Gibraltar: "Hotdogs And Hot Tokens" – How The Crypto World Is In Danger Of Getting Out Of Control And How To Harness It.

Last Updated: 15 November 2017
Article by Marcus Killick OBE

"Welcome to Crypto Club. The first rule of Crypto Club is: you talk about Crypto Club. The second rule of Crypto Club is: you TALK about Crypto Club!" (with apologies to Brad Pitt).

Something has happened; in the Petri dish of capitalism a new life form has been created. Slowly and unsteadily at first, teetering between evolution and extinction, loved by a few, loathed by others, ignored by most.  Yet, in the last couple of dozen or so months, it has turned viral, expanding at an exponential rate. Its early adherents have, at least on paper, become multi-millionaires.

As their wealth accumulates others join, the cycle perpetuates, and the life form grows. Others are sucked in, value increases by 10, then 20, then 100 times. So further "wealth" accumulates. The life form grows; breeds and other new life forms join it. Their novelty excites, their potential thrills. In a stale grey financial world, hampered by low interest rates and restrictive regulations, they exist outside restriction, in vivid Technicolor.  Crypto becomes the crystal meth of capitalism.

Some stand aside and warn, cautioning of bubbles and Ponzi schemes. For the most part the mainstream media ignore or express concern. But this is a world of Snapchat, Instagram, LinkedIn and Telegram (and numerous others). This new life doesn't need the Financial Times to spread its message. Nor does it need stockbrokers or financial advisers. It spreads peer to peer. If it were a virus it would by now be regarded as airborne.

Begrudgingly at first, the mainstream financial and commercial world begins to take an interest. Regulators and governments see both its threats and opportunities. But their response varies wildly. Some ban, some ignore others choose to seek a way to harness it before it is too late.

Yet this life form is complex, it is no amoeba, rather it has many cells, each distinct and dissectible.  At its base is the Distributed Ledger Technology (DLT), often referred to the Blockchain. In reality this is the game changer. This is the element that will alter the way we live our lives, no less than the internet or the internal combustion engine did. It allows a more trustworthy, secure, faster and cheaper way to conduct business. No need for banks, no need for a stockbroker, no need to pay PayPal. Payment is person to person, transactions are peer to peer.

But the lifeform has other cells. One is crypto currency, initially its was Bitcoin but it has been joined by Ether, Dash and numerous others ( said to be in excess of 900 and growing). Each one mimics currencies in various ways and with various degrees of success. None however are backed by a central bank or national government. Their value is based solely upon trust. Trust they will represent a stable store and measure of value, trust they will be accepted as a medium of exchange, trust they will not simply disappear. Bitcoin's value or rather its increase in value, is based at least in part, upon its strictly limited supply. An infinite supply would kill value; the simple economics of supply and demand dictate that.

There is simply no room for the number of crypto currencies being created. Ultimately a couple will dominate, some will stagnate and most will fail.

Another cell in this new life form is the Initial Coin Offering (ICO). Many now prefer the term Initial Token Offering (ITO). However, because both could be confused with the far more conventional and regulated Initial Placement Offering (IPO), others prefer more differentiated terms. Initial Token Distributions (ITDs) has gained support but Secondary Token Distributions are likely to achieve less popular usage.

The general purpose of raising funds by these methods is to provide the capital necessary to develop the underlying product or service. The development should be blockchain based but the link of some to DLT is, at best, loose.

Some of the Whitepapers, upon the decision to put money in are based, would shame a first year economics A 'level student. Others are of a significantly higher standard. However as there are no required minimum disclosures, it is currently a case of caveat emptor. Some organisations have been created to perform an independent assessment but this part of an industry let quality control is still as an early stage.

However in the current feeding frenzy, quality is sacrificed for speed and the need for greed. Individuals who have seen the worth of their crypto currency increase massively are looking for the next locomotive to ride, regardless of destination. There are signs of sense being regained but it is a slow process. 

With apologies to purists, broadly ITOs fall into two camps. Firstly there are the securitised offerings. These are regarded by a significant number of jurisdictions as being securities and therefore subject to all the regulatory requirements of any security offerings. This clearly makes them unattractive from a cost and flexibility point of view. As a result Utility Token Offerings have gained in popularity.

To be clear Utility Tokens are designed to fall outside the scope of conventional financial service regulations. This does not mean they are wrong, malevolent or illegitimate, simply that they are out of scope. They are neither an equity nor a debt, there is no right to a  financial return. The right is simply to use the service that is subsequently developed via the Token. You are a creditor of the company issuing them but, if the service is not subsequently developed, your chance to recover your money is close to zero. Your token's value will ultimately depend both on the creation of the service and the subsequent demand for that service.

To put it in simpler terms, imagine being asked to put money into the building of a hotdog stand. In return you get a number of free vouchers for the hotdogs that are to be produced. If the hotdog stand never materialises, you have lost. If it does become a reality but its hotdogs are disgusting and no one wants them, you have lost. However, if they are amazing and everyone wants them, as they can only buy them with your tokens, your tokens will increase in value. And you can always eat the hotdogs yourself.

To stretch the analogy to breaking point, what would cause you to hand over your money?  Presumably a decent business plan, properly costed with an identifiable market. You would probably want to ensure the person setting it up knows what they are doing, perhaps has run hotdog stands in the past. You would want to make sure they were not a crook and that your money is spent on building the hotdog stand not on "research trips" to the Caribbean. Perhaps it would be good if an independent person held the money and only released it as it was needed to build the hotdog stand. Perhaps also someone to make sure that the stand was properly built and the hotdogs held safely so they couldn't be stolen. It would also help if you liked hotdogs yourself.

From the person seeking to raise money for their, hopefully delicious, hotdogs, they would want to reassure people of the above. They could promise, but who would check they fulfilled their promises. Perhaps they use others regarded as trustworthy to oversee them. On the other hand, wouldn't it be better if there were some rules governing the above. Rules which are flexible enough to cover all manner of stands (from Hot dogs to clothing), and proportionate enough to not make compliance cost prohibitive. Perhaps someone could be tasked with checking the rules are complied with.

Wouldn't this be win win? The prospective hotdog entrepreneur gets to build their stand, those putting up the money get a degree of reassurance. Wow, a set of requirements that work for everyone.

Early next year, Gibraltar will begin to provide that environment. No wonder when it announced the creation of a proportionate and bespoke regulatory environment earlier this year the floodgates opened. Initially the regulations will focus on elements of the DLT eco system such as electronic wallets and exchanges, but ICO/ITOs will follow.

No regulatory system works in a zero failure environment. Regulation is not an alternative for sound financial judgement by individuals. There will be regulated ICOs that fail. The best that can be done is to reduce  and manage the risk, not eliminate it.

The Petri dish of capitalism has produced its new life form, it cannot be ignored and it will evolve. The choice is to pontificate, procrastinate or be proactive. It is only the last of these that give us the chance to influence what it will become. Gibraltar has chosen that course.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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