William Mougayar

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6 Blockchain-based Innovations…or Loopholes?

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On August 19, 2018

In Think Tank

There is no shortage of innovation in the blockchain sector. Technological innovations were the starting points, led by developers. Now, we are seeing entrepreneurial innovations, led by creative entrepreneurs and financiers who are applying the technology in ways not thought of before.

In this post, I’m highlighting 6 applied innovations in blockchain or token models, many of which border on being loopholes that are currently flying under the regulatory radars.

1) Create Your Own Currency

Traditionally, only governments created sovereign currencies. With the blockchain, anyone can design a currency by giving it a special purpose. Using Ethereum, a developer can create a new currency (now called token) in a few lines of code. The good part is that this has fueled billions of capital to fund startups and projects who created trillions of tokens, but this has also simultaneously lowered the quality bar on what gets funded.

2) Say the Smart Contract Issued the Tokens

Since typical regulatory frameworks prohibit companies from raising money from the public without substantial disclosures and due filing processes, one loophole is to structure the public ICO such that- technically, it is the smart contract that is the issuing party. This means that token buyers aren’t sending their money to an entity, but rather to a piece of software that holds it, and returns the equivalent number of tokens. Regulators are still scratching their heads around how to subpoena or arrest a blockchain smart contract.

3) Foundation Controls the Tokens

A common practice is to create a non-profit “foundation” that actually administers the receipt and use of the tokens, but then commissions another entity to develop the technology. There could be a variety of relationships between the foundation and the developer entity, and sometimes the foundation is created before, and sometimes after the ICO. Foundations offer a layer of legal protection, but the fog hasn’t completely lifted on them, and there are no standards for foundation structuring.

4) Adopt a Virtual Jurisdiction

The virtuality of the online world is now taken to the legal level. Traditionally, companies are created within the jurisdictions they are typically conceived from. Of course, we’ve had Delaware-type entities and Cayman-based funds as the precedent for choosing remote jurisdictions. With the blockchain, the leading new alternative jurisdictions are Switzerland (Zug), Gibraltar, Malta, Cayman and a handful of others. All you need is a local lawyer in that jurisdiction to get this done.

5) Air Dropping, Not ICOing

As I’ve described in an earlier post (Utility vs. Security Tokens: Why Not Both?), companies are now air dropping tokens (e.g. 20% of total distribution), while keeping a significant percentage as reserves (e.g. 60-80%). Then, they wait until the token starts trading upwards (assuming there is some speculative hype or real usage that drive it). At that point, they start selling their reserve tokens into the public markets to fill their treasury. In essence, it’s like getting the effects of an ICO without raising money from anyone, and flying under the suspicious radars of regulators.

6) Trade-Driven Mining

This practice is being popularized by new exchanges (Binance, Huobi, KuCoin), and it is well described in this article by Mohamed Fouda (How Asian Exchanges And Investors Are Making Huge Profits Through Trade-Driven Mining). As the author explains, the exchange token is distributed to users based on their trading volume, in essence subsidizing the transaction fee. By distributing their native token, the exchanges also drive the demand and price up, and they make their profits from the token appreciation in the market. In addition, to further tighten the supply/demand equation (which drives the token price even more up), some of them (e.g. Binance, KuCoin) are buying back and burning a significant number of their tokens from up to 10-20% of their profits, each quarter. This is the most machiavellian scheme I have ever seen in this space.

In my opinion, all of the above schemes equate to legal, or financial engineering prowess, and are less about product innovation. You can implement any of the above and still fail if you haven’t been able to develop a real product with substantial traction.

In the case of the trade-driven mining example, the scheme looks like a perpetual bribe for usage, almost like loyalty points that appreciate in value, so it is very attractive to users. Luckily for these exchanges, they do have a product that works.

Generically, one could extrapolate that model into any usage-driven token reward for any product, blockchain or not. Wouldn’t be nice if Apple had given you a token for every product you bought from them, and let that token appreciate in relation to their stock price? If that was the case, you would have received a x22 bump on that token price since the first iPhone was introduced, 12 years ago. Even with a less extreme case of appreciation, let’s take United Airlines whose stock appreciated x3 in the past 5 years. Anyone would have loved a 3x bump on their MileagePlus points, no? If a new credible and safe airline appeared on the scene tomorrow, with a fly-based mining reward scheme that is linked to their token appreciation, I’m sure it will instantly get filled with travellers.

That said, the jury is still out on the longevity of these practices. Entrepreneurs are always 3 to 4 steps ahead of regulators.

