Risks For Audit Are Too High

Ernst and Young did some research on the crypto world.  They analyzed more than 372 ICOs, and found that $400 million of the total $3.7 billion funds raised to date had been stolen by hackers.  How’d the hackers do it? Phishing.

A while ago West Loop Ventures hosted an event on security.  Joe Rickard and Stel Valavanis talked extensively about how they approach security in the finance world.  Phishing was one of the things they talked about.  It is the number one way through the security in the network.    Somebody mistakenly opens an email and it’s over.  I remember Joe saying that hackers wouldn’t hack if there wasn’t any money in it.  With crypto, the money just got a lot larger and the networks they can attack became a lot larger too.

Hackers are looting $1.5MM per month.

One of the interesting things in the report is that fewer ICOs today hit their target raise than they did last June.  That is a sign that the market is getting a bit saturated.  It’s also a sign that the quality of the ICO is worse.  As we know and have seen repeatedly throughout human history, if there is free money on the table everyone will go for it.  Many of the ICO’s that are being undertaken are just after the money because they cannot raise money from any other venue.  Blockchain and the network effects that come with blockchain are not essential parts of their business model.  In other words, they are slapping “blockchain” and “ICO” on their business and hoping that one of the greater fools gives them money.

Ernst also noticed that the quality of white papers was low.  There were errors in coding, not to mention errors in grammar.  Hey, if you are going to take the time to write a white paper at least get the grammar right.  There were conflicts of interest that were not resolved or hidden terms that didn’t show the true costs of exchanging the token.  This is not only because of the frantic rush to raise money on the part of the startups but because the people raising the money aren’t thinking their business models through.  Garbage in, garbage out.

That sloppiness hurts the entire marketplace.

Companies like Ernst fear the risks of being sued and are avoiding even auditing the books of crypto companies.  That’s too bad because this is a time when the major accounting firms could come in and set some standards.  I understand their fear but the crypto business needs them to lead.  It’s not going to fade away.  The SEC, CFTC and other regulators in Washington DC will move at a snail’s pace and the probability of them getting it wrong is high.

Back in the early 1960’s, the futures industry was considered a junk industry.  Over the course of time, people had committed a lot of fraud.  Boiler rooms were commonplace and traders trying to corner the market and colluding happened.  The customer was getting screwed over.  Leo Melamed changed that.  He started a private organization, the National Futures Association, that cleaned up the industry.  We need that in crypto and it’s probably up to the very large VC firms that are active in the space to do it.

Personally I have seen more and more white papers and frankly, they are great for lining bird cages.  The business doesn’t need blockchain to execute its strategy.  It could use a database or some other sort of technology to execute. Of course, a good investor has “strong opinions loosely held”.   A lot of the ideas don’t fall into the intersection of “that’s a really stupid idea but it would be totally cool if it really worked” category.

I am not against ICOs.  I am bullish on blockchain and there are businesses I have seen where using blockchain technology is going to solve a lot of problems and expand markets along with making them more efficient. However, the business undertaking the ICO should approach it similar to an IPO.  White papers should have good grammar and show transparently why the business is undertaking the ICO to execute its mission.  The white paper should also underline the risks associated with the ICO along for potential reasons the effort might fail.

Being clear, transparent, and orderly will go a long way to avoiding a future lawsuit.  It also raises the bar on quality giving the entire marketplace more credibility.