Multi-Layered Raises and why they are relevant

Partha Bhattacharya
11 min readAug 26, 2018

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The development of Vault is presently under way. However, I have been thinking about the evolution of crowdfunding in general. Having put in some thought, I felt like publishing a post on my thoughts on a few more limitations of ICOs and how Vault will have some features that take care of these problems.

Some problems in ICOs are the following:

  1. No accountability for usage of funds
  2. Companies instantly raise huge pile of money instead of raising funds in rounds (series a, series b, etc)
  3. Pre sale and Pre pre sale resemble funding rounds slightly, but they come with their own problems — almost all of it, and outrageous amounts of it is used for marketing
  4. Investors are not only speculating, but are speculating on the ‘there is a greater fool’ philosophy
  5. Companies are left with less money, top-buyers incur losses, few lucky speculators win

No accountability for usage of funds:

The token sales are legally considered as revenue, and not investment, and the tokens are considered to be utility tokens and not shares in the company. In the very beginning of the history of ICOs, this did make sense, because the people you were giving your money to, had proven track record, and the token you were receiving(say ethereum’s ICO) did have some real usage. The accountability came from the fact that the developers have a proven track record and sincere mission. The value of the token came from the fact that the token is fairly limited in supply, and is necessary for using the product — and the product is not something you can replace by a simple code-fork. Both the above — trustworthiness and utility — are absent in modern ICOs. This is not because people who are collecting funds are inherently bad guys. This is because the ICO system by design, creates a nash equilibrium where the bad guys get way more money than the sincere developer who is trying to create something interesting. More on this later. But the main issue here, is that perhaps proceeds of a token sale are trying to pretend to be what they are not. The receiver of funds treats it like revenue, the contributor treats it like a ‘get rich quick scheme’ and both of them inherently agree to pretend in front of the rest of the world that it is a sound way to invest money. There is dishonesty at the root of this system, and it was fun for some people when the music was playing, but the music has now stopped. Perhaps Vitalik anticipated this, and earlier this year proposed the DAICO as a way to reform ICOs, and several companies began building their own DAICO platforms. However, I believe we will soon realize that not only is it important to regulate flow of funds after a DAICO, but it is also important to not overfund projects, which brings me to my next thought.

ICO funding doesnt happen in rounds:

A common saying in the ICO space is —“You get only one shot at raising money from the public”. Let me start off by saying that this is definitely true. The kind of people who are into ICO investing are not the kind of people who are used to carrying out company valuation exercises, and will certainly hesitate to participate in multiple rounds of funding. Not only that, but the subsequent rounds would not even qualify to be called “initial” coin offerings. Lets say a team wishes to sell 500,000$ worth of tokens to the market as a first round, and after 6 months seeks to sell another 4,500,000$ of tokens as a second round. Now think about the investors who have bought in secondary market at a higher price because of scarcity/speculation. They are at a loss. There are 2 ways around this. Either be upfront about future sale rounds, or drop it in as a surprise. Dropping a surprise sale at 80% discount on the market would be nothing short of betrayal of investors, so that leaves us with being upfront and honest. Now if the secondary market is aware that another sale will drop 6 months later at the same valuation, who in their right mind would want to participate in the first round? This means that by being upfront, the company has created a game theoretical situation where nobody will contribute in the beginning. The correct way to deal with this is to have subsequent coin offerings(SCO) at a higher $ price per coin of sale. Lets say, the first round was 1$ per coin, let the second round be 2$ per coin, third round be at 3$ per coin, and let the valuations and hard caps of each round be known from the start. One problem that this solves is that a team that does not perform will not be able to raise large amount of funds. This problem was already addressed by the DAICO system which allowed for a refund in case of unsatisfactory performance. However, the refunds from a DAICO are typically diluted for secondary market participants. Making the funding happen in rounds avoids that to a larger extent. The bigger problem that this solves is the problem for the little guys. There are numerous talented guys on github who do not need or desire to raise 20 million dollars. Maybe they want to raise 500,000 dollars, and based on their PR and fame, thats all they can hope for. However when funding is a one shot thing, people will hesitate to go for such a sale because while it may result in a damn good product, thats all it will ever be. It cannot guarantee an exchange listing, cannot guarantee publicity or marketing, cannot guarantee operations scaling and so on. If this developer has the ability to raise a second round in the future to accomplish the above mentioned gargantuan tasks, then people who have faith in his or her competency can actually take a risk and fund the project. It is a much more sound investment strategy to bet on the talent of a diligent human being than to invest in the possibility of greater fools existing. Now when this initial seed fund is layered with a DAICO system, it is the perfect environment of trust for all involved parties. Small set of 15–20 investors, pre decided cash flow governance, and small dedicated team. Another added advantage over a DAICO here is that the developer is incentivized to design a product which causes the token value to naturally appreciate. Else future sales wont go through. This is neither the case in traditional ICOs, nor in DAICOs.

