PUBLICATION
October 15, 2018

Should you issue your own currency?

#blockchain
#cryptocurrency
#token
Liza Aizupiete

Risk-takers are taking advantage of the investment opportunities present in creating their own digital currencies — and cashing in millions. This has resulted in hundreds of new coins and tokens entering the market. Brand new coins are constantly being created both by existing and new companies but also by individuals looking to release their own cryptocurrency. While this trend is forecast to continue, it beckons the question — should you really issue your own cryptocurrency? And if so, should you go for issuing a brand-new coin or should you simply issue a token on an existing blockchain?

The difference between coins and tokens

The whole concept of an “electronic coin” is derived from the original Satoshi Nakamoto’s whitepaper, Bitcoin: A Peer-to-Peer Electronic Cash System, where it is defined as “a chain of digital signatures” publicly recorded and verifiable on a decentralised open ledger — the Blockchain, and which are validated by “proof of work”, or votes cast by so-called miners with their CPU power, who earn the coins in return. In other words, a coin is the underlying native monetary unit of each blockchain.

For example, the electronic coin called Bitcoin is the original cryptocurrency that is native to the Bitcoin Blockchain. Since its inception, Bitcoin’s source code has been openly published and made available for public peer review and improvement. This has allowed developers to either build on top of it — creating new use cases, or replicate the original code, modify it and develop their own variations of it. As of today (15 October 2018), this has resulted in over 900 unique coins being developed with their own blockchains, achieving a total market value of USD 203 billion. In contrast, there are close to 1,200 various tokens approximately totalling a USD 15 billion market valuation that don’t have their own blockchain but rather have been built on top of existing blockchains. There are currently 18 known Blockchains that host one or more tokens on top of them. [1]

The most accomplished derivation of Bitcoin is the Ethereum Blockchain, and although the networks are distinctly different, a lot of their operations are very much the same. However with Ether (ETH), in addition to working as the underlying monetary unit, it also powers the network of tokens (smart contracts), which are built on top of it, by design, using scripting or smart contract functionality, e.g.: predominantly EIP-20 (previously ERC-20) Ethereum Improvement Protocol standard, albeit there are other less known protocols also available. [2] A token, therefore, is the result of a specific application created on top of a smart-contract capable blockchain, (also referred to as “Turing complete”). These tokens can either represent securities, private cryptocurrencies, representation of commodities, or other assets or, and most frequently, utility instruments for the issuing entity. As of October 2018, there are 875 Ethereum based tokens in existence and the bulk of all tokens in existence. [1]

Function of coins and tokens

The function of coins more often than not is to act as monetary units within an ecosystem. The application of tokens, however, may vary in representing assets or rights of various kinds.

Tokens can represent securities, such as shares in a company, or derivatives of commodities, or some other assets, where the value is derived from a legal pledge of the issuing company and/or production and consumption of goods and services.

Both coins, as well as tokens, can function as private currencies. This means they can both perform as monetary units within a more or less broad ecosystem. Whether the coin or token can be used as a monetary unit is defined by access, their respective usability, and the demand. The most in-demand coins and tokens are available for exchanging against other cryptocurrencies or for fiat money on various cryptocurrency exchanges. These exchanges generally facilitate the growth and development of their listed assets by providing a platform that acts as a price discovery mechanism.

Tokens specifically, however, usually represent a utility or service for which the owners of the tokens are able to pay with for products or services on the token platform and not necessarily for exchanging with other assets.

Regulatory Impact

The evolution of the cryptocurrency industry has given rise to the phenomenon known as the ICO (Initial Coin Offering).

The term is somewhat misleadingly derived from the term “IPO” (Initial Public Offering) and refers to the token issuance process. ICOs usually take place on the Ethereum Blockchain, typically resulting in ownership of tokens, not equity, as is the case in the IPO process. As the cryptocurrency industry matures, regulators are slowly stepping in with the intent of protecting potential investors from fraud.

