ICO Resources

Joshua Cook and Mike Heath are corporate and securities partners at business law firm Gunderson Dettmer, where they specializes in the representation of emerging growth companies and private equity investment funds.

In this opinion piece, Cook and Heath give their view on developments in the fast-growing blockchain use case, noting the ways the tech augments the traditional fundraising process – for better and worse.

Are ICOs ready to disrupt the VC world? Spoiler alert: not yet.

I've spent my entire career doing venture deals for tech companies and I know the good, bad and ugly of fundraising. I've also seen private company shareholders, frequently small ones, stuck holding onto private company stock because there's never been an efficient way to sell it.

Token sales may just change all that.In the bad ol' days (i.e. like six months ago), the development path for a software startup looked a bit like this:

• Step 1: Incorporate
• Step 2: Build team and product, generate revenue and huge user base
• Step 3: Entice a VC to buy ~25% of your equity
• Step 4: Repeat step 2 and step 3 at increasing values and bigger user base numbers until you can sell the company or take it public.
  
  

Token sales (also known as initial coin offerings – although your lawyer hates it when you call them that) seem to offer a great hack.While VC firms expect to see a functioning product before investing, some software companies are raising millions on a white paper.

And while not every project is an obvious choice for blockchain, certain network effect companies that once relied on scale to attract VCs are short-circuiting the process by selling tokens instead – in some cases raising 10x the value in 1/10 the time.

That inverted math has many firms and investors struggling to figure out if they should get in on the token rush.

Advantages and risk

Tokens have some compelling advantages over a conventional equity financing for both issuers and purchasers:

• If it's not a security (and that is the $64 billion "if"), you can make a public offering with press. Securities laws restrict most traditional venture financings only to accredited investors and prohibit publicly marketing the offering to drum up demand.If offerings were opened up to anyone with an internet connection, it might democratize venture investing the way Facebook democratized news editors (for better AND for much worse). It could also unleash the long tail of the retail buyer – although there’s certainly a policy discussion to be had about whether that’s a good thing.
  
  
• Tokens are liquid. So long as there is a functioning crypto-exchange, tokens are much more liquid than private company stock. And because crypto markets are more transparent, you're actually able to see global asset prices in near real-time. Private company equity markets are more or less totally illiquid. The transactions that do occur are typically complex, slow and comparatively large.
• 
  

But, and it's a big but...

• It can be very tax inefficient for issuers. When a company sells equity to raise money, it doesn't pay any income tax on the proceeds. When a company raises money through a token sale, the proceeds are treated as revenue, and therefore subject to tax. In the U.S., you'd expect to pay roughly 40 percent of every dollar raised. While some sales may be structured through tax-exempt and/or offshore entities, that structuring is more expensive, more complicated and riskier than a traditional venture financing.
  
  
• Issuers have little regulatory certainty (i.e. you might not know that you're breaking the law, but ignorance won't be a defense). Even after the Securities and Exchange Commission (SEC) weighed inwith the catchily titled "Release No. 81207 / July 25, 2017: Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO," there is still significant uncertainty as to whether a token is a security. The SEC declined to provide a bright-line test, instead emphasizing that each sale must be considered individually.
  
  To further complicate matters, while the focus to date has been on the SEC's position, the SEC is not the only potential actor in enforcing securities laws. Plaintiffs' attorneys, state attorneys-general and state securities commissioners will all take an active interest in these sales. In response to the regulatory uncertainty, we are seeing projects like Filecoin voluntarily choosing to run its SAFT offering in compliance with Rule 506(b) and Rule 506(c) for their pre-sale and public sale respectively (i.e. accredited investors only.)
  
  
• If an issuer is trying to "do it right," a token sale is (as of now) slower and more expensive than raising an equity round.
  Many projects are providing their buyers with a terms-of-sale document, which reads like a mini-IPO prospectus. Preparing one is a fact-specific undertaking that needs to be tailored to each project. This costs money.
  
  Since these token sales are often global offerings, more risk-averse issuers choose to run regulatory and tax analyses for each jurisdiction they may sell into (e.g. Japan, Canada, Germany) as well as the U.S. This costs more money.

• You're a token holder and you lost your private key? Oh well. In conventional financings, the issuer is a trusted third party. If you lose your stock certificate, the issuer will almost always give you a new one if you pinky swear that you really lost it. But if you lose your private key for your wallet or if your wallet is otherwise compromised, welp ... that sucks.
  