Pre-sales and private pre-sales:

Perhaps the culture of private pre sales started with the spirit that I expressed in the previous points, but it ended up becoming the fuel that charged up a massive rogue ICO industry. Lets talk about pre sales and private sales. Yes, they are sort of like seed funds and initial funding. However there are some very disturbing realities about these pre sales. First of all, they happen behind closed doors. Nobody knows what deal is exactly made, and what kind of discounts are offered. Secondly, almost all of the pre sale funds are used for solely one purpose: to market the shit out of the company and ensure a successful crowd sale. What happens next is that the pre sale investor dumps the tokens on the secondary market and moves on to the next ICO, and the company is sitting on a huge load of cash. Now what would you call a start up, which uses almost all of its initial funding rounds for just marketing and branding? I would call it a scam. But there is another way to look at it. And that is to accept that presales and private presales are not even close to what seed funds, series A funds etc are supposed to resemble. A company is supposed to use the first round of funding to hire people, build something, market the product to onboard users, and show user growth before asking for the next wad of cash. Now maybe some companies would have done the same, if it wasn’t for numerous ‘crypto venture capital’ companies that pressure companies into quickly marketing, swindling public and insisting on an exit. Given that there are so many companies out there, and if you choose to do things by principles, your investor will find someone with weaker morals, this is EXACTLY what I meant when I said that there is a bad bad nash equilibrium. The only way for this nash equilibrium to break is for the end investors to ask the following question: “if you received funding already and made nothing with that, why should i give you more funds?”, or even better, “how does your funding mechanism ensure that it is in your best interests to protect my interests?” — but the question that erstwhile investors ask is “Is there enough hype to ensure I can find a greater fool?”. While this mentality begins at the large private investors, I am not exactly saying that they are villains. I am saying that they saw a system that could be exploited, and any rational person would exploit it. But now the hen is dead, and there will be no more such rogue golden eggs. The right way to go about it is what any sane investor will tell you, find a talented team, give them money, but ALSO GIVE THEM TIME. Perhaps ICOs followed by SCOs is the design that should have been followed from the start. But hindsight is always 20/20. However, its never too late.

Greater fool theory investments:

“But they don’t even have a product!”
“So what? Someone else will buy it from me at 5 times the price.”

This was a conversation between my friend and I last year(August 2017). He is now a hundred times richer than me. I guess I don’t need to tell you which side of that conversation I was on. My second point touched upon the fund raising guys perspective. Third point dealt with the perspective of VC sharks, and now I want to address the perspective of the every day investor. The greater fool theory is a tragic nash equilibrium where everyone is playing a risky game, and the guy who isnt playing the risky game is losing(missing out on profits). As a result more and more people join the risky game, until there are no more people left to join, and then the music stops. When the music stops, everyone is hurt. Perhaps the most hurt are those who entered late. But everyone is hurt. Now the reason behind such practices is twofold.

Firstly, most retail investors in crypto space have never traded, and do not understand that there will be market corrections, and hence everyone gets FOMO at the same time. This drives prices up to insane points, where it becomes rational to sell off and buy the next hot thing, because otherwise, everything will crash anyway. A carefully priced SCO, say at 2x the ICO price will keep the price stable between 1x and 2x until the SCO is complete. This reduces the limelight recieved by individual coins that appreciate 300x in 6 months and set up the mood for retail investors to happily buy worthless coins at 10x their real valuations. They are used to seeing much more overpriced stuff.

