A Blog by Jonathan Low

 

Jul 3, 2017

Bitcoin, Blockchain and the Unbundling of Capital

The challenge faced by proponents of crytocurrencies - as well as those who may be thinking about using them - is whether their hope to supplement or even replace existing systems will provide cheaper, faster and higher returns more equitably and safely distributed. Or not. JL

Abhishek Kothari reports in Medium:

There are roughly 863 cryptocurrencies/tokens in the market today. The total cryptocurrency market has a market capitalization of $100 billion which is roughly equal to the amount of venture capital deals entered into in 2016. Blockchain and its applications in the form of Bitcoin, Ether and other cryptocurrencies/tokens have opened up the debate on greater efficiency, transparency and democratization of the entire capital raising lifecycle i.e. from angel investments to IPO’s.
At the end of this article, you will understand how blockchain has wider ramifications for the financial services industry in general and raising capital in particular.

1. Evolution of Capital: The Joint Stock Company

While the history of joint stock companies can be traced to the Song dynasty in China, in more modern history — the Company of Merchant Adventurers to New Lands, chartered in 1553 with 250 shareholders was one of the first Joint Stock companies. Barring fraud, which is very hard to detect, the Joint Stock Company has survived centuries of corporate structures to emerge as the most reliable form of public expansion of a corporation.
Shareholders have voting rights in proportion to their shareholding. There is a separation of management from ownership (theoretically) and there is a powerful oversight of the management by the Board of Directors.
Many structures such as partnerships, Limited Liability Partnerships, Trusts have enabled the creation and raising of capital with different incentives structured.
Today, Initial Coin Offerings (which are decentralized)using tokens in place of equity shares is creating a new kind of capital market i.e. one that is a hybrid of venture capital (because the money is invested in early stage projects) and the stock market because essentially it is raising capital from the general public and not necessarily qualified investors.
It turns the VC and the capital market models on their respective heads and creates a unique hybrid.

2. The Overarching Theme

There are roughly 863 cryptocurrencies/tokens in the market today.
According to Coinmarketcap, the total cryptocurrency market today has a market capitalization of $100 billion which is roughly equal to the amount of venture capital deals entered into in 2016 or 0.5% of the biggest equity market in the world, the NYSE founded in 1817:
Source: Coinmarketcap, Google search
The market capitalization of the cryptocurrency market is staggering considering its comparison with Venture Capital deployed globally in 2016 but not so much when you compare it to the market cap of an institution such as the NYSE.
This is because, cryptocurrencies are not equity or fiat currencies. Atleast, not yet.
But, there are parallels:
  1. Initial Coin Offerings (ICO’s) are a method of crowdfunding blockchain based projects using platforms such as Ethereum. In a way, this is Venture Capital
  2. The coins/tokens, which represent part of the platform, can be traded on exchanges such as Coinbase although they don’t carry voting rights.
  3. There is a market (demand and supply) for cryptocurrencies.
This is where the parallels stop. While a share price may reflect the present value of future cash flows of a company discounted by an appropriate discount rate, it is harder to quantify the fundamental value of the tokens/cryptocurrencies. The inherent risk in the form of hacking or a lack of official endorsement by governments adds to the suspicions of speculation.
However, it is almost universally agreed that Blockchain remains a revolutionary technology.

3. Removing Friction

Consider this: Gnosis, a prediction market application (also called a Dapp or Decentralized Application) based on the Ethereum platform raised $12.5 millon in 12 minutes on April 24, 2017 with a market cap of $300 million. Consider the intermediaries to an IPO- underwriters, investment bankers, brokers etc.
While an ICO is nowhere comparable to the trust that IPO’s enjoy, there are striking parallels and for advocates of blockchain, it removes friction in investing. Especially (as per Bloomberg) when there is no limit to number of funders as opposed to the 99 vetted investors limited to traditional VC funding rounds.

4. Where is the Oversight?

Imagine a hypothetical world in which each capital market regulator in the world consists of a node in the decentralized network with the most computing power but collectively, these regulators plus a majority of the participants in the Blockchain could monitor code and build trust for the common user base, it would go a long way in commercializing this technology. While this scenario could be true, it is somewhere between a promising and a Black Swan event today.
Granted this scenario could be the antithesis of de-centralization when you centralize oversight but it is also what will prevent the blockchain based platform from turning into the wild wild west.
However, there are resources such as Smith & Crown to track ICO issuances:

5. Could Consortiums Be The Answer?

Many industry leading corporations have formed alliances such as:
a) The Ethereum Enterprise Alliance is a network 116 organisations consisting of fortune 500 companies, not for profits and banks that aims to harness the Ethereum platform for enterprise ready applications.

b) R3 CEV — As per Wikipedia:

R3 (R3CEV LLC) is a distributed database technology company. It leads a consortium of more than 70 of the world biggest financial institutions in research and development of blockchain database usage in the financial system.
R3, for instance is open to regulators to join in to gain industry insight.

c) Hyperledger


To understand how regulators are engaging with Blockchains, refer Chuck Thompson’s piece on coindesk.com:

5. Is Crypto Currency The Next Bubble?

In the short term, possibly yes. But, in the long term, it is yet unclear. While corporations and countries are now increasing their engagement with Blockchain, the underlying technology is gaining traction and like any binary event could boom or bust. On balance, it does seem to be a disruptive, long term strategy.
In other words, if there is transparency on how a token is valued, it could boost acceptability. Today, it is a function of scarcity, speculation and long term investment optimism

6. Conclusion

Whatever the outcome, Blockchain and its applications in the form of Bitcoin, Ether and other cryptocurrencies/tokens have opened up the debate on greater efficiency, transparency and democritization of the entire capital raising lifecycle i.e. from angel investments to IPO’s.
But, the rapidity with which this technology is proliferating means that there has to be swift intervention to do right by the common man. As Sydney J. Harris says:
The real danger is not that computers will begin to think like men, but that men will begin to think like computers.
Technology devoid of empathy is a highway to destruction.

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