How Telegram's Crypto Coins May Attract $2.6 Billion: QuickTake

(Bloomberg) -- Cryptocurrency ventures raised about $4 billion last year in initial coin offerings. It was a mad scramble of ICOs that saw companies with a mere scrap of an idea -- and even some that had been formed as jokes -- attract investors and the increasingly skeptical attention of regulators around the world. Now, Telegram Group Inc., the messaging service registered in the British Virgin Islands, is in the midst of the biggest ICO ever. It anticipates receiving $2.55 billion in three rounds of funding, according to documents seen by Bloomberg.

1. What’s special about Telegram?

Telegram’s differences with most other ICOs go well beyond size. It’s a provider of encrypted messages that’s already become popular within the cryptocurrency community. It has an established brand, claims over 170 million users and has registered its ICO with the U.S. Securities and Exchange Commission. The service has won the trust of users ranging from Islamic State terrorists to French President Emmanuel Macron. Even so, some in the digital-coin world remain skeptical, passing on the offer.

2. Why is Telegram doing an ICO?

Founder Pavel Durov, a Russian expatriate, wants money to expand and compete with bigger rivals. Facebook Inc.-owned WhatsApp and Messenger dominate the market. Durov has said he won’t give up control of Telegram to other investors. The ICO structure lets him raise funds while keeping control.

3. What’s Telegram offering?

Durov plans to create a new, bigger blockchain platform and then issue a mass-market cryptocurrency to run on the system that will be called the Telegram Open Network. He’s using the ICO to sell the virtual coins called Grams for use within the messaging app, allowing payments that leave few traces of identity. Investors are paying for to-be-issued Grams at a specified price that already escalated in the second round. The plan is that next year, Grams can be traded or exchanged into fiat currencies. The new network aims to include a digital wallet, storage services similar to those of Dropbox Inc., a proxy layer to hide identity, an applications platform and a payments channel. The funds will also cover operating expenses and corporate costs.

4. What’s the appeal?

Blockchain networks, the public ledger systems that make cryptocurrencies possible, have been plagued by periodic bottlenecks. In perhaps its most grandiose goal, Telegram says its next-generation network aims to clear millions of transactions per second, compared to 7 to 15 per second for crypto market leaders Bitcoin and Ethereum, to potentially challenge Visa and Mastercard as a mainstream payments network. In one sense, the ICO investors are just pre-paying for Grams. But they could also benefit should the coins appreciate over time. Grams were priced at $0.38 in the ICO’s first round, $1.33 in its second round and may be priced higher at the remaining round.

5. How’s the ICO going?

In its first round in February, Durov raised $850 million from venture capital funds, and in the two remaining rounds, in March and possibly June, is seeking another $850 million in each, according to informational documents that contain a number of caveats. So far, the ICO has been offered privately and, in the U.S., only to people of at least a certain level of wealth, known as accredited investors. Telegram is considering advancing ultimately to a public ICO -- in which anyone could buy Grams, according to company documents. It is promising to return money to investors should it fail to create the planned blockchain with a built-in cryptocurrency by late 2019.

6. Who is passing on the offer?

Some long-time cryptocurrency investors are skeptical that Telegram will be able to fulfill its many promises and have passed on the deal. The company’s technical white paper doesn’t add anything to blockchain research that would suggest it can deal with problems that major live projects, like Ethereum, haven’t been able to resolve. “It’s like claiming to solve cold fusion or cancer,” Pantera Capital’s Charles Noyes said. Bart Stephens of Blockchain Capital said that with the pull-back in crypto prices, Telegram’s “valuation is even more problematic relative to more established tokens/coins like Bitcoin and Ether.”

7. How does Telegram compare with ICO peers?

Many startups -- such as EOS, Tezos, Filecoin and others -- have been raising hundreds of millions of U.S. dollars to create new, potentially disruptive businesses from scratch, based on distributed ledger technology. Unlike some of the startups, Telegram already has a strong existing business and team of developers led by Durov’s older brother, mathematician Nikolai Durov. The same team previously created Russian social network VK.com which beats Facebook by the number of users in the country. Also, most ICOs raise money in Bitcoins and Ether from the cryptocurrency investors, while Telegram is raising funds in a traditional, fiat currency, and mostly from classic, not crypto-focused venture investors.

8. Why is Telegram working through the SEC?

The SEC and other regulators have been cracking down on many ICOs, saying they are securities offerings in disguise. While many companies doing ICOs say the goal is to let people who want to use a product fund its development by buying the tokens it would use, regulators say that in most cases investors really are hoping to sell their tokens as their price goes up. The SEC views tradeable coins as securities. It has repeatedly warned that the U.S. ICO market may be full of fraud. Telegram, which is striving to create a mainstream product, files disclosures with the SEC.

9. What are the risks?

Telegram developers might fail to build a superior blockchain with high-speed transactions. National governments may also introduce legislation, restricting transactions in virtual coins. If Gram fails to become a mass-market cryptocurrency, investors may end up with so-called candy wrappers, losing much or all of their money.

10. So who will own the company?

Durov. He may be taking this route because in his earlier venture, VK.com, he lost control of his social network to powerful billionaire Alisher Usmanov. Like an IPO, the token sale determines a certain value for Telegram. In total, raising $2.55 billion for 66 percent of Telegram’s tokens implies a market value of $3.86 billion.

The Reference Shelf

• Here’s the world’s biggest cryptocurrencies by market capitalization.
• Telegram’s preliminary white paper was an explainer for the first round.
• A Bloomberg News article on why some crypto insiders sat out Telegram’s offer.
• WhatsApp is said to be the most popular messaging app in 104 countries, Facebook is 64 countries, Telegram in Iran only.
• A Bloomberg News article on how Pavel Durov says his app can’t be bought.
• Here’s a look at Rule 506 of the SEC regulations.
• A Forbes article called Telegram the “cryptocurrency world’s preferred messaging app.”

--With assistance from Olga Voitova and Laurence Arnold

To contact the reporters on this story: Ilya Khrennikov in Moscow at ikhrennikov@bloomberg.net, Camila Russo in New York at crusso15@bloomberg.net.

To contact the editors responsible for this story: Rebecca Penty at rpenty@bloomberg.net, Todd White, John O'Neil

©2018 Bloomberg L.P.