Secondly, there is not much that the coins can do to preserve their own value. a lot of them have completely worthless tokenomics, but even the ones with good tokenomics suffer, because token economics take time to play out. ETH didnt reach 1000$ in 3 months. it took 3 years. When people are looking to make huge profits in a matter of days, they will naturally turn to stupid investment strategies out of simple rationality. One of my favourite token models — KNC token, has not appreciated much, it is actually at ICO price 11 months after its launch. One can start to see how this phenomenon would loop back to motivating ICO teams to overspend on marketing. However this problem is addressed by a DAICO system, because not only is there a basic support base due to ability to refund, but it also enables token holders to give actual consensus to the flow of funds.

All of the above is not guaranteed to turn household investors into level headed individuals, but it is a step in the right direction.

Company and Investors both worse off:

To make my final point about SCOs, I need to talk about the story of Confido, a very famous ICO during October of 2017. It was a decent project, with a decent idea, with one very striking feature, which appealed to me as an extremely welcome step in the ICO space. The developer wanted only $400,000 in a market where it was modest to ask for 10 million $. He said that he didn’t need more than that. Sure, ok, made sense at the time. As it happened, I wasnt the only person who was impressed with this bold plan. The ICO was oversubscribed. Pledges went up to total over 3–4 million dollars in the beginning itself. But Joost(CEO) wouldnt accept more than 400k $, so he set a cap for 2 ether per investor — again, a very welcome move. It still left lots of unmet demand. What happened next was crazy. The ICO ended, the price of the token went from 4c to 1.3$, taking the market cap to 12m$, and based on trading volume, around $2,000,000 had flowed into confido tokens in the next 24 hours. And then in the following 48 hours, the price crashed back down to 30c, leaving majority of secondary market money(80% of the cash flow) in an 75% loss, the company holding $400,000, and a few lucky speculators with 2000% profit on their investments. Now if Joost had agreed to raise $2,000,000, nobody would have been at a terrible loss(based on final market cap, they would be at 40% profit), and Joost would have had 5 times the money with zero angry people. The only problem is that Joost couldnt have possibly known the exact amount to raise. What if a 2,000,000$ raise got bloated up to 40m and crashed? He would have even more angry people.
Imagine an alternative scenario where Joost declares that he will sell tokens worth 400000$ only, and will allow the contract to sell(as a primary market) round 2 tokens at double the price, and round 3 tokens at triple the price at caps of 1.2m$ and 3m$ respectively with stipulated start and end times in the future, he wouldn’t have to worry about huge price swings, as his primary market would act as a stabilizer for speculators, and at the same time, adequately reward people who came in earlier. Not to mention, the whole thing being a DAICO would make it so much more legitimate.

Traditional ICOs have no restriction on the spend schedule, removing accountability from the process
DAICOs restrict the fund usage at collection
By raising money in tranches, there is an implicit resistance between trading tokens after initial rounds

Would like to conclude with this point, saying that the market has had nice swings, and in the process hurt several people. Now will remain dead, without further cash infusion, until and unless the community(us) agrees upon safe investment practices and systems which focus on value, and not on greed.

Keeping in mind these thoughts, we have decided to enable a multi layered fund raising system on Vault. We are finalizing the details of the same nowadays. Join our Telegram community to contribute with suggestions!

Among other news, we are preparing a universal standard for poll smart contracts so that we can build poll audit tools on our new website, for any poll contract that is compliant with our protocol. We have already submitted ERC-1261, and the poll EIP will be submitted soon as well. We have also purchased the domain names www.erc1261.org and www.pollscan.io

https://t.me/joinchat/FwqASEdUSqFIPNBNwPZzfg

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Partha Bhattacharya

Co-Founder at Electus Network, Ex-Goldman Sachs, Electrical Engineer