The ambition that gave birth to the InterPlanetary File System is as immodest as the name.
The brainchild of a Silicon Valley start-up called Protocol Labs, IPFS aims to give anyone the chance to buy and sell unused computer storage space. There is even a made-up unit of exchange for this proposed market: a digital currency called Filecoin.
Speculators do not seem concerned that this spot market for global computing resources is still only a plan embedded in a piece of open source software. Or that, if it catches on, it will be competing with corporate giants such as Amazon, the leading cloud computing provider. Despite these obvious obstacles, Protocol Labs raised more than $250m in an open online sale of its invented currency that ended last week.
So-called initial coin offerings, or ICOs, like this have turned into the year’s most striking financial craze. More than $1.8bn has been raised by software developers from the sale of new currencies with names such as Tezzies, Atoms and Basic Attention Tokens.
In unofficial online markets where these and other digital tokens are traded, the mania has hit even more bizarre levels. The value of Ripple — at five years, a cryptocurrency veteran — soared this year on a wider boom that was led by bitcoin. Ripple’s notional value, including coins held by the company for later sale, jumped from $500m at the start of the year to more than $35bn, before falling back to $19bn.
The boom in cryptocurrency prices has been fed by uncontrolled speculation, leading regulators to act. In recent days, Chinese authorities have banned ICOs and are now reported to be on the brink of shutting down all cryptocurrency exchanges. The Financial Conduct Authority, the UK regulator, warned anyone thinking of buying coins in an ICO that they should only do so if they are prepared to lose everything. Jamie Dimon, chief executive of JPMorgan, sent bitcoin prices down 10 per cent on Tuesday when he called the currency a “fraud” and threatened to sack anyone at his bank caught trading it.
But cryptocurrencies’ promoters argue that beyond the speculative mania, something profound is taking place. It has created a new way for start-ups developing platforms based on blockchain and other technologies to raise money, using online crowdfunding techniques.
Networks such as IPFS are based on a vision of decentralised online services where ordinary users interact directly with each other, rather than through internet companies that set themselves up as gatekeepers to the online world. According to the enthusiasts, many of the most popular internet applications could be remade in this way, leaving the control — and the profits — in the hands of the users.
“This is much like the internet was early on. It could be bigger than anything we’ve seen,” says Tim Draper, a venture capitalist who was one of Silicon Valley’s first cryptocurrency advocates.
For investors like this, the new networks have rekindled the libertarian dream of an internet that operates beyond ossified social institutions. “Society is being transformed by this,” says Mr Draper. “We are going to be a much more affluent and fair world when the dust settles here. ICOs are filling in where governments have failed.”
But there is another view that draws on a different aspect of internet investment history. “There’s a tendency to turn the brain off and jump in. It’s like Pets.com [which shut down in 2000],” says Mark Williams, a lecturer in financial risk management at Boston University. The speculation is being fed by a hype that is as insidious as the dotcom craze of the late 1990s, he says: “People are treating it like a lottery ticket.”
For the unwary, ICOs represent an even bigger risk, as uncertainty about how they should be regulated means most lack even basic protection of securities laws that governed the dotcom IPOs. As pure digital events, the online fundraisings are also exposed to familiar internet frauds, from phishing scams used to rip off the unwary to the hacking of the underlying software underpinning the new ventures — the fate that befell the first prominent ICO last year, for a company called the DAO.
Supporters agree that naked speculation accounts for much of the money that has been pouring into ICOs, as buyers are drawn in by the massive notional profits made by the earliest investors — though how many have been able to cash in at the prices quoted on unofficial online exchanges is an open question.
The value of the best-known digital currency, bitcoin, has risen eightfold in the past year. That has led to a hunt for the next untapped markets, lifting the notional value of all cryptocurrencies to more than $130bn. With nothing more needed to launch a coin sale than a “white paper” — the document that coin promoters use to lay out their grand plans — and the promise of some computer code, the steady flow of ICOs in the past year has turned into a flood.
The boom, which began in early summer, is already exhibiting many of the characteristics of other speculative crazes. New coins have proliferated: more than 150 token sales have been conducted or announced this year. CoinMarketCap lists prices for about 1,100 coins, with more than 120 ICOs planned before the end of September.
Celebrity endorsements have followed. Paris Hilton used Twitter to boost LydianCoin, a currency for a mooted advertising market that its backers hope will raise $100m. Boxer Floyd Mayweather got there before her, using the run-up to his late August bout with Conor McGregor to promote the prediction market Stox.com and content marketplace Hubii Network.
Like the dotcom boom, an all-encompassing tech vision has been used to justify valuations that make no sense on any other yardstick. In the case of ICOs, the Big Idea is that the technology on which the cryptocurrencies are based will enable a new generation of online applications and markets that will end up dwarfing today’s internet giants. Like selling spare computer storage, the rules for these networks would be set — and the profits made — by the users, not some huge corporation.
Some of these applications will one day be worth “trillions of dollars”, says Olaf Carlson-Wee, whose cryptocurrency hedge fund Polychain Capital is one of the investors leading the charge into ICOs. Given the potential scale of these future markets, he argues, even bets that look like they have a low chance of success make sense.
Just as the dotcom craze was stirred up by extravagant hopes for the world wide web, the ICO boom is the product of another supposedly transformative technology: the blockchain. First used as the backbone for processing bitcoin transfers, blockchains are open, distributed ledgers where transactions between any two parties on a network are authenticated and recorded.
