Shares of Xunlei (NASDAQ:XNET) plunged nearly 30% on Jan. 12 after the National Internet Finance Association (NIFA) issued a warning about the Chinese tech company's cryptocurrency plans.
Chinese regulators banned ICOs last September, causing some companies to either pivot to "initial miner offerings," which sell hardware for mining purposes, or self-finance the development of their own cryptocurrencies.
Xunlei picked the latter, and launched its "Wanke coin mining project" for its new cryptocurrency LinkToken (formerly called Wankebi) last October. NIFA, which discourages its members from investing in any ICOs or cryptocurrencies, claims that LinkToken is a "disguised" ICO that could be taken down by regulators.
What's a "disguised" ICO?
ICOs are used to raise money for cryptocurrency ventures. But the lack of clear regulations opened the floodgates for fraudulent ICOs, which offered no clear roadmaps toward launching real cryptocurrencies.
In response, China and South Korea banned ICOs, while regulators in other countries scrambled to implement new rules. Chinese companies can't launch their own ICOs, but the rules don't bar existing companies from developing their own cryptocurrencies with their own capital.
But by using these cryptocurrencies to convince investors to buy their stocks, these companies have adopted ICO-like business models. These companies also aren't obligated to disclose many details about their cryptocurrency plans -- which makes them "disguised" ICOs to industry groups like NIFA.
Why investors shouldn't trust Xunlei
Xunlei generates most of its revenue from the Xunlei Accelerator, a cloud-based platform that boosts the speed of online transmissions for streaming videos, online games, and other cloud-based content. On its own, this business generated 21% sales growth last year, but it's still unprofitable due to tough competition and high operating costs.
As a result, Xunlei's stock had dropped 17% in the 12 months before it made its coin mining announcement on Oct. 12, 2017. But after the announcement, the stock rallied almost 260% into the end of the year as investors bought anything related to cryptocurrencies.
But last November, Xunlei disclosed that LinkToken would be a "kind of digital asset" for use "on the company's internet properties, and should not be traded on other transaction platforms." Furthermore, it warned that its cryptocurrency was merely "a symbol of proof for these applications, rather than a subject of speculation."
Therefore, Xunlei might eventually offer LinkToken as a virtual currency for buying some unspecified goods, but it won't be offered on exchanges like bitcoin. It could also simply be a "proof of concept" for the Accelerator's uses in cryptocurrency mining. Just like an ICO, Xunlei isn't obligated to justify the massive appreciation in its market value with clear plans.
Beware the cryptocurrency bandwagon
Xunlei isn't the only company that abruptly pivoted toward cryptocurrency mining or its underlying blockchain technology.
Three years ago, online marketplace Overstock.com (NASDAQ:OSTK) became the first e-tailer to accept Bitcoin in late 2014. It subsequently invested heavily in blockchain and launched its own cryptocurrency trading platform, an ICO, and a trading platform for other ICOs.
Shares of Overstock rallied more than 360% over the past 12 months on those developments. But here's the problem -- analysts expect it to generate less than 1% revenue growth this year as its bottom line sinks into the red.
Last October, failed medical device maker Bioptix abruptly renamed itself Riot Blockchain (NASDAQ:RIOT), bought some mining rigs, and claimed that it could pivot into the blockchain and cryptocurrency markets. The stock's subsequent triple-digit rally gave the company -- which generated just $24,000 in animal health licensing revenues last quarter -- a market cap of over $200 million.
There's also the tiny non-alcoholic beverage maker Long Island Iced Tea, which saw its shares soar after it renamed itself Long Blockchain and declared that it would invest in blockchain technologies. Short-term traders didn't question the absurdity of these plans -- they simply stampeded into the stock.
The key takeaway
This dubious list of companies riding the cryptocurrency hype seems to grow longer each day, but the lesson is always the same -- investors shouldn't chase stocks rallying on cryptocurrency or blockchain developments that aren't essential to their core businesses.