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The Long (Blockchain) Crash

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On August 16, 2018

In Think Tank

For the blockchain market, comparisons to the Internet abound, especially on whether the dot Com crash of 2000 will bear similarities to its blockchain cousin. A simple analogy would lead you to believe that since we are probably around the 1997-1998 time-frame in relation to Web chronology, when we cross into 2000, a similar crash might happen. For that class of believers, they would have you sit out the current blockchain activity, wait for an imminent blockchain crash, and then pick up its pieces, just as you might have done with the Internet, post 2002 when the post dot-com bear market ended. But that argument doesn’t necessarily hold a lot of water in the blockchain space because of the thesis of this post:

Rather than one big crash that resets the entire field, there will likely be a succession of mini crashes, one following the other. Each one of these mini crashes will flush some bad coins, while simultaneously bringing new ones, and giving birth to new projects of increasingly higher quality.

So, if you are waiting for a big blockchain crash, it may never happen as such, because it is already happening in smaller (yet significant), successive doses. It’s like death by a thousand cuts. More importantly, if you are a venture investor, skipping this period would have you miss the opportunities that continue to emerge, as well as miss the learning experiences which only come from being directly involved in something. Furthermore, while the Internet crash of 2000 put a temporary chill on the funding of new tech companies, the blockchain’s market cap volatility is barely affecting the pace of startup innovation and open sourced decentralization projects that are getting funded.

If you look at the recent market highs of January 2018 (and December for Bitcoin specifically), and compare to where we are today, you will see that we already have seen the equivalent of a crash in terms of market capitalization losses, across the board. The low of $190B on Aug 14th 2018 is about one quarter of the market value high of $828B that was attained in January. Many coins are currently trading at 10-20% of their highest value. And there were other crashes prior, when market caps lost billions again. Here’s a chronology:

Chronology of Major Cryptocurrency Crashes by William Mougayar

It is interesting to note that while the first crash took place over a 2-month period, the second one took 4 months to materialize, and the current one has been 8 months in the making. Maybe there is a correlation somewhere, but it may be too early to declare a pattern. Each one of these mini-crashes corrected the market by 57% to 77% of its original value.

In contrast, the dot-com doldrums lasted 19 months to be exact, from March 2000 until October 2002, when several companies lost 80-90% of their stock value, and many didn’t even survive. Interestingly, upcoming companies such as eBay and Amazon also saw their value drop significantly then, but recovered quickly thereafter. The dot-com crash did wipe $1.7 trillion in total market capitalization value for companies, but this is not a fair comparison because that included drops from large, established tech companies such as Cisco and Qualcomm, and not just the dot-com newcomers.

Here are some factors that make investing during this turbulent period challenging, but still interesting:

  • Many companies get granted early liquidity, which isn’t always a good thing. Along with that, comes volatility as a risk itself, because the price fluctuations are speculation driven, and not performance related. So, the price movements caused by traders who are momentum chasers will give you false market signals.
  • The Blockchain ecosystem has perfected the art of hype and expects that ideas, not results should be funded. Some entrepreneurs believe that the bigger the idea is, the higher the expectation of the funding requirement should be. And there is this false sense of entitlement that “token valuations” are the current norm, and that new, virgin projects need to inherit these similar multiples from the minute they are conceived.
  • The laws of startup evolution and typical high failure rates will continue to apply for several reasons that Fred Wilson aptly enumerated in a post titled Drinking From the Firehose: “Some will fail to ship. Some will ship things that don’t work. Some will ship things that work but aren’t adopted. And some will ship things that are adopted but are surpassed by something better.”
  • The fog has not cleared yet on the infrastructure and middleware layers. New players could still become dominant in the space within a two year period, given the right product is conceived. Moving sands can quickly reshape a beachhead.
  • There are far too many pure crypto funds that operate like a hedge fund and they are speculating in a cryptocurrency market where it is too early to clearly discern the fundamentals that can be measured. The current system is loaded with promises, and there aren’t enough visible cases of blockchain usage to re-balance the scale between forward expectations and actual performance. We have clearly overshot expectations in this area. I’d like to see more projects with users, and more visible use cases going live. As I wrote earlier, we are in dire straits for token usage metrics to bring some sanity into how we could (better) evaluate some of these coins, A Guide for Blockchain Usage Metrics.
  • Getting users is still the toughest part of blockchain projects. Not only do companies have to get their model right, they also need to get the token model to work properly. So, it’s a compounded set of iterations, interlaced with each other.
  • Too many cover ups are difficult to detect. Any project that raised money in 2017 and still has no users or traction to show is probably headed to zero. A token offering is a lease on startup life. It keeps you afloat independent of VCs deciding to fund you or not. Extending your life doesn’t mean you have a good life. In the absence of real accountability strings, self-assessment is not always good enough. Nobody will admit their baby is ugly. Sending them multiple times to the contest won’t help them win.

