If you look at the list of the 10 largest online crowdfunding campaigns in history, eight of them raised money through the Ethereum platform. Far more shockingly, of those eight largest raises, seven have occurred in the last 45 days.
There are many debates to be had about the cryptocurrency ecosystem: its viability, importance and future. But, I would argue it is becoming impossible for technologists and investors to dismiss or ignore out of hand.
But several issues need to be resolved before the ecosystem can fulfill its potential. Here’s what I think are the important questions:
1) How Do You Run a Good Initial Coin Offering Process?
Generations of bankers have refined the process for successfully taking a company public. In contrast, we are in the very early days of the community figuring out how to run an ICO process for maximal impact and value. It is clearly still more art than science.
A little under a month ago, the Basic Attention Token was floated by a seasoned group of technologists. The good news is that the team raised more than $30 million in under a minute. The bad news is that the way they ran the process, they ended up with just a tad more than 100 distinct initial owners of their coin. That’s too few for the team to benefit from a broad currency-holding and supportive community. And with their ICO strategy, the team left a huge amount of value on the table, since demand that couldn’t be fulfilled in the offering led to an enormous pop when the currency started trading.
Soon thereafter was the Bancor ICO. Bancor’s team suffered a very strange fate in their ICO process, raising far more money—over $150 million—than expected. That’s because Bancor designed its ICO to withstand the large-scale denial-of-service attacks that other ICOs were suffering by allowing themselves to manually control the time window and shut-off point for their fundraise. But in raising so much more than planned, the Bancor team may have eroded some of the trust of the community because the reality of their raise was so different than the original design.
Last week there was the Civic ICO, which used other rules for issuance. These included a waiting list and maximum buy-sizes, which accomplished some of the goals of raising significant amounts of capital and distributing ownership more broadly. But it also left many people out in the cold, unable to buy the amount they wanted or any at all—despite waiting for hours for a chance to buy.
The Tezos ICO, which has been much anticipated, opened up on Friday night—and so far seems to be running smoothly with an effectively unlimited fundraising cap and a wide time window. But it is clear we are seeing rapid iteration as organizations try to figure out how to run a good ICO process.
2) How Do You Deal with High Volumes of Private Discussion?
Private communities are forming left and right to discuss, analyze and coordinate trades. While there are some public or internet-based research and reporting services evolving to cover and discuss coins and ICOs, all of the action is happening in Telegram threads and Slack channels. There is no question that market-moving federations of traders are sharing information in private.
This is to be expected—it is rational for individuals to form trusted communities in private. Groups like these have been around for a very long time. Further, given the level of attacks and bot-scams that are floating around the more public internet and discussion forums, it is reasonable for people to pull back into private spaces.
But the number of these private channels and activity levels make the communication very difficult to manage over messengers or team collaboration platforms that aren’t designed for this type of use. Trying to read things across these closed groups without a consolidated news feed or inbox makes it clear just how valuable things like email and Facebook really are in the social space.
It is clear that traders and funds that build technology to analyze and read private data faster than a human can on their own will have a major advantage in these markets.
3) What Happens When Everyone Raises a Crypto Fund and a Crypto Trading Desk?
Six months ago, there were only a few small operational crypto funds trading coins for limited partners. In the last month, I have seen pitches for dozens of them. Some of these funds are being raised by traditional institutions with traditional bases. Others are running or planning to run ICO processes themselves. Still more are run by individuals who have done well in the crypto markets individually and are looking to expand their capital base. I don’t know this for a fact, but if I had to guess I would say that there are more crypto funds raising capital right now around Silicon Valley than there are venture funds.
The same thing goes for trading operations. Individuals and funds are setting these up left and right, on the theory that given the heavy volume and high volatility in the crypto markets, traders can make more money than in public equities.
As with any funds and trading operations, the best will almost certainly massively outperform everyone else. Over time, all the serious players will build superior tools for managing information and trades—long term, there will not be much advantage in that. But the access to information and offerings afforded to the best and most trusted pools of capital should be a largely insurmountable advantage.
This begs the question: As serious players with serious tools get into the game, how different will the crypto world end up being than the traditional stock market?
4) When Will the SEC Get Involved and What Legal Frameworks Will Dominate?
I believe that it is very difficult to argue that these coin offerings are not securities, and that they will not someday be regulated as securities. I operate under that assumption personally. I think that most serious people share this view, even though they might argue differently at times.
The big law firms obviously also see this and are gearing up advisory services and documents to help clients be well-positioned for the legal and policy discussions to come.
The first question, however, is when will the SEC get involved and on what terms. There is an argument that so long as Americans aren’t clearly falling prey to scams and things are going well, the SEC doesn’t need to get involved in what looks like such a small market today. But, if things continue to grow, and the offering volumes continue to skyrocket—with little formal governance—it is hard to imagine the SEC won’t establish guidelines.
Of course, since the crypto market is fundamentally global, it’s far more difficult for the SEC to actually outline regulation across the whole ecosystem. And partial regulation would be the least effective and most unfair outcome.
