should we make of the contrast in terms of amount raised and the speed of funding? ICOs on the surface appear to be a process-light alternative approach to a Series A. However, a closer inspection demonstrates this asset class presents some significant dangers.

By claiming that they are crowdfunding vehicles, ICOs go around regulations designed to protect individuals and organisations against fraud.

Crowdfunding a village church spire is one thing, raising funds to build a multi-million dollar organisation based on a dubious business proposition is quite another – and is clearly not what crowdfunding was designed for. However, until recently there has been very little clarity from the regulatory authorities, and organisations participating in ICOs have used that to their advantage.

In July 2017, the Securities and Exchange Commission provided some clarity on the back of a ruling concerning a recent scandal involving a hack of a blockchain investment fund where mainstream investors lost millions: the infamous “DAO” hack. The SEC effectively stated that ICOs exhibit all the hallmarks of a regulated security, and therefore should be subject to the same issuance regulations.

This has been tantamount to firing a warning shot over the bows of organisations aspiring to launch an ICO, but it has not provided the market with the level of clarity that it needs. It leaves many ICO investors in regulatory limbo with an asset considered and regulated as a security that has not gone through the necessary regulatory approvals to be issued and traded.

Not only is that a headache for investors but it also poses a dilemma for the regulators: Does the SEC protect the rights of consumers that bought into the ICOs before this most recent guidance, by providing some form of exemption?

Alternatively, the SEC could adopt a laissez-faire approach and let these securities fail, which would be akin to declaring over $1bn (£0.75bn) of assets effectively a worthless pyramid scheme.

Bitcoin, too, remains a risky asset class

Bitcoin, the original virtual currency, also faces its own set of problems. Unlike ICOs, Bitcoin doesn't have an intrinsic value, meaning that it is not tied to the ownership of a business model that can pay dividends or coupons (then again, neither does a unit of traditional currency, bitcoin proponents would argue).

The Bitcoin philosophy is one of a global currency that enables a peer-to-peer borderless transfer of value in a way that is agnostic to geography and regulation.

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. Bitcoin, invented in 2008, has risen how much in value in the past two years?

  2. Initial coin offerings, or ICOs, claim they are what in order to go around regulations designed to protect individuals and organisations against fraud?

  3. The Commodity Futures Trading Commission in the US recently declared Bitcoin what?

  4. Bitcoin's valuation has been driven up by a massive influx of capital from three countries in particular. Which is the odd one out?

  5. On 1 August this year, Bitcoin split into three currencies. True or false?

  6. As a mechanism for transacting, how many minutes does Bitcoin take to settle?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Learn about the history of Bitcoin and how ICOs work.
  • Comprehend how and why the virtual currency has grown and the hurdles it faces.
  • Understand the headwinds facing Bitcoin and the impact for wealth managers.

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