Crypto Invest Summit: Great Lineup in L.A., So How Do The Stars Line Up?
CryptoOracle partnered with Crypto Invest Summit (CIS) to put on a well-attended and informative event in Los Angeles last week. Everyone involved in the effort is to be commended, and I’ll cite in particular those closest to my corner of the crypto community, CryptoOracle (CO) co-founders Lou Kerner and James Haft, CO team members Jennifer Litorja, Caron Kramer and Pablo Gonzalez Ruiz, as well as CO’s man from the future in health care, Dr. Alex Cahana, who organized a great health care track.
The goal here is to serve some glasses of insight from the fire hose of content at the event. The resulting takes (e.g., quizzical views of U.S. regulation and security tokens) and errors (none, hopefully) are mine, while I try to cite particular sources and presenters where helpful. To give more context on the content here, the sessions of focus during my whirlwind were: The Future of Blockchain Gaming; The Brooklyn Project & Regulation; Building A Crypto Community; Selling & Marketing Your Token Offering; Bootstrapping Network Effects Open Discussion / Q+A; Liquidity: The True Measure of the Success; Lessons Learned From Security Token Offerings; Bringing Blockchain to the Masses; When Will Crypto Replace Fiat?; a live taping of the CNBC Crypto Trader Show; CryptoHealth Landscape 2018; How Will Blockchain Disrupt Health?; Invest like a VC; and Healthcare and Data: Privacy, Security and Ownership.
FYI, videos for CIS sessions will be available shortly at the CIS site and CryptoOracle TV.
Speculation still dictating tone of the market
Fundamentally, the crypto market remains driven mostly by speculation. This invites chartists, and one predicted from a CIS stage that the stock market’s rising wedge pattern and bitcoin’s descending wedge pattern would mean a crash for the former and a surge for the latter by year-end. You see crypto funds in bull markets, and VCs in bear markets. So say hello to my VC friend, who would just as soon invest in equity now, thank you very much, and take tokens “for free,” to quote another presenter. To its credit, Pantera says it is sticking to steady investment in utility tokens, despite the resultant volatility of results (down perhaps 70% this year vs. up 350% last year).
Looking for use cases
Unsurprisingly, Tim Draper painted with a broad brush on a sweeping canvass of opportunity: the combination of Bitcoin, blockchain, smart contracts, and big data applications should create a platform to disrupt industries in the trillions of dollars. His hit list of sectors included the usual suspects, like finance, venture capital, banking, commerce, insurance, and real estate. However, he made a point of highlighting two others — health care and government — which he sees providing particularly poor service at high cost. As if on cue, Dr. Cahana’s presentation in the later health care track showed the U.S. below the global life expectancy/cost curve. If beating an opioid addiction saves the health care system $25,000 per year, then crypto can help cut the patient in on some of the savings (e.g., through compensation for data on compliance), for a win-win. But back to Draper, who added the insights that most government functions (in particular transfer payments and insurance) are virtual, and thus more suitable for crypto disruption, and that the personalized treatment facilitated by big data analysis of blockchain data could face resistance from incumbents like drug companies, which look for one-size-fits-all blockbuster drugs prescribed at scale.
Those expansive views aside, although crypto is global, don’t expect it to attract the best and the brightest to solve the problems of the developing world. At least the experience of the large incumbent tech platforms supports this chauvinistic view. Each FANG stalwart started with the developed markets as the value engines. For example, in its first full year after going public, Google generated 75% of its revenue from the U.S. and the U.K. Bitcoin is the most valuable crypto, but its value is driven by store of value and cross-border payments use cases that are relatively unimportant in developed economies. In the U.S., talk of the travails of censorship, and certainly the censorship of value, courses through neither coastal cocktail parties nor fly-over barbecues.
Turning from censorship resistance leaves our focus on auditability, verifiability and accessibility as the promises around which to build crypto use cases, per a ConsenSys exec. Everpedia looks to improve on Wikipedia’s base of only roughly 10,000 regular contributors, but is this small band really doing that bad a job? Although Everpedia fans argue yes, Lunyr’s modest traction whispers no. Per a ConsenSys exec, the main smart-contract-inspired use cases thus far are for exchanges and gambling. From outside the crypto-verse, exchanges look like navel-gazing applications, helpful for value transfers among those who already have tokens, but does the liquidity from exchanges drive token adoption in the first place? Perhaps the argument is that all these exchanges are integral to the necessary infrastructure, but again, infrastructure to support what applications?