  
• While it's axiomatic that "trusted third parties are security holes," in my experience, there's often another security hole, and it's sitting between the chair and the keyboard. Multi-sig wallets and other innovations may help blunt the risk of loss for a token holder, and people might be more careful with the assets if they know there's no pinky swearing in crypto, but only time will tell. One thing that we know for sure is that there's no "lost crypto affidavit."

A financing model without VCs?

But let's assume that the market gets comfortable with the drawbacks around a token sale; the SEC gives clear guidance that token sales aren't securities offerings, and public token sales displace conventional venture financings – at least for certain software companies. In that future world, venture capitalists will be totally disintermediated, right?

I'm not so sure about that. Venture funds already provide something of a curation function in the Wild West of token sales. Filecoin notably (and not without controversy) ran a pre-sale with a number of top-tier venture funds participating. Likewise, Bancor touted Tim Draper's involvement with its token sale.

Rightly or wrongly, a particular fund's participation in a token sale seems to give a project a stamp of legitimacy.Although anecdotal, I am seeing people (myself included) drawn to token sales who do not have the technical chops to evaluate a white paper.

Proof-of-spacetime sounds amazing, but let's be honest, I don't know if a "tuple of polynomial-time algorithms" is the right approach to the problem because I don't know what a "tuple of polynomial-time algorithms" is.

But if I know that the venture funds that backed the companies that built the internet are backing a particular blockchain project, then maybe I'll defer to their opinion on polynomial-time algorithms.

The token sale phenomenon has incredible potential, but it's still in its infancy. I can imagine a global token market parallel to conventional equity markets with similar liquidity and speed of execution.

Sure, token sales have...continue reading: 
https://www.coindesk.com/token-sales-compelling-advantages-real-risk/

Balaji S. Srinivasan is CEO of 21.co, a start-up that's proposing a system where strangers can pay investors and other busy people to respond to their emails, as well as a board partner at Silicon Valley venture capital firm Andreessen Horowitz.

He has a Ph.D. in electrical engineering from Stanford and has been an early investor in crypto-related projects and currencies including bitcoin, ethereum and Polychain.He's written about cryptocurrencies and tokens frequently, including this piece three months ago about the power of tokens.

After causing a stir in July when bitcoin hit $3,000, the digital currency is now at $5,000.

Here's an edited version of our conversation from last week (and audio of our discussion is located here on my podcast):

Eric Jackson: You can trade private shares on a grey market today, what is so special about the blockchain for facilitating a market for private assets?

Balaji S. Srinivasan: So, first of all, I just want to say that in my view the equity analogy is incomplete. Especially if doing a blockchain or token in the U.S., to be compliant with all regulations you need it to have a utility component and not just use it as a proxy for equities. This is not too hard to do, as there are so many interesting things you can do with tokenized networks. So while I won't be a stickler in every point in this interview for making that distinction, it's a very important one to keep in mind: you want to work with your lawyers to ensure that tokens or blockchain-based assets in general aren't equities.

With that said, relative to existing secondary markets in either property (like houses) or equities, the scale of what is happening with the token market is unparalleled. It's one thing to have a bunch of small secondary markets; it's quite another to turn the internet itself into a market. Anyone with an internet connection can purchase a token. See shapeshift.io for a great example of this.

The rise of all these new tokens and public blockchains means the internet will, in the long term, become by far the biggest "stock" market — once the regulatory issues are worked through — just as it has become the biggest library.

Jackson: How do you see the regulatory aspect of tokens playing out in the coming years?

Srinivasan: The first point is that it's very important to remain compliant with all available regulations in your jurisdiction. From a U.S. perspective, the good thing is that the SEC has made clear that there are some forms of tokens that are not securities.

For example, they referred to ethereum itself as a currency, and they have granted that legitimate innovation in the space is possible.

"The rise of all these new tokens and public blockchains means the internet will, in the long term, become by far the biggest 'stock' market — once the regulatory issues are worked through — just as it has become the biggest library."-Balaji Srinivasan, Founder of 21.co, partner at Andreessen Horowitz

The second point is that this is an international phenomenon; like bitcoin regulation, we'll probably see many different paradigms for token regulation around the world.

Jackson: You often hear that, if the SEC doesn't embrace cryptos, the community will move to places like Zug, Switzerland. What's your view?

Srinivisan: It's not really a future event — the community is already there and growing fast. Crypto is already far more geographically decentralized than (say) search or social. The major players in many other tech verticals are often in the Bay Area and Seattle; the major players in crypto are already spread all over the world. Ethereum for example has its major two loci in Brooklyn and Berlin, with its foundation in Switzerland.

Jackson: Why won't the SEC require tokens only to be sold to accredited investors?