As of today, regulators have not come to a concerted view of the industry, there is no clear regulatory path, which issuing companies can follow. Broadly speaking, since 2017 however, basic Anti Money Laundering and Combating the Financing of Terrorism (AML/CFT) rules are being enforced on the industry participants, either explicitly in certain jurisdictions, or voluntarily as companies choose to follow these guidelines in good faith and anticipation of future regulatory demands.

The regulatory bodies of the United States, such as the SEC (Securities and Exchange Commission) have yet to clearly define the industry’s products (tokens). SEC has indicated that merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security with the consequences that security token issuance must be registered with SEC or granted an exemption. [3] The CFTC (Commodity Futures Trading Commission) defined digital currencies as commodities in 2015, in order to regulate activities involving digital currency futures, swaps, and other derivatives. The FinCEN (Financial Crimes Enforcement Network which is part of Treasury) requires exchanges to register and have AML/KYC programs in place. The IRS (Internal Revenue Service) has focused on capital gains made with cryptocurrencies, going so far as pressuring the Coinbase cryptocurrency exchange and soliciting their entire list of customers, to enforce KYC/AML and reporting. [4]

On our side of the Atlantic, in the European Union, each country has defined their own specific AML/CFT rules in compliance with the 5th EU AML Directive, which includes cryptocurrencies more broadly. Although the implementation of the law is yet to be enforced, many European countries have chosen to proactively issue authorisations for the carrying on of businesses related to cryptocurrencies (virtual currencies). The European Securities and Markets Authority (ESMA) is examining how ICOs fit in with existing regulation and how they affect competition in the wider capital raising sector. [5] Some jurisdictions like Switzerland, Malta and Gibraltar have moved forward with issuing new rules or guidelines also for utility token issuance.

The issuance process

The issuance process can be either simple or complex, depending on what you are looking to accomplish. As most software in use is open-source, you can simply copy and paste its code, resulting in a fork of an existing blockchain, and thereby creating your own fully functioning blockchain. The question is — will you be able to maintain the code going forward?

You can also build a wholly new blockchain from scratch, in which case you will need to be a savvy developer to accomplish such a feat. And yet, the main question is: what difference will your blockchain and coin have from the other 900 that exist already? Is there a unique problem your new blockchain is solving?

Finally, if by issuing your own cryptocurrency you intend to perform a fundraising through the selling of tokens, then you are specifically looking at conducting an ICO.

The ICO process largely resembles the issuance of IPO securities and VC (venture capital) investment, especially at the seed stage, with the main difference being the strict legal grounds faced by IPOs and VCs as opposed to the near absence of any legal guidelines for ICOs, at least for the utility tokens.

If you need to produce a prospectus for IPOs, and you also need to present a business plan for VCs, contrast this with the common approach taken by ICOs: come up with an idea, write a whitepaper and present a roadmap. Having a team and advisors, as well as partners is must, just like for IPOs and VCs. Having a product is beneficial, but not necessary. You may just as well be raising the funds to build something new.

The ICO is a unique go-to-the-crypto-capital-market vehicle; it can be seen as an extension of your marketing and sales campaign; the ICO process can be summarised as a “reach-out” to the external world about your existence as an entrepreneur. If the token model you have devised compliments the business idea you are selling, and you have to spend enough time reaching out to potential investors, there is a chance that your ICO will succeed.

Typically, ICOs are conducted in several stages. Once you have begun the pre-sale process, you will be able to gauge if the idea you are selling is attractive enough to reach a minimum sales threshold. Failure to reach this threshold is usually followed by returning any funds raised back to the original contributors. Upon surpassing the minimum threshold, you are able to proceed with the public token sale more confidently. Depending on your ICO type (capped, uncapped, auction, etc.), you will need to observe all the limitations you have imposed onto the process.

