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The Dark Side of The Blockchain: What You Should Know About ICOs and the Ethereum Bubble

Not too long ago people were mocked for being enthusiastic about cryptocurrencies. There were popular comedy sketches, such as this one, showing looney guys being obsessed with Bitcoin. There were numerous articles titled “Why cryptocurrencies are a scam” or something along those lines. And there was general reluctance to take the Blockchain and everything that comes out of it seriously.

Now, things have changed.

The market capitalization of the cryptocurrency sector has exceeded $100b and Etherium, Bitcoin’s more flexible relative and the hottest thing in the world of blockchains, is rising in price at a frenetic, $100/week pace.

The Ethereum boom has to do with the popularity of ICOs, Initial Coin Offerings, that the network’s signature technology – smart contracts – has made easy to produce.

And since ICOs have gained such a momentum, we feel it’s appropriate we explain in detail what they are.

In today’s article, we’ll discuss why people are jumping on the ICO bandwagon so feverishly, and explain why investing in them might not be very wise an idea.

Let’s start!

What are ICOs?

Initial Coin Offerings (ICOs) or Initial Public Coin Offerings (IPCOs) are smart contracts that help cryptosphere startups raise money for their ventures. They receive funds from investors automatically (in Ether, a currency used on the Ethereum network) and, in exchange, send out whatever tokens (or coins) a startup has to offer.

For the most part, these tokens hold no value of their own and are merely a promise of future profits for investors.

ICOs eliminate traditional fund gathering regulations and are extremely easy to set up. There is even a template, ERC-20, that allows people to create ICOs in minutes, without any coding knowledge required.

So, how are ICOs causing the Ethereum’s price bubble?

What are ICOs

Some of the most recent ICOs have raised ridiculous amounts of money – hundreds of millions of dollars – in terms of several hours or sometimes minutes. Investors keep pouring funds into them, hoping to get a huge interest quickly, and that creates a buying pressure and inflates the ICO hype even more as no one wants to miss out on what seems to be such a huge opportunity.

However, the only way to get into an ICO is buying up Ether and sending it to a smart contract. And Ether, still being a baby-cryptocurrency, has a very low supply.

So what we get in result is an ever-growing number of ICOs (roughly one new ICO is created every week), a peaking demand, and a shortage of Ether – the only currency that allows buying into ERC-20 contracts. Hence, the price of Ethereum skyrockets.

Though no expert can really tell how this situation is going to play out – there hasn’t been a precedent for it earlier – most seem to agree that Ethereum is in a bubble and that it’s going to pop, sooner or later.

What is wrong with investing in Ethereum’s ICOs?

Investing, itself, isn’t a problem. After all, there are risks involved in any type of startup funding. What’s alarming about ICOs, however, is that lots of the startups offering ERC-20 contracts have not even developed a tangible product. They’re being greedy raising 10, 30 or sometimes $100m and have nothing to offer in return except an untested idea.

Of course, there is a starting point for everything. We’re not saying you should only invest in finished products. But if you compare ICOs to traditional funding (i.e., startups getting $0.5m-$1m of seed money, renting an office, hiring a few experts, building an MVP and then starting to fish for further investments) these contracts really do look fishy.

What can cause the Etherium bubble to burst?

Though experts seem pretty positive about the Etherium’s fall, no one knows exactly what will cause it. In our opinion the following downfall scenarios make the most sense:

#1 SEC comes after ERC-20 contracts

If regulators tighten the guidelines for startup funding on the network, it might prohibit everyone, save accredited investors, from participating in ICOs. If that happens, the demand for Ether will drop significantly.

Also, SEC might classify a lot of ICOs as unlisted securities. And that would be even worse, as afterward, they’d probably dig deeper into the cryptoworld processes, and penalize other blockchains, besides Ethereum, for having “loose” security standards.

#2 More ICOs turn out buggy

One of the first big ICOs on the Ethereum network, the DAO (decentralized autonomous organization), turned out to be flawed.

Slock.it, the DAO creators, wanted to make a decentralized way of handling business, a modern, blockchain-powered business model that’d suit both enterprises and nonprofit organizations. They had no actual management structure at the time, their project’s code was open source and the investments they’d raised for it amounted to millions of dollars ($168m to be precise).

In June of 2016, however, the DAO was hacked: its ICO had a bug in it and the attackers wasted no time to exploit it. They stole a substantial part of the DAO’s funding (approximately $50m), forced Ethereum’s core developers to fork the coins, and brought the public to the realization that the network wasn’t as immutable as everyone had thought it was.

Should something like that happen again, it might lead to a full blown Ethereum’s crash: no serious investor would ever entrust a buggy network with their money again.

#3 Another network split happens

After the DAO fiasco, the Ethereum network got fragmented. A decision was made by the Ethereum community to hard fork the network’s code, and thus produce a new version of it, and to move the stolen funds to a new smart contract to return them to the DAO token holders.

However, not everyone on Ethereum was happy with that idea. There were a number of the network’s members, Ethereum purists if we may so call them, who rejected the fork aggressively on the grounds of sustaining the Ethereum’s immutability (the principle that Ethereum, as all blockchains, cannot be changed).

The unforked network that they’d preferred to stay on was named Ethereum classic, as opposed Ethereum – the updated version.

And if the Ethereum’s creators have to pull another network split, which is very likely since Ethereum is moving to proof-of-stake, it will surely put a stop to the whole ICO frenzy.

Summing up

What can cause the Etherium bubble to burst

We want you to take out these four key points from the article above so that you always stay on the safe side:

  • There is certainly an Ethereum bubble. It will pop. We don’t know when and nobody else does.
  • The price of Ether will keep growing unless startups stop churning out ICOs (which we don’t see happening)
  • Despite ICOs being risky in general, some people have managed to use them very successfully as speculative vehicles. So If you’re feeling particularly lucky, you might try gambling with these contracts too. If not, we recommend staying away from the ICO craze.
  • We see three probable causes for Ethereum’s bubble to finally burst: SEC intervention, new bugs in major IOCs, or another network splitting. It will only take one them to make the network’s house of cards collapse.

If you’d like to learn more about Ethereum, Bitcoin or the Blockchain in general – feel free to contact our expert.

Perfectial team wishes you good luck!

The post The Dark Side of The Blockchain: What You Should Know About ICOs and the Ethereum Bubble appeared first on Perfectial.

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Ross Demush is a digital marketing specialist at custom software development company Perfectial, a leading provider of web & mobile development services, specializing in FinTech, Real Estate, Media & Entertainment & eLearning.