Once upon a time, raising money required endless schmoozing and connections with investment firms or ultra-rich individual investors. Investment was generally believed to be the province of special investment banks and funds. However, the democratizing effect of the internet has forever changed that dynamic, and it isn’t entirely clear how the new economy is going to eventually take shape. From Kickstarter to crypto crowdsales, these days it seems like everyone and their dog is a “quasi-investor” which creates an entire realm of complexity and risk which we will have no choice but to wrestle with for many years to come.

 

First, There Was Kickstarter

The first player on the scene was Kickstarter, the popular crowdfunding website for everything from paintings to high-tech gadgets. Kickstarter opened up an entirely new audience to participate in a speculative, somewhat “investment-like” activity, with nothing but the About page to metaphorically plaster over the “Kickstarter is Not a Store” message, while simultaneously capitalizing on ordering specific products rather than equity in a company or venture.

Kickstarter was the first to pose the question of what, exactly, is this new form of internet financing or crowdfunding, and what should it behave like? Is this a preorder of a product? Is it an investment where your return is measured in the eventual product? Should people who receive nothing after backing a project be compensated? What if someone outright scams someone else using Kickstarter as a medium, by promising and then failing to deliver? How do we reconcile the practical reality that a product may differ from what was originally pitched, with the danger of underperformance, or even non-performance, by project creators in the fulfillment of their project?

 

Crowd Equity

Kickstarter set off a race for many different outlets to adopt similar methods for raising money for projects of various types. They are now everywhere, and a great deal of consumer money is being funneled into crowdfunding projects, and the practice is only recently catching the eye of regulators.

But Kickstarter is actually a fairly simple transaction compared to the increasing trend of “crowd equity” where individuals retain some enduring stake, rather than simply receiving the product. Kickstarter is not really an “investment” so much as a platform for donations-plus, where the obligation of the creator lies somewhere in the fuzzy boundary between a preorder and a hands-off donation.

Crowd equity has also been the subject of a great deal of discussion by regulators and by Congress, including the CROWDFUND Act and the JOBS Act, which have been discussed at great length elsewhere. The old ways of having large institutional investors are now in the process of rapidly changing to something new and as-yet unknown.

In my opinion we still lack a satisfactory solution to even the Kickstarter-grade problem of delivering a product. But that hasn’t stopped pioneers from blazing ahead with an entirely new kettle of fish- crowd equity.

 

 

The Crypto Crowdsale

The most modern, but most likely not the final, evolution of this trend of democratizing investment is in the form of a “crypto crowdsale” also known simply as a crowdsale, or in some cases an “ICO” or “initial crowd offering.”

Crowdsales make me very nervous, both because of how legislators and regulators have never even heard of the practice, and also because of how tight the analogy could be between a crypto asset and some other form of unregistered security. Many of these crowdsale tokens are blatantly advertised as granting ownership, equity, profit, or some other monetary or material benefit, as part of some collective enterprise such as a company.

A perfect example of this rampant crowdsale fever is The DAO, an effort by the people at Slock.It to create a “decentralized investment system” which very rapidly raised about $150 million, in what looked like open defiance of any country’s restrictions on investments meant to protect investors. I do not believe that there was any malicious intent, but there was clearly a lack of forethought about the fact that investments are actually regulated and that some attempt must be made to comply with those requirements.

However, crypto crowdsales as a collective are actually far more complex than blindly labeling them all the same. For many types of tokens it is not so clear-cut that the token represents a security. For example, Tokenly tokens are used to represent physical rewards from a Kickstarter-like project, enabling a user to transfer their backer rewards to be claimed by a different person in the future. Because there is no expectation of profit, I believe Tokenly tokens are a fairly straightforward case of not being securities. Not all tokens are dangerous and deserving of close scrutiny, classification as securities, or consumer protection laws to protect consumers, especially since smart contracts and tokens have the potential to provide superior, and proactive protections, rather than only retroactive remedies.

The difficulty lies in tokens which mix and match many different features and network characteristics. For example, perhaps a certain project intends to issue tokens which are intended to have a fixed value. Or a project has tokens which are redeemable for a fixed service, even if the value of that service is likely to increase in the future when the service is actually available. What if the token is never transferable, suggesting it can’t be a security? What if it is only occasionally transferable, such as under specific conditions? By mixing and matching features within a smart contract, every species and variety of token must be examined separately to determine how best to protect consumers and investors- if they even are investors- and that is a monumental task fraught with uncertainty and unknowns.

Honestly, I am all ears for any reasoned opinion on tremendous and important issue of whether crowdsales are a good idea to more equally share investment opportunities in an accountable way, or if they are a dangerous trend which undermines traditional consumer protections, and investor protections.

 

Conclusion

The potential is clearly buried in the blockchain to create smart contracts that will provide superior consumer protection and investor protections than old systems, due to the extreme difficulties of voiding or modifying smart contracts on the blockchain retroactively. But the novelty and complexity of the systems involved open up a wide gulf of ignorance and uncertainty both by participants and regulators which creates dangers which, if the system were widely implemented and understood, would evaporate. It’s currently the Wild West, and much like the early days of the internet before it settled down, being the Wild West opens up its share of dangers.

We are just going to have to cast off the shore and navigate the waters as best as possible, because one way or another, blockchain business is happening right now, and if we don’t do it, other developers elsewhere certainly will.

One day we may find ourselves in a world where this uncertainty will seem much like old remarks about computers, such as Ken Olsen’s remark in 1977, “There is no reason for any individual to have a computer in his home.” We may find that we have actually permanently solved the age-old problems of fraud and deception in the marketplace by performing business transactions on the blockchain using pristinely engineered smart contracts which are as inevitable as they are impervious to manipulation.

It would be a terrible shame to destroy that perfect future for the stated aim of protecting consumers/investors, when the actual effect of interfering or preventing the development of these systems is an ongoing problem of fraud and deception which creates the need for things like bureaus of securities and consumer protection.