Of course, there are many different kinds of ICOs ranging from fraudulent to highly credible, from decentralized blockchain endeavors and crypto currencies to centralized closed networks or even to companies not even involved in blockchain at all. This paper focuses on decentralized blockchain endeavors, which includes crypto currencies as well as other peer to peer blockchain networks. As well as, for example, decentralized blockchain endeavor for an open security marketplace as proposed by ChainBLX and others.
Most established venture capital (VC) companies are investing with a longtime horizon (5-10 years to exit). VCs don’t only provide funding; they will become partners in the business which they invest in (e.g. controlling the board of directors by placing directors on the board). VCs provide their expertise, and use their connections to enhance that business. Therefore, enticing a VC to invest in a company is akin to brokering a joint venture deal between your company and one of the leading companies in the world rather than merely requesting a bank loan.
Thus, a VC not only considers the potential rate of return (ROI) of their investment, but also considers how the company fits in their overall portfolio. Because of this specific mindset, VCs are similar, but not equal to, larger companies who are ready to undertake a joint venture with any smaller company or start up. In a joint venture; a larger company invests resources and time of top management, time of highly skilled employees involved in cross functional teams and often infrastructure and materials. Thus, a large company invests time, expertise and money, the same three principle elements a VC invests in a startup.
The VC firm invests the same three elements but rather than providing skilled employees in cross functional teams (mostly engineers and project managers) they provide more support geared to C level management and with this more strategic and budgetary expertise.
Therefore, both VC and larger companies engaging in business are very concerned about the management team. They often prefer to have some members of the management team be ones that they have already worked with. This partly ensures that matters are handled as expected. This said, the focus from VC is more directed to the overall higher management expertise, where the focus of the larger firm for a joint venture is more focused on the management of the cross functional teams and the engineers of the project itself.
The current VC business methodology is the root of a major problem with getting VC companies to invest in decentralized blockchain endeavors because a real decentralized blockchain venture has to write the management out of the equation as quickly as possible, as postulated by Karl Seelig (Co-Founder of ChainBLX) at the CB Blockchain Conference on March 22, 2018 in San Francisco.
“Normally when you build a company, you think about how to keep all the power to yourself and so on. With blockchain it’s totally different. You want to decentralize; you want to give the power to everyone. So, you have to always plan how to write yourself out of this equation.” Karl Seelig (Co-Founder ChainBLX)
The reason is that a decentralized blockchain project shifts the trust from one entity to the whole consumer base. Any concentration of power would give a non-desired, counter-productive, possible single point of attack. Which could be used to overtake control, abuse, or hack the system or to commit fraud.
Therefore, most of current ICOs are supported by the blockchain community itself in the same way that open source projects are supported by donations and evaluated for the value it brings to this community and/or ICOs are evaluated for strict speculative reasons from certain members of the same community. The non-conformity of decentralized blockchain endeavors with the current business model of VCs seem to drive a nearly unreachable gap between both communities.
To breach this gap, VC would have to change their business methodology perception. VC companies would have to evaluate endeavors by how effective the current management team writes itself out of the equation as soon as possible, rather than how well they believe they will work with the current management team in the long run. VCs will have to evaluate the longevity of the endeavor by how much community support currently exists, as well as how much the community will grow in the future and the plan to foster such a growth with support but not being in charge. VC should evaluate how one decentralized blockchain endeavor increases their overall portfolio strength of all blockchain endeavors. In addition, VCs have to analyze the future value of the token or coin for their potential return on investment. All in all, a lot to ask. And to gain funding over VCs its more likely that a startup has success by conforming with their business model than a VC with the model of a new arising but untested industry.
This being said, the good news is that VCs really don’t have to change their business model rather than their point of view. Once this change occurs VCs may soon recognize the tremendous opportunities they gain from a decentralized blockchain business model investment such as, accelerated timeframe to product launch and with this less startup cost and uncertainty of expensive long development phases. VC firms will see through blockchain-community engagement, cost savings and better reliable key performance indicator of future success of the endeavors they invest in, as well as honest feedback given of the current state of their endeavor. VCs firms will also enjoy a wider variety of possibilities to exercise influence over the whole endeavor as explained. Exactly here the expertise of VC firms comes to fully aide and advantage of any decentralized blockchain endeavor able to be financed over VC. Last but not least the exit strategy is planned and built-in from the beginning and can be executed with flexibility to the liking of the VC (considering their current prognosis about the future of the project, need of liquidity for other projects).
It’s a little bit like curling vs ice hockey. VC are used to seeing investments as investment in one player keeping control over the puck instead of investment in the guys with the broom deciding where the curling stone goes. The risk reduction for the VCs comes from the fact that you can add and replace the guys with the broom quicker than the person holding the puck during Ice hockey game.
First, it is unreasonable for anyone to ask for VC from a business partner in a joint venture, or any educated investor to provide a onetime lump sum payment upfront without any milestones and staged funding attached to the investment. There is absolutely no reason why an investment in ICO cannot be staged as most traditional investments in more than one founding round.
Second, as the management team for a decentralized blockchain project has to provide and execute a plan as effective as possible to write itself and the investors out of the equation, the methodology of compensation has to be clearly established. This means an overall economic analysis of the value of the potential future value of the coin/token as well as a delusion factor due to the creation of new coins/token, has to be clearly established if applicable.
Third, just because the management team writes itself out of the equitation concerning the direct control of power over the project, it does not mean that they’re done, nor the job, nor the investors. Granted now it is time to clean house if necessary. VC firms as well as the original management team can now change how they want to proceed, but whatever their decision is, the indirect involvement of both of them stays necessary to make this endeavor profitable. In this phase, “the hidden phase of Decentralized Blockchain endeavors,” the experience from the remaining team and VC comes to full bearing. The hidden phase is to increase the value of the coin/token by actively guiding the growth of the decentralized blockchain endeavor, meaning adding new open source features and undertaking marketing as well as business development in form of convincing enterprises to become a part of the project. (Simply put, as more people start using the blockchain project, more valuable the token/coin.) Just because the decentralized blockchain project has now a life of its own, doesn’t mean that it can be abandoned by the creators. The life of its own and the possibilities for third parties to create their own business upon the blockchain is a boost in popularity, which traditional companies seldom experience.
A wide range of strategies for VC become available here. Instead of a traditional second round investment, VC firms can actively foster the blockchain endeavor by choosing the same team, other teams, or a mixture of both for further contribution in marketing and open source software to increase the value of the token or coin. VCs will have to require that the founding teams plan for this second hidden phase. VC firms also have to stage investments so that there is a possibility to finance such a phase beyond the initial breakeven point.
VC firms will notice that due to the initial set up there will be much less administrative cost in a decentralized blockchain endeavor than in traditional investments. They also will notice that the decentralized blockchain endeavor will adjust much quicker to market conditions due to the community involvement and be able to find and exploit its market niche.
Thus, if generally considered, there is not a big difference to investments in such a decentralized blockchain endeavor or to invest in a company, which will offer an open source version of its software and has a software as a service (SaaS) model behind it. The biggest difference is in the generation of revenue for the investor and founding team. In a decentralized blockchain endeavor the revenue stream for investors and founding team is only linked to the appreciation of the token or coin. Therefore, investors like everyone else, will evaluate a decentralized blockchain project considering the overall economic impact of the endeavor rather than a narrower traditional view. VC firms will in addition ask for a premium to invest in decentralized blockchain endeavor because of the legal due diligence they have to do. (Just because it is called token or coin does not mean that different governmental regulation doesn’t apply.)