Blockchain was going to change almost everything. It would even achieve the transformation and digitalization of VC, but the hype was followed by disenchantment, but neither is right. Here is why.
A brief history of the Blockchain Rollercoaster
Blockchain has come a long way: from the first works on “a cryptographically secured chain of blocks” and the incorporation of Merkle trees in the early nineties, to its adoption as the underlying technology of Bitcoin in 2008, it lived a life of tranquility, known only to a small proportion of people, before it had its breakout moment that took the value of cryptocurrencies to record heights just before Christmas in 2017.
The rise of Initial Coin Offerings sparked an interest in virtual currencies and the technology that powered it. Suddenly, Blockchain was the silver bullet for everything. Instead, cryptocurrencies have entered a prolonged period of funk and regulators have cracked down on ICOs, so much that the concept of cryptocurrencies even has been declared dead; Blockchain still struggles live up to its hype and adoption in the real world has been slow, though there are glimpses of hope and areas that have managed to make progress.
Despite this, the public image of Blockchain has suffered due to the abuse in parts of the crypto world and the disillusionment regarding the wider application of the technology. Jonny Fry and its TeamBlockchain the other day went as far in the weekly update Digital Bytes as to say that the ICO bubble and the rise in BTC and ETH did the Blockchain market enormous damage as “the market overlooked the fact that clear regulation is vital for market adoption: it gives security to honest entrepreneurs and their clients who, themselves, need to be sure they are operating within the law and safeguarded from frivolous civil action.”
No need to add much to that. The confusion that persisted in the market for a long period of time regarding the regulatory application led to the misconstrued perception that token issues would exist in some form of lawless space. When the first concerns surfaced that securities laws actually might be applicable, issuers of ICOS claimed that their respective token ought to be categorized as a utility token and as such would not be fall under existing securities lawssince the latter are particularly burdensome and have some severe consequences in the case of wrongdoing.
While that was approach quite understandable – after all hope springs eternal – the crypto community had to learn the hard way that these statements would not stand the test of time when the authorities came down on them.
Whereas some skepticism would not have hurt, personally I prefer not to be overly negative and it isn’t all doom and gloom.
Other concepts have evolved like that of Stable Coins, which, in a nutshell, involves the issuance of a token on a blockchain. The tokens are classified as securities given that they usually represent an underlying asset such as shares, debt instruments or funds.
The Regulatory Response
The Swiss regulator FINMA has given a regulatory evaluation of Stable Coins in September last year. The Swiss watchdog published a supplement to its ICO guidelines outlining how it treats such under Swiss supervisory lawfollowing a request from Facebook’s Libra project, which has come under a lot of scrutiny. Such as exercises can contribute greatly to the adoption of a concept as outlined above. At the same time, the Facebook approach as well as proclamations that stable coins are the next big thing run the same risk of creating expectations that simply are not justified.
To explain this further let’s have a look at the impact of blockchain and the digitalization of Venture Capital: in the wake of the crypto boom, ICOs were presented as the end of venture capital as we know it. Considering the ease and speed with which projects collected large amounts in little time (and often with little preparation), it seemed that the classic fundraising models would come under enormous pressure.
More than two years on, we are a little wise and know that there a couple of ifs and buts that would stand in the way of such statements.
Digitalization of Venture Capital
First, if we are talking about digital transformation of the VC model, we need to bear in mind that token models don’t work everywhere. The tokenization of assets like shares needs to be represented on a blockchain to ensure that investors can equally invest and monetize upon a valuable business. In September 2019, the German government has issued its Blockchain Strategy. In this paper, it also discusses the intention to open up German law to accommodate electronic securities, staring with bonds and then moving to shares. Guidelines like the FINMA paper from above or the clarification and amendment of German securities laws are an important element to enable digitalization of financing as without it, there is either too much uncertainty for it to thrive or it simply is a case of old wine in new bottles.
Then, there is the regulatory element we already discussed above and in the previous paragraph: Reputational damage is putting the lid on the “classic” ICO model and serious investors think twice before they put their money into such projects. The token community has tried to remedy the concerns about the seriousness of such fundraising models by introducing concepts like the Simple Agreement for Future Tokens or short SAFT. It’s based on a related legal construct, the Simple Agreement for Future Equity (SAFE), an alternative to the in the StartUp world popular convertible note. It’s a bit of a mixed bag with some already calling it a day, crypto lawyer Stephen Palley rightly pointed out last year that SAFT tokens would be considered securities following a decision by the SEC and not remove the issue of token classification. What it shows though is the need for regulatory certainty and a consistent framework.
Pros of VC
And lastly, there is, of course, another important element that adds value to the “traditional” VC model: Venture Capitalist have plenty of experience in determining the worth of a company, the likelihood for it to succeed and what measures might improve these chances.
That doesn’t mean that it is right for everyone. VCs often act purely on economic consideration within certain risk parameters. There are plenty of examples of ideas and projects that have been shunned by such investors that turned out to be a major success.
The Bottom Line
What does this mean then for the digitalization of Venture Capital? More than anything that everything should be taken with the right measure of realism and pragmatism. Blockchain technology, regardless of all the gravediggers spreading bad news, has a huge potential and still is only at the beginning of its journey. At the same time, exaggerated optimism serves no one but dubious token issuers that want to make a quick buck (and don’t consider the long term consequences – just ask the guys from Centra, for instance). So, the road, as ever so often, lies somewhere in the middle. And the same holds true for the digitalization of VC and other forms of fundraising: technology transforms this sector as it does in other fields and the exact application and its outcome is something that only time will, but in ten or twenty years we’ll be wiser. Right before the next big thing…