Reverse ICOs: Part 1

Methodology, Incentives & Profitability

Harry McLaverty
Aug 1, 2017 · 8 min read
Chance could save SoundCloud, maybe he’ll use this! 🤔 (Source: https://goo.gl/images/XBmG5u)

Disclaimer: I’ve written this blog primarily for content creators, media consumers, blockchain enthusiasts, VC investors, and technology management teams (especially SoundCloud’s!). It requires a basic understanding of the blockchain ecosystem and the SoundCloud platform — best you run through these links before diving in!

In light of SoundCloud’s recent staff layoffs, I thought back to 2013 when I was an intern at Doughty Hanson — one of SoundCloud’s earliest investors. Before I started there, I did a short stint at a consultancy firm where I learned about information research so I could hit the ground running at DH. One of the first ever pieces of analysis I completed was on SoundCloud, explaining what the company did and how it could improve — the investors at DH took a look at it and told me that they had sent it over to the management team, I was in shock!

Since then, I wrote my dissertation on blockchain tech and have seen the ICO market skyrocket. At Convergence.vc’s Creative Industries event, thoughts were cast by blockchain leaders like Vaughn Mackenzie (CEO, Jaak), Lawrence Lundy (Head of Research & Partnerships, Outlier Ventures) and Jamie Burke (CEO, Outlier Ventures) about how traditionally underperforming social networks and music platforms with high product value and engagement like Twitter and SoundCloud (I’d add in Kik and Medium also) could exit through a so-called ‘reverse ICO’ to essentially decentralise themselves. These are my initial thoughts on how that process could take place.

How could a Reverse ICO work?

Ideally, SoundCloud would develop their own decentralised ecosystem and undergo a reverse ICO internally.

Comparing IPOs and ICOs is relatively straightforward; startups ‘IPO’ (or ‘go public’) by offering a portion of their equity to the public markets in exchange for money, giving the company a fluid valuation. Similarly, protocols (the blockchain equivalent of startups, essentially) ‘ICO’ by offering a portion of their tokens to the public markets in exchange for money, giving the protocol a fluid valuation.

Companies undergo ‘Reverse IPOs’ as a simpler and quicker way of ‘going public’. A private company finds a typically underperforming public company and buys enough shares to control it. They then strip away everything but the organisational structure of the public company rendering it a shell, before completing a ‘share swap’ where shareholders in the private company swap their shares for shares in the shell company — rendering the private company public (Example: Burger King).

Similarly, I imagine that SoundCloud could partake in a ‘token buy-out’ of some decentralised protocol, and then issue a token-share swap by creating tokens that represent SoundCloud share ownership and swapping them on a token swap platform like Swap by Consensys. This means that the company’s overall success is measured by a token price, not a share price; the fundamental price drivers behind token prices differ from share prices which is fundamental to how the organisation would make money. (Note: if they were ‘reverse ICO-ing’ with an organisation with a company and a foundation, they could acquire the private entity and proceed as above). Ideally, they’d develop their own decentralised ecosystem and undergo the switch internally.

How Could SoundCloud Sustainably Incentivise All Stakeholders with Tokens?

SoundCloud’s product has three main stakeholders: platform (the company), people (the creators and consumers that make the service what it is) and partners (the advertisers that do not create or consume). Each one of these stakeholders has a series of ‘missions’ to undertake to make the service sustainable, and the best that it can be for everyone.

Each stakeholder has a series of ‘missions’ to undertake to make the service sustainable and the best that it can be for everyone.

Platform Missions: To keep the service running, the platform (i.e. SoundCloud) needs to reward desirable actions to drive acquisition, retention, engagement, and to increase their token price (much like Amazon maintaining the long-term growth of its share price). These actions are what makes the product valuable and are fundamental to key metrics including the number of plays, daily and monthly active users, virality coefficient and upload frequency.

‘Reward people for doing things and they’ll keep doing them’ 🔑 (Source: https://goo.gl/images/o9LY6H)

People Missions: Missions for content creators and consumers are probably where you can get most creative, and how different services could best distinguish from each other. Four ‘people missions’ that I thought of go as follows:

  • Advertisement: Spend tokens to advertise and earn tokens to be advertised to
  • Premium Content: Charge tokens for access; spend tokens to access the content
  • Tipping: Reward others for content you like (especially important for independent artists)
  • Sampling: Earn tokens if other creators earn tokens from music that samples yours (through a percentage revenue fee) — managed by storing songs on a blockchain
Users are neither creators or consumers but are both to different degrees ☺️ (Source: https://goo.gl/images/9xAB3s)

Partner Missions: SoundCloud’s advertising partners will still be an important stakeholder, but in this case, people decide whether or not they want to receive the adverts making the product more useful whilst also increasing the advertiser’s conversion rates because they only advertise to people who have a vested interest in their product or service. I imagine that these adverts would be seeded by the platform which then offers creators and consumers the right but not the obligation to view the advert and they could also earn tokens for SoundCloud partners to advertise through them for a percentage of total fees.