For all of the above reasons, fundamental venture capital investing skills and experience will continue to be important, and not just the ability to get an early token discount in a private offering (so you can flip it), or figure out when a coin’s price will take off because some major exchange is going to list them.

There is hope that amidst this most severe correction, less babies are thrown with the bath waters, and that the better tokens re-bound faster than others. There are some gems and real diamonds in the ruff as well as ones that have yet to come out. We need a recovery where the good coins distance themselves from the not so good ones, just as the stock market rewards performance with varying degrees of valuation multiples that are not so arbitrarily granted to companies, but are based on deserving realities.

In sum, with the blockchain, good companies will continue getting created, out of each mini crash cycle. This was not the case with the dot-com crash when almost everything dried out for almost two years after the main crash. If you are an active investor, you’re not going to get necessarily smarter by avoiding the battlefield, even as potential winners are sitting on the same roller-coaster ride as the ones that will get ejected along the way.

Yes, the blockchain can keep giving, but it will also continue bleeding.

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The Self-Effacing Globally Decentralized Organization

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On July 22, 2018

In Think Tank

I have been an avid student of globalization for over 2 decades, and while globalization has its many advantages, its pitfalls are several fold and felt on society.

Global companies are big, and for them, growth is the primordial goal. They need to open new locations and continue to introduce new products in order to continue to grow. American, Asian and European companies have perfected the art of global growth by expanding their presences everywhere there is an emerging market. I reflected on globalization during a recent trip to Italy, as I realized that the global retail brands had taken over Rome and Milan. In the apparel category, shopping areas and streets that used to be filled with small Italian artisan designer brands 15 years ago, are now supplanted by mostly American and global fashion and designer brands. The streets signs look the same as you would see in an traditional mall, with many similar brands everywhere. How many Timberland shops do you really need to see while walking 30 minutes in Rome? It seems that the old “Walmart taking over Mainstreet” phenomenon in small towns has now hit the big cities, and it’s not the work of Walmart, it’s rather death by a thousand brands. This bring us to the blockchain, and making me ponder what kinds of global organizations will it create? From what we can see today, there are 2 types of organizations that are emerging: companies that will grow the traditional way like today’s global organizations do, and others that will be global via a self-effacing way of decentralized propagation. In the emerging global-traditional types, we have the likes of Coinbase, and they are easy to spot and follow. These companies will have a global footprint as they grow and expand beyond their bases. But on the other side, we have the new self-effacing blockchain organizations. These are not your typical organizations. The most visible ones at this point are protocols that enable a multitude of other projects, and some will achieve a global footprint that rivals traditional global companies. In that camp, we have Bitcoin of course, as well as Ethereum. There is no official central organization behind Bitcoin. Its growth and direction are largely shaped by the global community that touches it. Ethereum has been very much on the same path. The Ethereum Foundation did plant the seed for the Ethereum protocol, and was responsible for the initial burst of technology development around it by funding EthDev, the original “core” development group. But today, the Ethereum Foundation (and its principal creator and founder, Vitalik Buterin) are going out of their way to act like an organism that doesn’t solely drive the Ethereum related agenda and activities, but rather acts more as one of its spokes, and takes much of its direction from its community. The Ethereum Foundation is doing a great job self-effacing itself in favor of a truly decentralized community with several discrete parts that move along a general directional path that is common and transparent to all. Maybe this gives a glimpse about to expect when we have more of these types of organizations, ones that are started with the specific intent of not evolving as central command and control organizations, but rather like ones that gradually step back and are comfortable being in the shadows of who they are enabling. Let’s hope the blockchain generates several organizations that are well intentioned on enabling the creation of many new players, many of which will help to create others, like a distributed network of businesses that are chained with one another. For these types of organizations, they are like a nucleus that generates benefits in the exhaust of their activities. Let’s hope that many independently decentralized blockchain businesses flourish and continue to shine in their originality, just like Milan and Rome used to be peppered with smaller, unique shops from independent designers that were original and creative.]]>

Tokenomics – A Business Guide to Token Usage, Utility and Value

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On June 10, 2017

In Think Tank

Token EconomyDespite the incredible amount of attention and material written about cryptocurrency tokens, there hasn’t been a good mainstream definition of what they are. In the technical realm of the blockchain, the concept of a cryptocurrency token is well understood. It represents a programmable currency unit that is bolted to a blockchain, and is part of smart contract logic in the context of a specific software application. But in the non-technical arena, what is a token, really?

