This past year has seen Bitcoin and other cryptocurrencies rise to dizzying valuations—Bitcoin, for example, rose 1500% in a year. In the last few weeks, the market for cryptocurrencies has become extremely volatile. Bitcoin has gained or lost more than 20% of its value over the course a few trading days multiple times. It is currently trading at about 70% below its peak value of only a few weeks ago. A similar market mania exists for companies associated with a related concept—blockchain technology. As an example, the Long Island Ice Tea Corp., a money-losing drink manufacturer, saw its share price increase by 289% in a single day when it changed its name to Long Blockchain Corp. and announced that it will seek to partner with companies that develop blockchain technology, a business it was not in and to which it had no obvious connection. Other companies are tapping into the irrational exuberance by bypassing normal market procedures and raising money through an Initial Coin Offering (“ICO”), a cross between issuing shares and creating a new cryptocurrency.

Putting aside for the moment the question of whether we are in the midst of a bubble, it is worth spending a few minutes understanding each of these innovations. After all, even if the bubble bursts, these innovations may well survive. First, some definitions:

A cryptocurrency is means of payment composed of digital units-of-value that use encryption to regulate the generation of new units and to verify the transfer of funds (hence the “crypto” part of the name). Cryptocurrencies are issued independent of a central bank. The most famous cryptocurrency is Bitcoin, but there are dozens of other well-known cryptocurrencies, such as Ethereum, Litecoin, and Ripple. There are thought to be over 1000 cryptocurrencies—compared with only about 180 traditional currencies.

A blockchain is a type of distributed ledger technology (“DLT”)—essentially a database that exists and is updated simultaneously across multiple, unrelated computers. Blockchain was invented as part of the creation of Bitcoin, but it has applications that go beyond cryptocurrencies. The genius of blockchain is that the technology allows multiple parties to accurately track peer-to-peer exchanges without requiring that the parties trust each other or rely on a trusted central authority. Blockchains work by aggregating groups of new entries into a “block” that is then verified and transmitted to the individual computers on which the DLT resides (this is the “distributed” part of the distributed ledger), where it is added to the previous records (the “chain”). Each block digitally verifies the one before it, making it extremely difficult to change any existing block without invalidating the entire chain. This makes the blockchain a reliable record of past events, even though it is not controlled or secured by a trusted central authority.

An Initial Coin Offering or ICO is means of raising capital while bypassing traditional banks and markets (and perhaps securities regulations). A company issuing an ICO accepts payments in return for a digital “coin”—better described as a token—that can be traded or redeemed at a later date for money, a service, or the future earnings of the company.

Cryptocurrency Early Lessons

Almost a decade after Bitcoin's invention, it is possible to assess some of its strengths and weaknesses. Cryptocurrency enthusiasts point to several purported benefits over traditional currencies. First, cryptocurrencies have a self-limited supply of coins. This is thought to protect them from inflation caused by printing endless supplies of coins (the way a government might use inflation to devalue its debts). Second, cryptocurrencies allow transactions that are anonymous in a way that is similar to traditional paper currency but very unlike other forms of electronic money transfers (which end up in a traceable bank account). Finally, the use of the blockchain to record cryptocurrency transactions eliminates the need for a middleman (such as a bank or credit card company) and should reduce transaction fees.

Weighed against these benefits are several drawbacks. First, cryptocurrencies are perfect targets for hackers. Once stolen, the currencies' anonymous nature makes it virtually impossible to track the perpetrators. Similarly, cryptocurrencies have become the payment method of choice for ransomware extortionists, malware sellers, and other illegal actors on the dark web. Indeed, other than as a means of speculation, this appears to be the most common use of cryptocurrencies. Finally, the extreme volatility of cryptocurrencies has made them almost unusable as a practical method of payment (as opposed to a form of speculation). After all, who would want to pay (or accept payment) using a currency that regularly changes value by thousands of dollars per unit?

So where will all this leave us once the current market mania for cryptocurrencies end? The answer likely depends on four factors: 1) whether countries restrict trading in cryptocurrencies (as some already have); 2) whether cryptocurrency hacking further destabilizes the market; 3) how the current cryptocurrency mania ends; and 4) whether some new version of cryptocurrency (perhaps even ones backed by central governments) can address cryptocurrencies' drawbacks.

How Blockchain Could Revolutionize Financial Services, Healthcare and More

Regardless of what happens to cryptocurrencies, there is little doubt that blockchain and other DLTs have a bright future. DLTs are revolutionary in that they create a way for multiple, unrelated parties to reliably work on the same database at the same time without having a central authority in charge to ensure accuracy and security. Blockchain experts see possible applications across industries. Several banks, for example, are working on a joint blockchain project by which they could together track and monitor transactions. The participants hope to be able to share a DLT, relieving each bank of the need to maintain its own, independent records. Similarly, some expect that healthcare records will be stored using blockchain, allowing individuals to grant access to different providers. Blockchain technology will also be used to track and implement smart contracts (contracts that automatically implement upon fulfillment of a condition). Others expect blockchain to revolutionize government record keeping, allowing cheaper and safer ways to track information like land registries, birth, death and marriage certificates, and provide a secure means of identification for the cyberworld.

In short, blockchain technology will likely allow new types of businesses to flourish in much the same way that the Internet created the environment for new technology giants like Facebook and Google.

Initial Coin Offerings and Their Impact on the Markets

As noted above, initial coin offerings share many similarities with initial public offerings. So many similarities, in fact, that legally speaking they may be the same thing. The SEC and other regulators have made clear they believe that in most instances ICOs are securities, and must conform to securities regulations. Thus, ICOs are unlikely to serve one of their primary purposes—as a means to sidestepping securities regulations. If ICOs have a future it will be in their ability to use blockchain technology to disrupt the roles of traditional market makers (such as investment banks and stock exchanges) rather than in their ability to reduce costs by avoiding legal and regulatory costs.

Whatever their long-term future, Bitcoin, blockchain and ICOs are certain to remain in the news throughout 2018. However the current market mania ends, these new technologies are certain to spawn new and complex business and legal issues.

Seth P. Berman leads Nutter's Privacy and Data Security practice group and is a member of the firm's White Collar Defense practice group. Corporations and their boards engage Seth to address the legal, technical and strategic aspects of data privacy and cybersecurity risk, and to prepare for and respond to data breaches, hacking and other cyber attacks. He can be reached at 617.439.2338 or [email protected].