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The Dark Side of the Cryptocurrency World

When cryptocurrencies were flying high in late 2017 and early 2018, the initial coin offering, or ICO, market was raking in billions from investors with dollar signs in their eyes. Unfortunately, the majority of ICOs ended up being money losers for their investors, and some people who promoted them are now in hot water -- including two celebrities.

In this Industry Focus: Financials clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss how poorly the overall ICO market has performed and what it could mean for the future.

A full transcript follows the video.

This video was recorded on Dec. 3, 2018.

Jason Moser: Let's talk about something a little bit, I don't want to say the lighter side of news, because I'm sure there are some people that probably ended up losing a little bit from something these guys were pushing. We were reading an article over the weekend in regard to this massive gold rush of cryptocurrency and these ICOs, initial coin offerings, that seem to be popping up left and right. It's difficult enough for someone to explain bitcoin and how it works and why it matters. Now, we've got all of these other coins that are coming from these ICOs. And apparently, there are some celebrities that felt like they would get in there and get a little piece of the action.

DJ Khaled and Floyd Mayweather are in a little bit of trouble with the SEC. It sounds like they may have been able to come to a resolution there. These two guys were backing these ICOs, they were pushing these ICOs, telling consumers, telling people, "Man, you've got to get in while the getting's good. You have to get in on this game-changer." Bottom line was, they never disclosed the fact that they were actually being paid to tell people that. It wasn't like they were doing it out of the goodness of their heart. Lo and behold, the SEC finds out, and now they've found themselves in a little bit of hot water. It sounds like the SEC is settling, the two individuals will pay fairly heavy fines and, I think, give back all the money that they were paid in doing the promotions there.

It goes back a little bit to this crypto craze, Matt. I understand why it exists. I understand that there's potentially a future there. We had Aaron Bush on here a few weeks back to talk a little bit more about it. But when I see stuff like this, I become so disenchanted.

Matt Frankel: It's completely understandable. People have lost enough money in legitimate cryptocurrencies lately. Not even counting the ICOs, the total cryptocurrency market cap has gone down by about $700 billion since the peak.

Moser: That's phenomenal!

Frankel: So there's been some money lost here. With these ICOs, personally, I hope that DJ Khaled and Floyd Mayweather aren't the only two who get in some kind of trouble for pumping these ICOs over the past few years. Just to give you a little bit of context, in 2018, so far, there have been about $12 billion raised with these ICOs. A study found that only 8% of them ever even make it to a cryptocurrency exchange. The rest either fizzle out, get stuck in the fundraising stages, or just disappear and fail entirely. Only 8% make it to an exchange at all. The rest are complete money losers. The study found that 81% were flat-out scams. I even heard a bitcoin expert on CNBC recently talking about how the ICO market is dead now, that it's been so bad, it's turned off so many investors, that it's just not a way that companies are going to be able to raise capital anymore. It's just been ruined. It's kind of crazy, what's happened there.

Moser: It really is. It's been a mania. I was thinking about this, and it strikes me, one the investing lessons I take away from something like this, it's a good reminder that it's OK to just look at something and admit to yourself that you don't know enough about it to really be able to offer an educated opinion, where you're going to put money behind it. It's OK to just take a pass. Warren Buffett does it all the time. He'll read through something and be like, "Nah, I'm just going to throw that in the 'too hard' pile." I've heard many people talk about crypto, and bitcoin in particular. I understand what they're telling me. It's difficult for me to still quite connect the dots there in understanding why I personally want to be exposed to that. So I throw it in the "too hard" pile. I just don't want to mess with it. I don't want to bother with it.

It strikes me that in the case of crypto, with the ICOs and the mania that came about, I bet you 98% of the people who were actually piling money into this didn't really have a clue as to how this works and why it matters, or why it doesn't matter.

Frankel: It's kind of the greater fool theory at work here. People see these things going up and up and up and up, and they say, "I'm going to buy it and someone else will pay more for it." Kind of the same thing that led to the housing meltdown in '07-'08. People saw other people getting rich on real estate, so they bought real estate at these inflated, astronomical prices, saying, "Oh, the next guy's going to pay me $100,000 more for the same house." The same thing is happening here, and it's really not panning out very well.

Moser: No, it's not working out very well. I never ended up investing any money in any type of crypto. Did you?

Frankel: I actually mined about 30 bitcoins when they were worth about $10. I really wish I had those back.

Moser: Mined a couple? What did you do to do that?

Frankel: Well, back then, it was really easy. In the early days, you could do with a basic graphics card or repurposed graphics chip. Now, you need these giant mining rigs. And I just did it to figure out how everything worked and what it was all about, and I wound up getting about 30 coins. I think I bought about 10 of them and mined about 20 of them.

Moser: What did you do with the coins that you had?

Frankel: I sold them when it was about $200.

Moser: At least you made something out of it.

Frankel: I sold it thinking I made the best move ever. Then I watched them go up to about $20,000 a piece. You do the math, $20,000 times 30.

Moser: That's better than the story of the guy who used his bitcoin back in the day to buy Papa John's pizza or something. You made out better than that individual, at least yeah.

Frankel: There was another guy who threw out a hard drive that had the encryption key for about $100 million in bitcoin.

Moser: Lord!

Frankel: He actually paid somebody a couple of hundred thousand dollars to search an entire landfill for it, and they never found it.

Moser: The hits just keep coming. Well, it's a good reminder for investors out there, make sure you know what you're getting into. And when you hear these celebrities screaming from the mountaintops about it, maybe give it a second look there and make sure they have a clue as to what's going on before you just start buying in based on their word.

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