A token is just another term for a type of privately issued currency. Traditionally, sovereign governments issued currency and set its terms and governance; in essence directing how our economy works with money as the exchange medium for value. With the blockchain, we now have new types organizations (and soon, more of the existing type) who are issuing their own currency in the form of digital money as cryptocurrency, and they are setting their own terms and rules around its operations, in essence creating new self-sustainable mini-economies.

What was the purview of governments is now in the hands of the many.

In the business realm, we can define the token as:

A unit of value that an organization creates to self-govern its business model, and empower its users to interact with its products, while facilitating the distribution and sharing of rewards and benefits to all of its stakeholders.

The Achilles heel of token-based models will be how they are concocted to interact with the business model that underlies them. However, much of the attention has been on designing ICO’s to optimize for cryptoeconomics, a term that has come to describe the mechanics and specifics of token distribution, according to a given sale and ownership structure.

Going forward, the token usage relationships will be far more important than the design of its underlying cryptoeconomics. As this article aptly points out, there is no perfect token sale structure. You can precisely engineer an ICO and that will get you to launch it properly, but then you still need to deliver a viable business model for the long term.

In early 2015, I explained (yes, it was quite early) token usages in the context of a Distributed Autonomous Organization Operational Framework, and I summarized a few usage models including the rights, rewards and work models that are being practiced now. Much of what I wrote then applies today, even more so, especially this part:

“The key objective of a DAO is value creation or production, and to make that happen, there needs to be a specific linkage between user actions and the resulting effects of those actions on the overall value to the organization.” 

“Usage without value linkage is a waste and will result in a failure backlash. A new DAO is like a startup. It requires a product/market fit, business model realization and a lot of users/customers.”

The utility role of the token is a primary consideration in the success of the models that intend to exploit their powers. Tokens are multi-purpose instruments, and we are beginning to see more clarity in how they are being applied.

After analyzing dozens of past and upcoming ICOs, I have come up with the following comprehensive categorization for the role, features and purpose of tokens. This should help prospective and existing ICO-based companies to hone-in and focus their efforts on what will matter for their future success.

The framework I’m proposing has 3 tenets for the token utility:

Role  –  Features  –  Purpose

Token Usage and Value Model by William Mougayar

Each role has a key purpose, as depicted in the below chart.

Guide to Crypto Tokens Usage and Value by William Mougayar

The Right

Owning a token bestows a right that results in product usage, a governance action, a given contribution, voting, or plain access to the product or market. In some cases, tokens will grant real ownership, even if most organizations are trying to avoid passing the Howey Test by skirting around the ownership aspect. For examples, look at Numerai, DigixDAO, FirstBlood and Tezos.

The Value Exchange

The token is also an atomic unit of value exchange inside a particular market or app, resulting in the creation of a transactional economy between buyers and sellers. This consists of features that allow users to earn value and to spend it on services that are internal to the inherent ecosystem. They can earn it by doing active work (real work and actions), or passive work (e.g. sharing data). The creation of such an internal economy is arguably one of the most important outcomes, and one that must be sustained over time. For examples, look at Steemit, Kik, Tezos, and Augur.

The Toll

Just like paying a toll to use a freeway, the token can be the pay-per-use rail for getting on the blockchain infrastructure or for using the product. This also ensures that users have skin in the game. It can include running smart contracts to perform a specific function, paying for a security deposit, or plain usage fees in the form of transaction fees or other metered metric. For examples, look at Gnosis, Augur, Melonport, Tezos, Dfinity, Ethereum, and Bitcoin.

The Function

The token can also be used as a lever to enrich the user experience, including basic actions like joining a network, or connecting with users. It can also be used as an incentive, if it is given in return to begin usage or for on-boarding. For examples, look at Dfinity, Steemit, Civic, and Brave.

The Currency

The token is a very efficient payment method and transaction engine of choice. This is key for enabling frictionless transactions inside these closed environments. For the first time, companies can be their own payment processors without the cumbersome or costly aspects of traditional financial settlement options. Tokens offer a much lower barrier for processing end-to-end transactions inside a given market.

The Earnings

An equitable redistribution of the resulting increased value is part of what blockchain-based models can enable. Whether it is profit sharing, benefits sharing or other benefits (such as from inflation), sharing the upside with all the stakeholders is expected.

Assessing the Token Utility

When evaluating a given token-based organization, the more boxes that can be ticked pertaining to the role of the token, the better it would be. The role of tokens is like nails that encroach on your business model. You want more than a single one to hold it firmly in place, and keep it defensible and sustainable.