The technical part of the token issuance is performed by savvy developers, ideally those that have experience in issuing tokens. Typically, your tokens are derived by deploying a smart contract script on the Ethereum Blockchain. The tokens may be pre-mined, or mined after the token sale, depending on the type of token you are issuing. If the tokens are pre-mined, as in a case of an auction-style sale, the contributors can receive their tokens automatically. These, however, may be systematically locked for a set period of time. If the tokens are mined post-ICO, then the contributors receive their tokens once the ICO is over.

Once the target is reached, and tokens are distributed, and voila! — you are a token issuer, and assuming you have set aside some tokens for your efforts, you now own your own piece of crypto asset on a decentralised and transparent blockchain. You or your organisation can now be labelled as “token issuers”. Whether your new token is a currency, security or other representation wholly depends on your initial idea, token economics, legal assumptions and any pledges you made towards your contributors.

Statistics

On the one hand, according to the Coin Schedule, the first half of the year 2018 saw over 700 ICOs raise more than USD 18 billion combined. That is over 7% when compared against traditional capital raising vehicles, namely IPOs and VCs, according to KPMG and PwC published data for Q1-Q2. This statistic demonstrates the viability and relentless capital raising growth potential for this new industry.

On the other hand, research by Satis Group LLC found that more than 80% of ICOs failed to raise enough funding or went out of business after their launch, or are classified as outright scams. 46% of 2017’s ICO’s failed for one reason or another. [6] Even so, the typical statistics for VC investments are nearly as bad. According to Forbes, 90% of entrepreneurs wind up failing. [7]

Likewise, the majority of IPOs fail in their initial stages after going public. [8] Does therefore the ICO phenomenon spell the secret to trading or company success? — Probably not. However, what ICOs have undeniably achieved is to open up an unprecedented financing tool for businesses, start-ups and even white-paper ideas, all without the need for intervention by investment bankers; it has also given unparalleled access to investors of any type, not just to high net worth individuals (HNWI) seeking a diverse investment portfolio. ICOs are the first meaningful use case for cryptocurrencies.

Questions to ask yourself

  • What is your value proposition? Do you have a benefit for your end user?
  • Are you going to use an existing blockchain to issue a token or create a new coin with its own blockchain?
  • Do you have the developer skills required? If not, do you the right developer on your team?
  • What unique features are you offering?
  • Does your project have a roadmap?
  • How are you going to seed your project’s initial stages?
  • Are there any potential buyers for your coin or token?
  • Will you be offering a secondary market for your coin or token?
  • Which jurisdiction will you choose for issuance?
  • What will the coin or token represent: a security, a private cryptocurrency, a representation of commodities, or other assets, or rights, or utility instruments?

To sum it all up

Being an issuer is a time-consuming legal juggernaut that is faced with a high rate of failure for your coin or token buyers, or contributors and yourself — the issuer. Even so, if you are planning on issuing your own coin or token, there is a chance of success, but there are a number of different caveats to consider. In short, it is essential that you have the right team on board that is equipped with the right development skills. It is also essential that you become aware of the regulatory requirements and how these will impact you, as this can be a huge hurdle, particularly when you are starting out.

You need to be clear about what you are looking to do exactly. Will you be issuing a whole new blockchain or will you issue a token on an existing chain? Which one and why? Let us know. We want to hear from you.

Sources:

[1] https://coinmarketcap.com

[2] http://icocrowd.com/new-ethereum-token-protocols-you-didnt-know-existed/

[3] https://www.sec.gov/ICO

[4] https://autonomous.app.box.com/v/tokenmania

[5] https://uk.reuters.com/article/usa-stocks-weekahead/rpt-wall-st-week-ahead-new-communication-sectors-shine-could-soon-wear-off-idUKL2N1WS1H4

[6] https://medium.com/satis-group/cryptoasset-market-update-b678aeda4c5e

[7] http://amyblankson.com/forbes-secret-reason-venture-capital-investments-often-fail/

[8] https://www.bloomberg.com/view/articles/2018-02-21/your-ipo-can-t-fail-if-it-s-not-an-ipo