Gambling would seem to have breakout potential as a mass-market dapp, but only if it can drive gamification at scale, namely the use of crypto transfers to incentivize new, valuable activities. What are these activities? That is, Mr./Ms. Economist, assume that you have a can opener, i.e., you have solved crypto’s problems of scaling, governance, smart contracts and whatever else, what would crypto’s killer dapps be? One presenter suggested an uncensorable global video platform. But would the risk of permanent child porn really be worth an immutable global record of the next Tiananmen Square? Ethereum purists seem to look down at tokenized frequent flier miles as killer dapps, questioning their need for censorship-resistance and the benefits of separating the value of one company’s loyalty economy from another’s. Staking appears in many proposed dapps, but it still seems an open question whether stakes can sustainably support the reputation and authentication management for which they are often brought into service.
What new features would crypto bring to gamers? Yes, some benefits fall within the subset of improved cross-border value transfers discussed previously, although largely dismissed as a driver of adoption in developed economies. Gaming is tantalizingly close to gamification, and one presenter offered that one practical avenue for EOS in particular could be gaming. But does crypto per se expand the use cases for gamification? For example, there is evidence that intrinsic rewards better motivate creativity than extrinsic rewards — does tokenization of those rewards change that?
Breathless boosterism (2017) vs. matter-of-fact skepticism (2018)
The smart contracts thesis looks to break free from the shackles of the “Bitcoiners.” The goal is to unleash trustless systems for value transfer in the service of incentivization, not just of the resources necessary to maintain decentralized computer networks (e.g., from the miners), but also of off-chain actors and actions. A counter-thesis of the Bitcoiner (e.g., Jimmy Song)— that the centralization, oracles, and other means necessary to create networks for value transfers of non-digital-bearer-instruments substantially undercut the viability of using crypto — seems more widely held than seen. However, like a black hole, even if invisible, this thesis leaves evidence of its existence, namely in a broader skepticism about use cases.
Consider some cross-examinations from the CIS stages of the following crypto projects and concepts:
· Crypto-fiat tethers just combine the worst of the worlds, per Tim Draper.
· Many protocols, like 0x, flounder for lack of associated business models.
· Crypto volatility is a barrier to enterprise adoption.
· Steem’s experiment in crypto-incentivized content suffers from a number of issues, such as the use of witnesses, governance and token economics.
· Attempts at large token-curated registries (e.g., a tokenized Yelp, Zagat’s or Wikipedia) may be biting off more than they can chew, given: 1) their tendency to devolve into popularity contests may make them inferior to expert-based approaches, 2) low voter participation rates can make the cost of manipulating results too low, and 3) the potential to manipulate validators through the use of high stakes.
· There seems some case for solving data problems of social networks, and one CIS presenter, metame (disclosure: advisor), has an intriguing approach encompassing this. Nevertheless, Vitalik himself has questioned whether there’s enough value in mere social network data, thusly: “Paying people for personal data is interesting, but there are concerns about adverse selection: to put it politely, the kinds of people that are willing to sit around submitting lots of data to Facebook all year to earn $16.92 (Facebook’s current annualized revenue per user) are not the kinds of people that advertisers are willing to burn hundreds of dollars per person trying to market rolexes and Lambos to.” Thus, personal data solutions in crypto may have to aim higher or more broadly.
· The many protocols relying in some way on reputation face the persistent prospect of Sybil attacks.
· Related to reputation is vouching for the quality or authenticity of data, but the proposed solutions of oracles and token-curated registries face skepticism, especially from the Bitcoiners’ black hole.
· The ratio of discussions about how to overcome crypto’s challenges (consensus mechanisms, scaling, legality, etc.) to discussions about how crypto could solve problems vexing enterprises remains high, marking perhaps one of the more disconcerting bubbles in the blockchain space.
The need for decentralization
Maybe the most common question which the unconverted pose to blockchain evangelists is “does the project need to use the blockchain?” — but is this query an acid test or a red herring? The most valuable “app” for the blockchain is Coinbase, a centralized token exchange reportedly raising $500 million at an $8 billion valuation. Even ConsenSys execs concede that decentralization is frequently a buzzword. The centralization introduced by the Lightning Network may well be worth it to dramatically reduce payment transfer costs. CryptoKitties are cute, but some wondered whether they would be less so even if produced by a centralized network, and their tech is clever, but does it drive value? True, decentralization aids in censorship resistance, but do loyalty points need such resistance? The power of decentralization to win the “hearts and minds” of entrepreneurs and developers, through incentives enforcing immutable promises to forswear the “bait and switch” of the centralized platforms (a process well described by Chris Dixon), is seen as dependent on first solving key infrastructure problems.