The second question is whether the SEC’s involvement would harm or help the market. There is an argument that the uncertainty and fear of scams is depressing the crypto market far more than any free-wheeling activity is helping it. Perhaps this in and of itself creates a conundrum for the SEC: how to protect Americans without explicitly blessing a fledgling way to do business and raise capital.
5) When Will the ICO “Party” End and Capital Raising Rationalize?
Many, or even most, of the organizations raising money through initial coin offerings today would have a difficult time raising similar amounts of capital on the private market through more traditional means. The amount of capital being raised—broadly speaking—is not commensurate with the stage of development of the organizations raising the cash.
Some old-school investors in the Valley analogize it to the late 1990s, when companies were recruiting at Stanford job fairs with millions of dollars of investment and booths labeled “pre-IPO company name TBD.”
The optimistic viewpoint is that the ICO funding underway is rational. Globally, we face a low-growth economic environment. The Valley is awash with well-heeled global capital seeking higher returns, but traditional access to investing in technology startups is limited to just a few. Blockchain fundraising via things like Ethereum is opening up access to “investing” in early stage technology to a much broader set of people globally, who are driving up prices in search of growth. Those that had already been investing in crypto assets have gotten seriously rich, which makes them more willing to invest more.
The pessimistic viewpoint is that these ICOs are taking advantage of people and actually de-legitimizing Ethereum in particular. Investment in these initial offerings are somewhat casino-like. In fact, some of the ICOs advertised on boards like CoinMarketCap literally are casino ICOs! People are not betting on the fundamental value of new businesses, but rather how these crypto assets will trade after they are issued. The game being played by many is how to get pre-ICO access to these crypto offerings before the general market so they can take quick profits. Some of the recent large ICOs may have depressed the value of Ethereum as people have come to this view of the world.
For now, the party is continuing. People are able to raise princely sums of money for new technology projects. But the debate rages every week about whether this is the “last” week of the party.
6) What Is the Long-Term Real Value of Distributed Ledger Systems for Capital Raising?
As a general rule, distributed systems are, in most cases, far less efficient than more centralized ones. Decentralization is a tax you pay when you have either latency issues preventing you from keeping a resource centralized, or trust issues.
With many distributed-systems projects and companies being started, you have to ask whether the distributed nature of this thing gives it an advantage over a centralized competitor. Taking an existing company or technology and putting the label distributed on it might make it perhaps easier to ICO, but in many cases puts it at a strategic disadvantage as a service.
Where blockchain should shine is places where investors are willing to pay a tax to generate trust where there otherwise is none. This makes things like bitcoin very valuable in places where the fiat currency is hard to trust because of questionable economic policy or inflation. It also makes something like Ethereum interesting for distributed voting and governance where the local politicians are hard to trust. Presumably that’s the reason for Vladimir Putin’s interest in Ethereum in Russia—he sees it as a way to prove the government isn’t rigging elections, making the country more appealing to foreign investors.
But what about capital raising for new ventures—which is the prime thing that people are excited about in the Ethereum world right now? Is there enough value in the form of “trust” that it is worth the distributed-systems tax, or are we witnessing a momentary regulatory “hack” that will someday go away?
I believe that what we are seeing, at least in the U.S., is somewhat akin to the Facebook founding story. In that case, if the Harvard administration had created a halfway decent online student directory there would have been no initial energy to enable Thefacebook to take off. It was only because a critical piece of online infrastructure was missing at the university that there was there an opening for a student service to take off.
In the case of Ethereum, there is clearly strong global and U.S. demand for easy ways to raise private equity without piles of legal, fundraising and accounting overhead. If the SEC had a digital platform for registering and coding private financings in an open way, there probably wouldn’t be enough energy for a less efficient distributed system to take off. The SEC is trustworthy enough.
But globally, there is no centralized trusted service for encoding private offerings and raising capital. That creates a real opportunity for something like Ethereum to take off, even if it is less efficient than more centralized options.
7) Are We Seeing a Repeat of the Early Internet?
Let’s go back to first principles. It has long been a collective dream of humanity to be able to remember everything and communicate with anyone, anywhere, any time. When the internet was coming to the fore, there were scams and regulatory issues. There were the boosters and the naysayers and bubbles. But, the dream that the internet represented was universal and clear.
There is a less obvious dream that may be just as important: the ability to get access to capital. I believe that the blockchain’s real use is just that. In the future, instead of having thousands of public equities, we will have millions or billions of securities, with clearly encoded contractual rules traded by machines rather than people (since there is no chance we humans will be able to deal with the complexity).
Could we achieve this vision of access to capital without an inefficient distributed system? Yes. In theory, a trusted entity like a government or group of governments could provide this service. But, they aren’t going to. It is too low down the priority list. So, much like the internet, the people will have to build it themselves.
It will be messy, there will be big arguments, scams, issues and learning curves. There will be opaque communications and strange power dynamics—all of which we are seeing now.
But I believe we are seeing the infrastructure for the most fundamental social shift in 20 years develop before our eyes.