ICO’s & Bitcoin: A Reality-Check

At Prime Trust I receive ICO (“Initial Coin Offering”) inquiries almost daily, with people wanting us to act as escrow agent for the offerings. More on this in a moment.

There are things that I truly admire about Bitcoin. In particular, the potential to ease international settlements is incredibly promising. And there are a number of interesting industrial uses for the exchange mechanism, and possibly even some consumer uses such as in-app micro-payments.

Like any commonly-accepted commodity (e.g. gold, diamonds), Bitcoin can act as a medium of exchange that isn’t tied to any specific currency. And it’s a heck of a lot easier to transport than gold or diamonds. Yes, note that I am calling Bitcoin a “commodity”, it is not a currency.

With the Bitcoin market heating up, we are seeing a rush of unsophisticated people blindly leaping in and buying coins of various types and in numerous ways. This reminds me of 1999’s “irrational exuberance” with the dot-com bubble. Did it mean that the internet was all hype and not real? Of course not. But stocks of meaningless or marginal companies and business models had been vastly overblown and overhyped. When the bubble burst, the market correction was also irrational, dragging down the current & future stars, causing unsophisticated investors to lose fortunes, while sophisticated investors feasted on the carnage as they knew that quality company’s would recover.

As long as (real) money flows into Bitcoin, and as long as the “mines” continue to keep supply low, then prices might maintain or continue to increase. Keep in mind, though, that there are 3 primary drivers to valuation of a commodity: scarcity, utility and liquidity, so even if Bitcoin remains limited in quantity, there has to be some kind of underlying use of the commodity to maintain any type of value, and there have to be people who will readily give you currency in exchange for the commodity. Remember, for every coin sold, there is someone smiling as they take your dollars/euro’s/pounds/ and other real currency in exchange for the crypto, but there is no assurance that the reverse will remain true. Now, when the exuberance cools off and money doesn’t flow in anymore, or if there’s some type of regional or global event that causes a lot of people to want to exchange their coins back into currency (since they can’t pay their mortgage or buy groceries with Bitcoin), then I think that’s when the music stops. You thought the real estate crash of 2008 was bad? At least those were real underlying assets (just misvalued). Watch what happens to Bitcoin prices when people stop buying them and, instead, want their money out. “Crash” will be an understatement. In my opinion, this…will…happen.

Now, back to ICO’s. This is a new way that businesses are selling “securities”. In a nutshell, you give them dollars and instead of stock (or bonds) they give you a new type of coin (not to be confused with a Bitcoin). What can you do with this coin? The same thing you can do with a stock certificate (except unlike stock, with a coin you probably don’t actually own any part of the company, depending upon terms of issuance)…almost nothing. Can you sell a company-specific-coin? Sure, if you can find someone who wants to buy it, and provided your sale is done via SEC rules for the type of offering it was issued pursuant to (Reg D, Reg A, Reg CF, etc).

The problem is that this has been a wild-west situation, with people cavalierly selling ICO’s to unsophisticated people who are irrationally glassy-eyed about “coins”, and with total disregard for securities regulations. The SEC has already started to take action against these, and a flood of regulatory enforcement actions are in the near-term forecast (see ICOs and a soon-arriving flood of SEC enforcement investigations). There will be lawsuits. There will be fines. There might be jail time. And, in my opinion, there will be massive losses for “investors”.

Some attorneys, and even some platforms such as StartEngine, are working to clean up this market and ensure that ICO’s are conducted pursuant to securities regulations. They are even hosting what I believe is the industry’s first securities conference for ICO’s in Santa Monica in November, the “ICO 2.0 Summit“. This is a very, very good sign.

So, am I open to Prime Trust becoming involved with ICO’s by acting as escrow agent for the offerings? I honestly don’t know. I expect that we will have customers who want to add their “coins” to their asset protection trusts, just as they would stocks, bonds, real estate, or other assets. That’s fine, as we don’t have an obligation to value those things (though we do obviously provide statements which include current prices/values for exchange-traded securities held in custody, just not for “non-quoted” assets like real estate, business interests, etc).

However…

• When we hold cash for people, it’s FDIC insured for each individual customer.
• When we hold marketable securities, they are in an SIPC insured account.
• When we hold real estate, it has title insurance.
• Private securities, business interests, partnership agreements and licenses are direct instruments with the issuer and held in our (street) name.
• If we hold coins, and an employee, hacker or someone else steals coins from the place where they are held, what insurance is there? None, as far as I know. What recourse would we have to recover the stolen property? Almost none, from what I can tell.

That makes it very scary for a chartered, regulated, insured financial institution like Prime Trust to agree to hold these for people. So if we act as escrow agent for ICO’s, what is our regulatory risk? What might our tort/civil risk be if coins get stolen or if/when things go south or the offering gets hit by regulators as fraud? How do we price that risk? I have yet to get comfortable answers to those questions. I’m open to figuring this out, but don’t mind missing the market if I can’t quantify the risk.