The making of a successful rebellion In the most important ways blockchain transcends the mundane realities of traditional commercialism. Nonetheless, projects still need access to capital and 2018 is shaping up to be a transforming year in this regard. Since the world may not be changed entirely in the year ahead, the following are some market perspectives, strategies and ideas to help blockchain entrepreneurs keep the money flowing until change is realized. Embrace the store/exchange value competition The store value market share of digital tokens is still quite small — and even if significant gains are made in 2018 it will likely remain so. Their exchange value market share is even less. The speculative frenzy notwithstanding, this is where investors are still mostly focused — on the large market cap tokens and the competitiveness of their store and exchange value attributes. Volatility can be accepted if other attributes are deemed sufficient to sustain further market share gains. Many investors are still trying to convince themselves that baseline attributes such as scarcity and immutability are real, they are studying potential governance risks, unpacking trust mechanisms and sorting through otherwise routine infrastructure items such as custody, trading / liquidity and regulations. In important ways, they are just catching up. The intensity of the competition between digital tokens and traditional store value assets is encouraging — indeed the same among digital tokens themselves. More and widespread debate on the merits is needed, including at ever more investor forums. Skeptics should be challenged to elevate their criticism beyond shallow platitudes and technologically deficient sound bites. Blockchain advocates should redouble their efforts and lead this debate, highlighting the realities of the global fiat currency experiment including the logical implications of ever mounting sovereign debt levels. Generational trends in social trust, institutions and the state of global governance more broadly are also important and logical asset allocation drivers and the case for digital token models should include this context. Store and exchange value attributes, particularly of the benchmark tokens, may seem elementary to originalists, but it is important to meet investors where they are. These are sentiment driven markets that depend on these debates, and just like every other market, will be made better by substantive, robust and relevant competition. Speculative interest and store / exchange value will dominant the capital formation landscape Given the state of investor focus it is important for the blockchain ecosystem to recognize that a rising tide lifts all boats. If the benchmark digital tokens gain store and exchange value market share in 2018, we can expect this result, and its magnitude, to lead capital formation throughout the sector. The reverse would also be true. The breadth and depth of investor participation in digital tokens remains too narrow and shallow for comfort — even after the significant gains of 2017. The importance of making further gains in this regard is difficult to overstate. The emergence of more discreet value propositions will certainly accelerate in the year ahead, but their collective impact on aggregate sentiment and sector capital formation is unlikely to be mature or significant enough to lead the narrative. This said, these new projects are critical to the medium and longer term health of the space and the role of blockchain entrepreneurs remains paramount to advancing this beachhead. If new killer apps gain traction in 2018 all the better, but planning for it to take longer seems the prudent course. There is high demand for discreet value propositions Investors need to understand their investments and this starts with a clear and powerful value proposition. When foundations are being built ideas are everywhere — and they range from discreet to broad and from clear to opaque. The investment world is used to this phenomena and can be expected to apply tried and true winnowing techniques to allocate capital — even during periods of speculative frenzy. There is no perfect formula, but certain financially logical variables tend to be favored over others. Large addressable (and monetizable) markets, specialized expertise, demonstrable traction, discreet problem solving and related value propositions tend to win out over the opposite. Some of the most prominent blockchain projects that emerged in 2017 cut significantly against this grain — broad, multivariate and technologically complex propositions raised significant and excessive amounts of capital. New projects are now unwittingly exposed (at least somewhat) to the sentiment associated with the near term progress (or lack thereof) made by these high profile projects. There is also a layering bias for new markets — base layers such as infrastructure and protocols tend gain early favor over higher layer applications — at least until more of the foundation is established. Digital tokens have also (so far and mostly) proposed adding new variables to this equation — namely, less than specific access to potential cash flows and new governance models. The two are related, but by itself the former will be a barrier to a smooth and ongoing intersection with the capital markets. Significant work needs to be done to demonstrate specifically how value will accrue to token holders beyond speculation — and it is not obvious in many existing blockchain projects. Governance transparency is paramount Above all, investors are fiduciaries for the capital entrusted to them. The inherently distributed nature of blockchain poses important challenges in this regard since the models are not only unconventional, but too often unclear. Blockchain remains in its infancy with respect to governance protocols and robust experimentation needs to continue. Significant debate continues between on and off chain consensus protocols. From the investor perspective, knowing the details of a governance