The need for a native token
Core to the value of native tokens is their “abstraction of value” — per a ConsenSys exec — of the utility of the network. For example, ERC20 tokens can avoid fluctuations of the value of ether, which are driven by a much more complex supply and demand equation. Pantera’s co-founder asked rhetorically “why buy a token that is not useful?” and said that bitcoin was the first utility token (to scale, certainly), only valuable if people find it useful (agreed). A blockchain solution without a native token would seem to have difficulty competing with a mere database. If a fundamental innovation of crypto as a technology is to allow for decentralized transfer of value, then you need a way of effecting and tracking these value transfers — that’s what native utility tokens do. By contrast, “security tokens” (more on those later) are by definition not useful. Rather, they are crypto receipts for transactions in rights that ARE useful. For example, if you arrive home to find a stranger squatting there, the deed to your house — tokenized or not — is not what ultimately gets the police to arrest the stranger for trespass. Rather, what does the trick is the verification of your ownership on the property ledger, and the legal rights associated with that ownership, which are ultimately enforced off the chain by the courts and the police.
Continuing U.S. legal quagmire
The consensus view seemed to be that the door to legal U.S. token sales without registration with or exemption from the securities laws is closed. One presenter said the SEC had put the “kibosh” on utility tokens. Another, a lawyer, tut-tutted than anyone thinking the SEC might change its stance on utility tokens was kidding themselves.
Several key constituents in the crypto community do not want to take “no” for an answer on utility tokens, however. A number of presenters said that a top priority remained clear guidelines as to when a token sale was, or was not, a securities offering. One concern is that the regulators may not sufficiently understand the technology (which is not much of a knock, considering the tech’s complex and rapidly changing nature), and that better explanations here could release at least some utility tokens from their current D.C. holding pen. The Brooklyn Project is trying to build a global consensus about how to treat token projects under the laws (and not simply the securities laws). Among its tools are old-fashioned, in-person legislator education, as well as more tech-savvy Telegram channels and Google Docs circulated for comments by interested parties.
To some extent, regarding token sales, the SEC has crafted a position that it is there to help, but in reality it is not doing so. A helping hand apparently appeared in the so-called Hinman speech in June, but a ConsenSys exec (hailing from a white shoe law firm) noted that this was merely a speech, and not binding guidance, and further that the apparent transparency of factors of focus in the speech has proven cryptic in practice. For example, law firms are leery of providing a legal opinion that a proposed project is sufficiently decentralized for its token sale to fall outside of U.S. securities law requirements. As another example, Hinman’s focus on whether token buyers plan to use the tokens apparently rules out the use of sales discounts, even though discounts (such as for volume) are commonplace in product markets. The SEC still has an open door policy to informally discuss how the law might apply to a contemplated token sale. However, what would be more helpful, according to a ConsenSys exec, would be just one SEC no-action letter (non-binding guidance on a fact situation where the SEC would not recommend a securities law enforcement action) on a token sale.
The inconsistencies in the current, conventional view of tokens under U.S. securities law persist. As emphasized by the COO of Phunware, blockchain and crypto are fundamentally innovations for the transmission of value. Thus, the issue is which value transfers are covered under the securities laws. Beginning of rant. Software-defined crypto networks with native currencies offer the potential to harness speculation to drive greater use of those networks. Despite this, the sale of utility tokens to users of networks apparently implicates the U.S. securities laws. The house view of U.S. securities regulators is that the sale of this narrow, technologically bounded device (utility tokens ALL relate to software, whereas the typical security relates to any industry) must be accompanied by securities law disclosure, as opposed to product/service disclosure. It’s as if the purchaser of an iPhone needs to read Apple’s annual report, as opposed to product reviews and e-commerce price lists. End of rant.
The security token mirage
Let’s look at security tokens through two different lenses. The first is as necessary evil to carry on crypto financing, with the security token the successor to the utility token, which was an interesting experiment in start-up finance that must give way to the realities of (U.S.) regulation. The second is as a way to use the crypto ledger to engage in untold levels of securitization, unlocking liquidity premiums on assets ranging from a newly discovered Picasso to boxes of discarded socks that don’t make the cut on eBay. For crypto nomads with dry throats, security tokens offer the oasis (or yoke?) of U.S. regulatory compliance, and increased liquidity for atomized assets and value streams of sorts both old (e.g., real estate, art) and new (e.g., fees from transfers of digital bearer instruments). These two lenses reveal two quite different markets. Consider first the market for utility token ICOs turned security token offerings (STOs), in particular in the U.S.
From downtown L.A., look not to the Pacific, towards Asia, a redoubt of utility token projects, but turn rather to the desert of the Mojave, and the oasis of securities tokens. The conference featured a separate and well-attended track on security tokens, and discussion of these tokens occasionally spilled into other tracks as well.