Underpinning new blockchain-based networks such as IPFS are protocols, or rules, embedded in software that govern how participants interact. At least in theory, many of the interactions that happen online, such as those on social networks, ecommerce sites and search engines, could take place between willing users on decentralised networks.
The notional value of all cryptocurrencies; bitcoin alone has risen eightfold in value this year
Number of initial coin offerings held or announced already this year, according to CoinMarketCap
Fall in the value of bitcoin this week after Jamie Dimon described it in an interview as a ‘fraud’
“If any of these protocols becomes ubiquitous on the internet, the upside is phenomenal,” says Mr Carlson-Wee. He contrasts it with the opportunity exploited by entrepreneurs such as Mark Zuckerberg and Jeff Bezos, who created services that ran on top of the platform created by the world wide web. Decentralised social networks or ecommerce would leave ownership in the hands of those who control the underlying protocol, not an application such as Facebook or Amazon. “Users can own their data and own the network,” he adds.
Mr Carlson-Wee’s enthusiasm is a sign of the coin mania that has been sweeping Silicon Valley, drawing in the familiar mix of ideologues, entrepreneurs and opportunists. Though only 27, he has raised $250m from four of the best-known venture capitalists, including Sequoia Capital.
What supporters see as a profound financial innovation, however, others warn can be an easy route to creating funny money. When buyers have been so willing to purchase currencies issued on nothing more than the promise of a future market, it’s not surprising that so many are trying to mint new ones.
“There is this hype that blockchains can change the world,” says Mr Williams. “It’s like the hype of the dotcom bubble, when you had to put a ‘dotcom’ on the end of everything.”
Sceptics argue that creating a separate currency for each application is unnecessary and that any digital currency, including bitcoin, could be used. Forcing people to buy app-specific tokens traps them with a holding that has a high chance of ending up worthless.
Proponents of the coin boom say this misses the point. If a market succeeds, then its currency will be more in demand. Since their supplies are capped from the outset, anyone holding a currency would benefit from its increasing value. This chance to profit from the growth of a network also provides a built-in incentive, making people who own tokens more likely to make use of the new networks.
It would be like a social network where early adopters make much of the profit if the business takes off, says one venture capital investor, who refuses to speak publicly for fear of being seen to add to the hype. “I’m getting Facebook bucks that grow with the network,” the person says.
Selling coins has another advantage that the ICOs are less keen to highlight: it exploits a regulatory loophole. By selling a currency rather than shares they stay outside the scope of securities regulation, removing any constraints on how they market their offerings.
This is one reason given by FunFair, a blockchain casino based in London, for creating its own Fun tokens. In a rare admission of the regulatory attractions of coin sales, it admitted at the end of August that it “could’ve been easier” to let people use cash and then pay them a dividend based on the company’s profits, but added: “Our lawyers rightly warned us not to do this as it would’ve risked us being classed as an unregistered security.”
Regulators are working on closing this loophole. The US Securities and Exchange Commission said in July that it had determined that many coins were in fact a type of security, and would look at the underlying nature of each ICO to determine whether they should be regulated as securities.
For their creators, ICOs have another obvious attraction. They have made it possible to raise far larger amounts than start-ups can usually tap, at least as long as enough investors can be persuaded to suspend their disbelief.
An early-stage open source company like Protocol Labs, for instance, might normally expect to raise an initial round of $10m from traditional start-up investors. But through the sale of Filecoin, it has already raised more than 25-times that. Based on prices buyers paid in the ICO, extra coins the company has retained for sale are notionally worth more than $350m.
The history of tech bubbles suggests that throwing such large amounts of cash at unproven new businesses often ends in tears. Of the Filecoin sale, the largest ICO to date, one investor says: “They got a bit carried away because the demand was there.”
The ICO bulls take a different view. The huge amounts flowing into coin start-ups, says Mr Carlson-Wee, are an indication that the old barriers to capital formation have collapsed: with anyone free to invest, the coin start-ups can look forward to unconstrained growth.
“I actually take this to be an inflection point,” he says. “The genie is out of the bottle and the pace of innovation has changed permanently.”
The race to develop a ‘blockchain world’
In one echo of the earlier internet bubble, the ease of launching an initial coin offering has already led to a splurge of “me-too” projects.
The idea of creating a decentralised real estate market, for instance, has led to more than 10 rival projects, among them Smartre, REAL, Estate Coin and Recoin. And more than a dozen online betting networks have been proposed or already funded, with names such as BetMaster, FunFair, QuickBetCoin and Wagerr.
Much of this reflects an attempt to turn ICOs into a form of “general start-up equity financing”, says Naval Ravikant, head of AngelList, a San Francisco-based network for connecting early-stage investors. The idea would be better if it was restricted to “a small but important category of venture investments — tokens powering distributed protocols with strong community support”, he says.
That belief has led to a hunt among investors for the projects with the potential to become the Facebooks, Googles and Amazons of the blockchain world.
The best uses in the short term will be ones where interactions can be fully automated, and where a blockchain can capture the totality of a transaction, says Matt Huang of Sequoia Capital. “If you need humans involved, it doesn’t work so well.” Trading storage space might be one such market, he adds.
Polychain Capital’s Olaf Carlson-Wee goes further, arguing a new computing infrastructure, based on blockchain-intermediated markets, will be the first big opportunity of the coin boom, and that more complex applications are likely to take longer to develop.
“The general idea of a sharing economy for computational resources is a rich vein. It doesn’t have room for human misbehaviour,” says Mr Huang.