Srinivasan: Without speaking for them, I believe their position as outlined in their filing is that if it doesn't pass the three prongs of the Howey test then it may not be a security. Obviously not everything that appreciates in value is a security. For example, a house can appreciate in value, but you can (and many people do) buy it for the use value. A domain name likewise can appreciate in value, but it's not a security. And from another standpoint a token is similar in many ways to an API key, but that's also not a security. It would be crippling to the U.S. economy to restrict the sale of houses, domains, or API keys solely to the 3 percent of Americans that are accredited U.S. investors.

Jackson: What can and can't be tokenized?

Srinivasan: Tokenization applies to scarce assets. Today the most appropriate thing to tokenize is something that's purely digital. Bitcoin and ethereum are the canonical. Filecoin and Tezos are promising. I think as of 2017 it is somewhat fraught to try to tokenize something like a private asset or a stock given the regulatory uncertainty.

With that said, by say 2025-2030 I expect that there will be multiple jurisdictions that allow the tokenization of virtually any scarce resource, all the way down to personal tokens. That is, like Upstart.com, you may eventually be able to take a stake in an individual's tokens, giving them a lump sum of digital currency today in exchange for a smart-contract-enforced percentage of their future earnings.

Jackson: What's the upper bound for all tokens? Some point to $9 trillion in value of gold holdings, some point to use cases like increased value of unlocked private value — like a bump of 10 percent in the value of all REITs — others point to inherent value of transactions (TPV)? How do you assess what different tokens are valuable?

Srinivasan: Anything scarce will ultimately be tokenized, because the benefits of digitization and increased liquidity are so great. That means cash, stocks, bonds, commodities, houses, cars, digital goods of every kind, and perhaps human time as well in the form of the personal token described above.The regulatory framework will likely eventually accommodate this.

Only a few countries need to allow it, and the consequent creation of wealth will be so large that it'll push many of the rest to have a liberal tokenization regime as well.

Jackson: Someone tweeted this week that ICOs this year were like the glut of fiber optics in the dot-com era; it facilitates later build out of the space. Is this a fair analogy?

Srinivasan: Yeah, it's the Carlota Perez/Gartner Hype Cycle thing all over again. Virtually every major technology has an initial spike of interest, then a dip, and then a long-term rise to success. The dot-com bubble is the canonical example, but there are many more. Bitcoin alone has gone through at least four of these cycles.

Jackson: If the current craze is like the dot-com era, are we in 1996 or 1999?

Srinivasan: Hard to call the timing as that's like calling the top. Certainly you can make an ethereum 2017/Netscape 1995 comparison, or a bitcoin 2013/AOL 1993 comparison. Each wave of hype gets a bunch of smart people working on important problems, and that continues even after the hype recedes.

Jackson: Is tokenization going to lead to a barbell approach to VC where some firms become super-angels and others become more like hedge funds?

Srinivasan: I think tokenization eventually means everyone becomes an investor, once all the regulatory issues are worked out — from your computer itself to a kid in India messing around with $10. It also means everyone from angel to VC to growth to public markets investors starts to buy the same assets. Kind of like how packet switching turned many disparate forms of information (photos, video, audio, text) into packets, the blockchain is turning many disparate forms of scarcity into tokens.

Jackson: There are a lot of crypto hedge funds cropping up in the past two months. How do you assess their quality?

Srinivasan: Look at the team behind them, and of course their track record.

Jackson: Are we headed to a world where every business has a token?

Srinivasan: Eventually, probably yes. If you believe that recent Bloomberg article, frequent flyer miles are evidently a more profitable business for airlines than actually flying people around.

Jackson: What are the cryptocurrencies that are most interesting to you (beyond bitcoin and ethereum)?

Srinivasan: ZCash, Tezos, Filecoin.

Jackson: Are all forks in cryptocurrencies a form of hidden inflation?

Srinivasan: I think they are more like a completely new way to consensually avoid inflation, and run actual experiments. If we could have forked the dollar in 2008 and had an exchange rate between BailoutDollars and AusterityDollars, probably AusterityDollars would have traded higher. But we don't know because we weren't able to run the experimental comparison between an inflating and non-inflating economy.

Jackson: How will we know which crypto companies today are going to grow to become the Amazons of the future?

Srinivasan: They'll say then what they always do: the big ones had great founders and teams. But that's usually only obvious in retrospect, and a necessary but not sufficient condition. Many great founders have one or more big failures on their track record. What makes them great is that they eventually succeed despite that.

continue reading: https://www.cnbc.com/2017/09/05/balaji-srinivasan-21-co-interview-on-blockchain.html