For token projects frustrated by the crypto market slowdown, STOs would appear to offer the prospect of tapping non-crypto investors, and tapping them now. Recognize, however, that investors in STOs are usually quite different from investors in utility crypto. First, utility token investors look for “asymmetric” returns, per one panelist — security tokens are structured to substantially eliminate the prospect of such returns. Second, utility token buyers ask different questions about projects, focusing on the need for use of blockchain and its decentralization and the need for tokens and their economics. By contrast, at CIS security token sessions, there was little discussion of these issues, or even of perhaps the more pertinent question of how to sync up the states of off-chain assets and their security token doppelgängers.
As we draw nearer the oasis, the large cool pool of liquidity starts to look more like the dry well of micro-cap stocks. For security token projects touching the U.S. market, a panelist advised having a legal co-founder, who could save hundreds of thousands of dollars in legal fees, as well as a number of sleepless nights. But securities lawyers, whether in-house or outside counsel, are not magicians, and must deal with the same consequences of U.S. securities laws that make the U.S. so unappealing to utility token projects. The U.S. securities laws hinder the ability of crypto projects to leverage the power of tokenization. The primary path to regulated fund raising is Regulation D, whether under section 506(b) or section 506(c). Reg D’s transfer restrictions and holding periods are part of the package, making clear to anyone who is still confused on the point that security tokens are not for usage. In any event, Reg D in practice diverts project tokens away from most potential users to accredited investors, such as angels and early-stage VCs. Regulation CF, for the smaller fry looking for $1 million or so, is little more attractive to security token sellers than it has been to security sellers. Regulation A+, touted to crypto projects for over a year now, has yet to produce a sale of a latter day utility token (please correct me if I’m wrong), and was merely mentioned in passing at the CIS sessions I attended. At the end of the day, even if project STOs begin to surface at scale, they face challenging comparisons to the securities of much larger and more liquid, if more conventional, public companies.
STOs: drunk on liquidity preference?
Let’s come in from the desert. MBA students at the University of Chicago share beverages at regular events called Liquidity Preference Functions. These have nothing on the tipsy fascination with liquidity among securitization, er, security, token fans.
STOs in service of securitization are certainly going after a huge market. Consider, per Elevated Returns, the estimated $240 billion size of the global real estate market, rife with illiquidity and lack of transparency. Real estate is just the tip of the securitization iceberg — huge asset classes from debt to art are also nominated as candidates for tokenized securitization. Alas, attacking large markets can make it difficult for insurgents to establish the competitive moats that drive superior returns, but that’s a critique for another day.
On the other hand, for those with assets to monetize, STOs are a story more for traditional investors than crypto disruptors. You can see this from where the investor demand is coming from for successful STOs. For example, Elevated Returns said that its recently closed $18 million raise came primarily from traditional high net worth and institutional real estate investors. Spice, a fully tokenized VC, originally looked to raise roughly half of its fund from crypto investors. In the event, crypto investors have thus far only contributed roughly 10% of Spice’s raise, with the vast majority coming from traditional family offices, funds of funds, angels, and high net worth individuals.
The STO bar’s specialty cocktail is liquidity, but improvements in liquidity will likely take a lot more than tokenization. Don’t just take my word for it. Listen rather to Barry Silbert, founder and CEO of Digital Currency Group and previously the founder of SecondMarket, which was a pioneer in providing liquidity for private shares of public companies. Silbert (at roughly minute 35 of the linked podcast) turns a skeptical eye to the liquidity promises of tokenization. True, as heard at CIS, tokens could reduce the administrative frictions — and thus delays — of asset transfers. But from the CIS stage, even security token offering bulls said that promised improvements in liquidity are not a near-term prospect. Ultimately, the security token market seems to focus on legal compliance and conventional valuation metrics, catering to traditional investors. This will likely attract a different community than crypto. As skeptical as Bitcoiners may be of smart contracts, it is more difficult to see them adopting en masse the cause of using crypto technology to make the physical world safe for securitization.
Community — crypto without money?
Let’s close with a nod to community, a defining feature of many successful crypto projects. Some at CIS urged a healthy skepticism about quantitative metrics of community engagement, like the number of followers on Telegram or Twitter, which can be gamed. Perhaps, more accurately, crypto projects depend on communities, plural, in that what captures the “hearts and minds” of developers may differ from what captures those of users. Despite the current bear market and an associated slowdown in money flows from token sales, which can invite broader skepticism about the future, the vibe at CIS reflected a crypto community focused on improving the technology, as well as the technology’s appeal to the non-enthusiasts.