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Some Digital Coins Are up 2,500%. What Could Go Wrong?

The Wall Street Journal. logo The Wall Street Journal. 9/4/2017 Paul Vigna

The burgeoning initial coin offering market is attracting investors’ attention — and dollars — but risks abound

Chinese regulators on Monday declared initial coin offerings illegal, dealing a blow to the latest financial-markets mania and sending the prices of the two leading cryptocurrencies, bitcoin and ether, tumbling.

The move by China, which included a call for fundraising activities through the digital tokens to “cease immediately,” follows on the heels of a recent warning by the U.S. Securities and Exchange Commission that it may treat the coins as securities. That potentially opens these unregulated offerings to greater oversight.

The regulatory maneuvering occurs as fears have grown about initial coin offerings, which have captured investors’ imagination like dot-com startups once did years ago.

Paris Hilton on Sunday tweeted about a coin offering. Boxer Floyd Mayweather has promoted two separate offerings. Tim Draper, a founder of the Silicon Valley venture-capital firm Draper Fisher Jurvetson, has said two of his coin holdings could bring about a “sea change as big as the internet.”

Coin offerings this year have raised nearly $1.5 billion, up from $256 million last year, according to research site CoinDesk. Of offerings that have gained since their launch this year, the coins have jumped nearly 28 times in value, on average, according to data from research firm Smith & Crown.

But the latest market gold rush also has produced its share of pyrite. Of more than 100 coin offerings launched this year, 10% have declined in value and 30% haven’t traded, according to Smith & Crown.

Losing deals, which initially raised nearly $300 million, have lost about 40%, on average, since their offerings, the Smith & Crown data show.

Duds have included some highly publicized offerings. Coins offered by Bancor, which is designing an exchange for the growing number of coins being offered by companies involved with cryptocurrencies, are down 12% through Aug. 30. Bancor initially raised $143 million. Estonia-based Polybius, which raised about $32 million, has dropped about 24% since its offering.

Bancor Chief Executive Guy Benartzi said his project had been hurt by external criticism, but added that the short-term price isn’t a concern to him. Polybius project manager Vitali Pavlov said the token’s price is probably due to limited liquidity, and he still sees “significant” upside.

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The losses haven’t deterred some coin buyers, many of whom have made so much in other deals that they are eager to take more chances. Mike Bardi, 28 years old, is a Chicago entrepreneur who started investing in cryptocurrencies last summer, just before the two big ones, bitcoin and ether, started taking off.

In a year, he turned an inheritance of $80,000 into a couple of million dollars. “It was pure luck, literally,” he said. Mr. Bardi then put $1 million into Bancor, even as the price was falling.

While Mr. Bardi said he is mindful of price swings, and isn’t willing to take a chance on another token offering, he said he believes in Bancor’s product and has no plans to sell. “I’m not really touching it,” he added.

Coin offerings are sometimes compared with initial public offerings, but are in many ways more akin to crowdfunding efforts. Purchasers of coins, which are digital tokens, aren’t buying stock in a company. Rather, they receive a coin that can conceivably be used at some later date to pay for a good or service from the company issuing the token.

The deals have attracted attention and dollars to the idea that technology systems of all sorts are about to be reshaped with open ledgers, or “blockchains,” that are cheaper, more flexible and more secure than existing systems.

For all the hype around the offerings, the risks are plentiful. Many of the companies issuing coins haven’t launched products yet. Instead, they have concepts they hope to develop. Because of this, more than 30 coin offerings haven’t traded since their launch, effectively leaving their buyers in limbo.

Those that do trade do so typically on unregulated platforms and generally can be bought only with virtual currencies such as bitcoin and ether.

China’s role in cryptocurrencies is significant, but shifting. A year ago, Chinese exchanges comprised more than 90% of digital-currency trading. Earlier this year, the People’s Bank of China started imposing regulations on the exchanges, and much of the volume moved to Japan and Korea.

After China announced its ban on coin offerings Monday, prices of bitcoin and ether dropped as much at 8% and 20%, respectively.

Questions still linger about just what a coin offering is, with the U.S. Securities and Exchange Commission recently warning that it may regulate some tokens as securities.

“Mostly you go in and buy a lot of darkness,” said William Mougayar, a partner at Canadian investment firm Virtual Capital Venture who has invested in several offerings including Civic, a builder of digital identity products, and Filecoin, which focuses on data storage. He predicts many, if not most, coin offerings will lose money.

In an echo of the early internet-stock boom, concerns abound about possible scams or simply efforts by some companies to profit by changing their names. Back in the late 1990s, companies found they could boost their value by adding a “.com” suffix to their name.

Some companies are hoping to gain a similar boost by adding the words “blockchain” or “cyptocurrency” to their name. Last week, the SEC warned that while some coin offerings may be fair and lawful investment opportunities, “There may be situations in which companies are publicly announcing ICO or coin/token related events to affect the price of the company’s common stock.”

The agency added that it had recently issued several trading suspensions on the common stock of some companies that had made claims regarding investment in coin offerings.

Another concern: While gains for many coins have been stratospheric, in many cases the biggest jumps have occurred in smaller deals. Coins sold by Voise in June have risen in value 453 times, but the offering from the company, which is developing a music platform that would allow artists to charge directly for their work, raised just $651,000.

And post-offering price moves are often harrowing. One $279,000 deal for gambling-dice company Etheroll started at six cents, soared as high as $165 and then fell back to $4.15 in about three months, according to Coinmarketcap.com, which tracks digital currencies. In other words, a person who bought $10,000 worth of coins at the offering could theoretically have sold them for $27.5 million at their peak, before seeing their value drop to $692,000.

Such wild rides haven’t shaken true believers’ faith. Over the past year, Jake Vartanian started a consulting business helping firms launch coin offerings—and gets paid in the newly created tokens. The 24-year-old said that except for exchanging some tokens to pay contractors who won’t take them, he still holds about 85% of the coins he has accrued.

“We’re really reinventing the stock market,” he said.

Mr. Vartanian said he is just waiting for the inevitable arrival of traditional investors. When that happens, he said, “younger people like myself will be the ones who benefit the most.”

Currently, the coin offering market is like a fire building on itself, with each new offering creating a new crop of winners, said Virtual Capital’s Mr. Mougayar. Very few coins have any real metrics upon which to base a valuation, he noted, and at some point there will be a significant pullback.

“They’re all probably 10 times overvalued, but who cares?” he said. “Relative to each other, it’s not so bad.”

Write to Paul Vigna at paul.vigna@wsj.com

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