The Emergence of Fund Tokenization
By Kyle R. Chapman and Robert Frasca
Blockchain technology, a phrase that has captivated the collective mindset of venture capitalists and entrepreneurs alike, is fueling the creation of an astonishingly diverse set of innovative platforms at a remarkable pace. From digital currencies and initial coin offerings (“ICOs”) to new cyber security and supply chain protocols, forward-looking enterprises have begun to realize that blockchain technology, and the opportunities it continues to foster, can no longer be trivialized or ignored. The evolution toward a more decentralized and secure ecosystem of information and digital assets will move forward whether existing industry stakeholders choose to participate in it or not. This is becoming evident as the first real, consequential debate on fund tokenization unfolds between existing gatekeepers and hopeful new entrants of the venture capital industry.
By now, venture investors and emerging business owners are well aware of the benefits an ICO can afford as well as the exponential rate at which the number of offerings and amount of capital raised through this mechanism have accelerated. In 2018 alone, there have been 926 ICOs that have raised an aggregate $5.9B compared to 872 and $6.1B over the entirety of last year.
Still, this rapid progression has not come without growing pains. Recovering from a black eye after a material number of fraudulent ICOs took advantage of regulatory absence, investors have found it difficult to discern between legitimate, promising offerings and deceitful, exploitative ones.
This investor apprehension has made it increasingly difficult for promising young companies to successfully build and launch a token sale in place of a seed round. Rather, more fledgling companies are now opting to be patient and mature to a point further along their roadmap to carry out a larger ICO sale. While traditional venture capital firms climb over one another to the already crowded seed and pre-seed market, young companies hoping to ICO are staying leaner for longer to benefit from late-stage distinction and proof of concept.
These diametrically opposed migrations have created a void between the vast pool of capital available to very early stage moonshots and the increasingly limited operational support and funding that is needed for fledgling companies to successfully scale toward a carefully structured coin offering.
With this, a phenomenon known as fund tokenization has arisen. Venture capital firms have begun to issue their own security tokens; the proceeds of which are used to identify and scale startups hoping to eventually ICO while the tokens themselves represent economic interest in portfolio company exits and ICOs. This model allows for the venture capital firm to take an equity position with non-dilutive ICO rights in a company, in place of a seed round, to help them scale toward a successful coin offering in the place of a Series A or B round — depending on the size of the ICO itself.
Still, the question remains: Why does the fund itself need to be tokenized? Can’t legacy venture capital structures fill the same void that a tokenized fund hopes to fill? Of course, it is possible. But the benefits of tokenization that venture firms involved in ICOs have witnessed — liquidity, inclusion, and transparency — are undeniable. Building out the infrastructure, technology, and consumer relationships that are required for launching one’s own ICO is essential to understanding how to do the same or better for one’s portfolio company.
At COSIMO Ventures, it is our simple and fundamental belief that a business, which intends to be the leader and developer of other businesses, cannot remain idle in the adoption of the very technological innovations it hopes to advance through the companies it backs. We intend not only to be a key player in the new wave of tokenization that is sweeping across the venture capital industry, but with the improvements our management team has made on existing models, we intend to advance it.
The pace at which this new tokenization model is spreading, similar to that of blockchain itself, cannot help but raise new regulatory and oversight questions as it resolves old. It is not unexpected, then, that many traditional asset managers hope to stave off this natural progression a little longer, to denounce its benefits in fear of becoming obsolete, and to encourage the rest of the industry to take a step back and wait until the dust settles and the establishments that dominate the industry today can dominate it tomorrow. To be sure, the advancement of science and technology is not fueled by those who pause in the face of progress and look to the past for answers that only the future holds.
It is time for a new liquid, inclusive, and transparent model for raising capital. Such advancements are important because collectively fostering the creation of new technology is important, and fund tokenization is the next stage of this digital evolution.
Our team at COSIMO Ventures hopes to share these insights with you as they become manifest during our own pursuit of fund tokenization and we will not hesitate to be clear about where we stand or where we believe our industry is headed.
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