model is as important the model itself. To the extent protocols are “on chain”, they will at least be known — even if many of the implications remain unknown. To the extent they are “off chain”, investors need to know the “charter and by-laws” (to use a conventional phrase) and also the fiduciary responsibilities of the board and how members will be held accountable. The exercise should be less about selecting a particular model than it is being specific and complete in describing the chosen form to investors — and codifying them such that investor representation (or lack thereof) can be better understood. Value opportunity notwithstanding, investors will naturally gravitate to governance models that best align with their own fiduciary obligations. But limits can be pushed — especially when value creation takes the lead. Many Google shareholders, for example, grumble about the significant spending directed towards projects that have (at least so far) produced no tangible shareholder value, but they also go along because their search application is so financially prolific. Value creation can be a similar virtuous circle for blockchain projects when it comes pushing for change elsewhere — and remodeling governance structures is no exception. There is significant public sector pent up demand for growth investments If nothing else, 2017 ICO demand offered some window into the public sectors appetite for growth investments. Even if not by original design, regulatory barriers have pushed the pendulum ever further in favor of the private capital markets. Enlightened regulators are keenly aware of this reality and many are actively thinking about rebalancing. Current policies have erected significant barriers between entrepreneurs and public investors and have profoundly changed the functioning of the global capital markets over the last generation. New gatekeepers have exploded into this void have become the incumbents — and because they continue to extract huge economic rents from the current system, they won’t retreat quietly. This is the current battlefield and it will remain as such unless blockchain does something about it. It is also a favorable one for the blockchain ecosystem as it offers opportunity to bring to bear the power of its technology on behalf of public investors and do so for its own sake and while also contributing to the health of the global capital markets more broadly. This is already happening in spades and can’t be advanced fast enough in the year ahead. How much progress is ultimately made relative to conventional forces remains an open question, but the presence of this pent up demand is favorable for blockchain capital formation. There is significant social sector pent up demand for participation Even more than the public sector’s demand for growth investments is the social sector’s pent up demand for greater participation in the global economy. This notion likely seems quaint to traditionalists, but there are good reasons to believe it can gain influence. The appeal of distributed models has resonance far beyond blockchain, but the enabling power of the technology offers potential for staying power. This is particularly true for network models where community management and incentives have the potential to outperform conventional approaches. There is also significant opportunity to re-imagine many conventional business models as new networks. The core of the blockchain ecosystem is evolving in this regard and many are coming around to the idea that a sustained and pragmatic ground war waged over time, may offer the best opportunity for progress — on all relevant fronts. The goal is to realize Toussaintian success in the long run and do so in favor of the naturally seductive and immediate impulses of less successful rebellions. Demonstrably better solutions coupled with constructive regulatory engagement will almost certainly better advance this agenda over isolation. There is a difference between intermediaries and value added services providers A proper derisive use of the term “intermediary” should imply an agent that is either unnecessary or paid excessively for their role. There are plenty that already meet this definition and indiscriminately adding to their ranks seems unproductive. There has been a lot of recent commentary about how blockchain is adopting “Wall Street” and other traditional structures. The reason for this owes more to demand for specialization than it does to a generic “intermediary” monolith. Clearing and settling functionality is redundant in blockchain and therefore superfluous — same with role of many payment intermediaries. To many, required use of an RIA (Registered Investment Adviser) to intermediate purchase and sale transactions may also be considered low or no value added. Specialized skills on the other hand, can and should add significant value. Entrepreneurs tend to excel as innovators, but also benefit from expert advice that support their endeavors. When it comes to engaging investors, experts can offer indispensable capital raising advice as can domain expert legal counsel and many others. Offering or “launch” best practices, advice and infrastructure is perhaps the service category most in need of improvement with respect to robust and ongoing capital formation — long after the speculative environment moderates. It is time to embrace a responsible regulatory framework Not simply because regulators say so (although this is important), but because investors demand a platform they know and understand to risk their capital. Even after the advances in 2017, invested interest in digital tokens remains incredibly narrow compared to many traditional asset classes and their liquidity is concentrated and thin. Perhaps ironically for many, increased regulatory oversight — and more importantly clarity — has the potential to be a major and favorable catalyst. While it is impossible to predict regulatory actions (like all human endeavors), there remains a wall of capital keenly interested in blockchain projects — and they are awaiting more institutionalized “green lights” to signal entry permission. Although this may be a terribly frustrating subject for many blockchain innovators it should not be. Rather like technology problems themselves, realism should prevail in developing solutions. In the near term, U.S. regulators seem inclined to regulate digital tokens as either a commodity or a security — and not as a currency although certain currency regulations will surely apply. Enlightened regulators already know that blockchain and digital tokens are unique, but they are constrained by the now existing regulatory framework. Whether a particular token is regulated as commodity or a security will probably be a function of whether capital was raised to fund a project (i.e. security’ish) or what regulators deem to be their applied functionality — whatever that might mean. It may feel like the proverbial fitting of a round peg into a square hole — but a larger goal has to be engaging more investors. Changing this regulatory framework — and investor conventions — will not be an overnight task and capital access must continue in the interim. The next phase of blockchain capital formation depends significantly on regulatory compliance, acceptance and application. Regulatory engagement should be prioritized This notion seems self-evident, but will benefit from consensus building within the blockchain ecosystem. Certain items seem more conducive to near term resolution than others; modifications to the physical settlement requirements for commodities being an example. “Launching” a new commodity is a bit of an ill-defined thing, but may fit for certain digital tokens — and might be accommodated. Some items may be advanced with technology solutions. Think for a moment about the core functionality of a traditional exchange. In the first order, it is price discovery and liquidity platform. This functionality is also necessary for digital tokens and should remain. Secondarily, exchanges provide clearing and settlement functionality which is superfluous for digital tokens save mostly for AML/KYC and related requirements. On the latter, it is not difficult to imagine how a technology solution could be applied to ensure satisfactory compliance. A simple participant filter applied by exchanges that includes provision of compliant information could do the trick. The information could be encrypted when transactions are registered on-chain, but also associated with a private key that could provide regulators a confidential window to this information. It also seems plausible to envision modifications to Accredited Investor standards to provide expanded investor access and maybe even related secondary market liquidity for these exempt securities — perhaps in combination with compliant technology application. Many in the blockchain ecosystem may not be aware that the SEC already offers a regulatory “sandbox” of sorts for securities. Reg. A, Reg. CF, but even more substantially Reg. A+. The latter enables “light touch” registration for up to $50 million per year in security issues — with some conditions of course. Certain of the now existing conditions for these regulations could be ripe for constructive modification and could be a fruitful forum for regulatory engagement. There are, however, a number of items that should be made lower priority — if not dispensed entirely. While it may have technological resonance, a “utility” versus some other token type is likely a distinction without a difference from a regulatory point of view. Regulatory forum shopping also seems equally unproductive — the goal being to access the deepest pools of capital. There is also privacy. Distasteful as it may feel, the privacy preferences of users cannot ultimately extend to regulatory bodies — compliant information will need to be made available to them. This notion does not have to mean to “centralization” and should be embraced by the blockchain ecosystem — even if as a necessary evil — as doing so will not only advance capital formation, but also faster adoption for many use cases. New heights for blockchain capital formation in 2018 Above all, blockchain projects seeking capital will be increasingly judged based on their investment merits. Discreet value propositions, clear and understandable value access and governance models will be necessary to realize broad investor appeal. Offerings will need to improve disclosure and be compliant with applicable regulations. Doing so does not, however, necessarily have to mean a wholesale return to the status quo. Technology can permit exempt offerings to be marketed globally — and to the extent Accredited Investor standards and issuer safe harbors can be modified, to an even broader group of investors. If secondary market liquidity can be realized in a compliant manner, these type of offerings could become highly effective. Perhaps more feasible in the near term, would be registered offerings that are compliant with existing regulatory “sandboxes” — such as Reg. A+. Many investors already believe that new companies should offer themselves to public investors earlier in their life cycle — in large part to permit earlier and less filtered participation in growth. Whether the related risks have been fully considered and if strategies to manage that risk would be employed are separate questions. Like all markets, but especially equity / venture like investments, sentiment is situational and cyclical. An opening for blockchain projects is to build a collective wave effect that results in the gains from winners being materially greater than the losses from losers. The more such a wave actually builds, the more capital will be available from a broader group of investors and the more the role of conventional private market gatekeepers will be reduced. It takes a powerful technology to underlie this type of momentum building and blockchain has this potential, but even more, it takes driven entrepreneurs to execute their vision and build genuine value one project at time.