This model could help more people like Chance to have their music heard 🔥 (Source: https://goo.gl/images/sdNhdo)

In a nutshell, this model is a decentralised and tokenised version of the On SoundCloud content monetisation programme for premier partners that blends together all other subscriptions for both content creators and consumers and entails that unlimited upload time, advanced analytics, control tools, unlimited track access and offline listening is offered for free whilst still building a sustainable and highly profitable business — clearly advantageous over the other music streaming platforms.

Note: There are a few very smart and experienced people who have put a lot of deep thought and hard work into outlining how tokenising companies like SoundCloud could work. For more ideas on how this could work, take some time to read work by Fred Wilson, Trent McConaghy, Mat Dryhurst, Jamie Burke and Simon de la Rouviere — great to have my work compared to people of this calibre and expertise!

How Could SoundCloud Use This Model to Become Profitable?

As long as their token price keeps increasing at the same rate that they want to scale, they’ll have a profitable, sustainable and zero commission operation.

One of the most exciting aspects of these systems is how they affect existing business models and lead to new profitability pathways. At present, we have a strong product and token that powers the system — the last piece of the puzzle is profitability. For a solution to this, let’s draw a comparison to Amazon.

Perhaps Jeff Bezos has the answer 🤔 (Source: https://goo.gl/images/aBasJj)

Amazon is a company that has incredibly high revenues yet is renowned for not making any money — reinvesting the majority of its profits to fund new business. It is less well known that it also sells its shares to fund new ventures like Blue Origin. Taking this to the extreme, we may imagine a situation where it completely suppresses profits and become entirely dependent on the periodic sale of its shares to fund its ventures — old and new.

Looking back at SoundCloud now, we could use a similar process in our model. The company swaps their shares for tokens and finances their operations by periodically selling a portion of their tokens on public markets — they would rely on the value of the token increasing over the time for them to grow sustainably. As long as their token price keeps increasing at the same rate that they want to scale, they’ll have a profitable, sustainable and zero commission operation. Furthermore, fundraising and revenue generation would now take place in the same way — selling its tokens.

What’s Coming Next for the Reverse ICO?

After this case study is reviewed and rigorously tested by blockchain pioneers, music industry leaders and equities analysis experts (unless token analysis experts already exist?), it’ll be time to think about which other services we love have an inability to effectively monetise without advertisements or subscriptions. I’ve already thought about Twitter, Kik, SoundCloud and Medium but I’m sure there are several others that would take interest (Tumblr, Snapchat etc?) —we know that high product utility and engagement are important but a more rigorous framework should be developed to include areas like contrarian token utility beyond ecosystem access (potentially a direct link to APIs?).

Current limitations to this model include technical detail (patiently waiting for Kin’s technical whitepaper!), a more stable payments system (assumption: IOTA would work much better than Ethereum), and we should think more deeply about how to assess project performance now that token value has become the new share price (there must be more metrics than MAU, DAU and number of subscribers), and we should consider exogenous factors like news cycles and partnerships. Regulation is also very unclear, especially around governance and platform IP (potentially programmable with Agrello?). SoundCloud itself would also have to decide how its marketplace would operate e.g. do they decide how much it costs to send an advert or what percentage of future revenues earned should be charged to sample someone else’s music — or would they manage a totally free market? Plenty of food for thought!

A big thank you has to go to Michael Tefula and Andy Ayim for being the very first people to review the article — their feedback was invaluable! Thanks must also go to teams and communities at YSYS (Deborah Okenla & James Abayomi Ojo), #poctech ambassadors at Campus London (Anushka Sharma, Katie Wu & Deborah Okenla — again!), Outlier Ventures (Jamie Burke & Lawrence Lundy), Hexayurt Capital (Rob Knight) as well as Frank E. Banks, Zyshan Kaba and Wong Joon Ian for valuable comments, advice and for sharing the article!

This blog post was written by Harry McLaverty, freelance emerging technologies and investment consultant to startups, VCs, and other ecosystem players. I am also a co-founder and trustee at WarwickTECH and one of the four #poctech ambassadors at Campus London.

If you’re new to emerging technologies, are trying to find business use-cases for your existing tech, or want to converge different technologies together and raise investment from the right funds then feel free to reach out on LinkedIn.

I’d love to hear your thoughts on this topic, drop a comment below and hit the 💚 if you liked what you read!