This is where entrepreneurs creativity has been shining, as they invent and create the many ways that a token can be put to use, at the operational level, i.e. as the rubber meets the road. It’s really about innovation at the token level.

If the token usage is obscure, not well explained, or not defensible, there is weakness in that model.

I’m not sure that app coins vs. protocol coins are the right way to segment these tokens. It doesn’t provide added clarity to an already obscure and new practice.

Here is a proposed set of questions to ask. If you are an ICO-based organization, give yourself 1 point for each yes answer, totalling a maximum of 20 points:

  1. Is the token tied to a product usage, i.e. does it give the user exclusive access to it, or provide interaction rights to the product?
  2. Does the token grant a governance action, like voting on a consensus related or other decision-making factor?
  3. Does the token enable the user to contribute to a value-adding action for the network or market that is being built?
  4. Does the token grant an ownership of sorts, whether it is real or a proxy to a value?
  5. Does the token result in a monetizable reward based on an action by the user (active work)?
  6. Does the token grant the user a value based on sharing or disclosing some data about them (passive work)?
  7. Is buying something part of the business model?
  8. Is selling something part of the business model?
  9. Can users create a new product or service?
  10. Is the token required to run a smart contract or to fund an oracle? (an oracle is a source of information or data that other a smart contract can use)
  11. Is the token required as a security deposit to secure some aspect of the blockchain’s operation?
  12. Is the token (or a derivative of it, like a stable coin or gas unit) used to pay for some usage?
  13. Is the token required to join a network or other related entity?
  14. Does the token enable a real connection between users?
  15. Is the token given away or offered at a discount, as an incentive to encourage product trial or usage?
  16. Is the token your principal payment unit, essentially functioning as an internal currency?
  17. Is the token (or derivative of it) the principal accounting unit for all internal transactions?
  18. Does your blockchain autonomously distribute profits to token holders?
  19. Does your blockchain autonomously distribute other benefits to token holders?
  20. Is there a related benefit to your users, resulting from built-in currency inflation?

Keep in mind that even if a company ticks the above list with a high score, they still need to execute on it. So, this list is more necessary than sufficient, for success.

All ICO-based companies are encouraged to review their token usage. The more usage scenarios they can check, the more resilient their Token-to-Market fit might be.

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Small Bets vs. Big Bets: Another Take on Tech Bubbles Formation

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On August 27, 2015

In Think Tank

“In theory, theory and practice are the same. In practice, they are not.” – Albert Einstein

bets-imageThere is an acceptable way to describe VC investments as bets. Venture investors “bet” on your idea, product, team, market. And that’s a perfectly good thing.

Some are small bets, and others are big bets. But there is a “big” difference between how small bets get big.

The difference is that big bets are more risky if they get big fast, whereas smaller bets that gradually become bigger are safer bets.

Smaller to bigger bets is the natural evolution of progressively commensurate funding rounds that have some orderly pattern to them, i.e. raising more capital as the company progresses with results.

But once in a while, there are aberrations and anomalies when the startup suddenly wants to raise a lot of money resulting in a bigger (assumptive) bet, before small results are achieved.

When lots of sudden big bets start to accumulate, there is a reason to start worrying that a bubble may be forming, because big jumps in valuations at early stages have a weak base, because they are generally prior to product/market fit, or prior to being reasonably confident that the startup will capture a large part of a given market.

Weak bases will crumble when things don’t go as planned, and when customers don’t adopt the new solutions as fast as the theoretical expectations.

Yes, you can accelerate user adoption with more money, but only up to a point, and usually after initial product/market, and if the market is big.

Memories of Webvan come to mind. Webvan raised close to $400M, reached $4.8B in valuation, only to produce $400K in sales, and then went bankrupt. The big bet preceded their practical market formation, because the conventional wisdom at the time was that you needed to invest that much money to capture that market opportunity. I’m hearing similar echoes of that “wisdom” in some blockchain related companies that are raising huge amounts of moneys to go after the financial services markets, as I wrote recently in Warning: Unrealistic Valuations in the Bitcoin and Blockchain Space.

Yes, Capital Markets do Matter for startups (Fred Wilson), and Public Stock Markets Will Affect your Funding Round Even if you Can’t Perceive it (Mark Suster), but ultimately, venture capital is an adult’s game. It’s a bit like hockey, football or rugby. Players get hurt all the time and it’s expected. Most of them get back in the game, bruised and often wiser. And that’s OK. But when spectators (the public) get hurt, then that’s not such a good thing.

Somewhere between the players and spectators analogy are the startups with high ambitions. I’m torn between cheering for their ambition so we can re-learn the lessons of extreme optimism, or whether to put a damper on that enthusiasm.

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