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The virtual currency boom echoes dotcom fever

In 1999, the actor Whoopi Goldberg made a bold decision. Rather than be paid for an endorsement for a dotcom start-up, she took a 10 per cent stake in the business. It seemed wise. At the time, everyone was investing in internet businesses and a rush of initial public offerings was making early investors into millionaires. 

I was reminded of this amid a flurry of news about the new boom in cryptocurrencies — and their celebrity backers.

Ms Goldberg’s venture, Flooz, was billed as the future of money in a digital world and it hoped one day to rival the dollar. The way it worked, however, was much less revolutionary. The service resembled a gift certificate: customers paid in dollars and received Flooz balances. These could be redeemed at participating merchants, with the hope that credits would one day circulate as money in their own right.

The problem for Flooz was that little prevented mass replication of its model. One prominent competitor, Beenz, differed only slightly, by allowing its units to trade at fluctuating market prices.

Like banking syndicates before them, the ventures decided to club together for mutual benefit by accepting each other’s currencies in their networks.

Even so, by 2001 both companies had failed, brought down by a lack of the one ingredient that counts most in finance: trust. Flooz was knocked by security concerns after it transpired that a Russian crime syndicate had taken advantage of its currency, while the fluctuating value of Beenz soon put users off.

Their loss turned into PayPal’s gain, the latter succeeding precisely because it had set its aspirations much lower. Rather than replace established currencies, PayPal focused on improving the dollar’s online mobility, notably by creating a secure network that gained public support. This, it turned out, is what people really wanted.

Did we learn anything from the failures of the internet boom? Apparently not. In what is looking increasingly like a new incarnation of dotcom fever, celebrities are endorsing virtual currency systems. Heiress and reality TV star Paris Hilton tweeted this week that she would be backing fundraising for LydianCoin, a digital token still at concept stage. It offers redemption against online artificial intelligence-assisted advertising campaigns. Baroness Michelle Mone, a businesswoman, announced she would be accepting bitcoin in exchange for luxury Dubai flats.

What is particularly striking about this path to riches is its “growing money on trees” character.

While the internet boom was dominated by IPOs, linked to a potentially profitable venture to come, this time it is “initial coin offerings” igniting investor fervour. Most ICOs do not aspire to deliver profits or returns. Indeed, from a regulatory standpoint, they cannot — most lawyers agree doing so could classify them as securities, drawing regulatory intervention which would force them into stringent listing processes. 

That opinion was substantiated in July when the US Securities and Exchange Commission warned: “Virtual coins or tokens may be securities and subject to the federal securities laws” and that “it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.”

So most ICOs make do by selling tokens for pre-existing virtual currencies for promises of direct redemption against online goods, services or concepts, or simply in the hope the tokens themselves will rocket in value despite offering nothing specific in return. 

They still think they can succeed where other parallel currency systems have failed, by bolting into pre-
established blockchain-distributed currency systems such as Ethereum or bitcoin. These already come with a network of token-owning users. But with the numbers of conventional merchants that will accept these currencies falling rather than rising, these holders need something more compelling to spend their digital wealth on.

As it stands, the real economy can only be accessed by cashing out digital currency for conventional money at cryptocurrency exchanges. This comes at some expense. But with regulators clamping down on how exchanges are governed, token holders who cannot or do not want to pass through know-your-customer and anti-money laundering procedures remain frozen out.

That leaves their holdings good for only three things: virtual currency speculation, which is ultimately a zero-sum game; redemption against dark-market goods or capital control circumvention. 

It is assumed ICOs offering real goods, services or real estate in exchange for cryptocurrencies can somehow tap into this sizeable, albeit potentially illicit and restricted, wealth pool. Yet if competing unregulated economies really start gaining traction, governments will act.

China’s central bank has already branded ICOs an illegal form of crowdfunding and more rulings are expected from other jurisdictions in coming weeks.

Then again, if history teaches us anything, the system’s own propensity to cultivate fraud and unnecessary complexity in the face of more secure and regulated competition may be the more likely thing to bring it down. When given the choice, people usually opt for security.

izabella.kaminska@ft.com