ICOs: Why People Are Investing In This $380 Million Phenomenon

Developers of new cryptocurrencies are raising gobs of money with little more than a white paper. Though real advances are likely to emerge from the trend, the bubble could get worse before it gets better. William Mougayar, organizer of the upcoming Token Summit, and Nick Tomaino, co-host, discuss where ICOs are going wrong now, what best practices would help the space mature, and how to separate ICO wheat and chaff.

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Transcript

Laura Shin:

Hi, everyone. Welcome to Unchained, a podcast engineered by Fractal Recording and produced by me, your host, Laura Shin, a Forbes contributor covering cryptocurrencies and blockchain. Thanks for tuning in. I am running a survey on Unchained. If you haven’t already, please fill it out to get a say on what topics the show should cover, which guests we should have on, and whatever other improvements you’d like to suggest.

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Today I have two guests. The first is William Mougayar, General Partner at Virtual Capital Ventures, an early stage venture capital fund, Founder of Startup Management and author of The Business Blockchain. William is also a board member of OB1 and a board advisor for the Ethereum Foundation. Joining him is Nick Tomaino, Principal at early-stage venture fund Runa Capital and author of the blog and email newsletter, The Control, which is about token-based blockchain protocols. Welcome, William and Nick.

Nick Tomaino:

How’s it going?

William Mougayar:

Hi, Laura.

Laura Shin:

William, let’s start with you. Tell us what your background was before you got into this space and how you stumbled onto cryptocurrency.

William Mougayar:

Sure. I’ve been in technology for close to 35 years, the first 14 years being at HP, Hewlett-Packard, and in ’95, I left HP to dive into the internet, and I was doing very much similar things to what I’m doing now, which is to write about it. I wrote two books at the time, and I used to do a lot of speaking engagements and was involved with startups that were early in the internet days. More recently, I did do startups. Sold the last one in 2012, and then discovered the Bitcoin world.

Laura Shin:

And how did you discover it?

William Mougayar:

Via Fred Wilson’s blog initially, and the first time I saw it, I was still too busy with my startup engagement at the time, so I kind of ignored it.

Laura Shin:

And just for people who don’t know, that’s Fred Wilson who is one of the VCs at Union Square Ventures.

William Mougayar:

Yes, and then as soon as we sold Engagio, then I had a bit more liberty to doing whatever I wanted, and I was lucky that I was living in Toronto. I am still living in Toronto, and this is where Vitalik Buterin, the inventor of Ethereum, is from, and I got exposed to him and met him when he was writing his paper, and when I started to read the paper and talk to Vitalik, it dawned on me very quickly that this thing was really going to get not just big, but important.

I saw very quickly the fact that this was a paradigm shift in terms of how software applications were going to be written and that this was something that could be as significant as the internet 20 years ago, and for the first time specifically, the fields of cryptography, the fields of peer-to-peer technologies, and decentralized methodologies were all coming together for the first time and working in harmony.

So it wasn’t just about sending money peer to peer. It was more that this was a new paradigm that was going to allow engineers, software engineers, to write applications in new fundamental ways. So it was really a technology that was disrupting technology. That’s how I describe it in my book, but the same way with the internet and the web, it was a new technology that was disrupting the previous paradigm of client server.

Laura Shin:

And what does that mean, client server?

William Mougayar:

Client server is the way that applications used to be written before the web, meaning that there was a computer, a server, that would be serving the resources and the computational power to programmers that would be on their client. So the web brought a new paradigm, which was still within the client server paradigm, but it used new technologies, the JAVA technologies, and the browser technologies, and the fact that the clients became more smart and more powerful. So, with the blockchain, we are doing another iteration of that model where the resources are not just on servers.

But they are in the cloud, which means that they are all over the globe. There could be thousands of nodes that are spread out. So you can think of the blockchain from a technological perspective as another evolution of cloud computing, but that has a very strong peer-to-peer component, which means that it is not just for the corporate world, but it is really brought in for the reach of anybody. So anybody can have a node. Anybody can be part of the infrastructure, and that’s a new paradigm that we are just entering right now.

Laura Shin:

So, Nick, tell us a little bit about yourself. What was your background before getting into cryptocurrency, and how did you end up working in the industry?

Nick Tomaino:

Sure. So, before I joined Coinbase, I was in business school, actually, on the east coast, and actually, I guess before that is when I really discovered Bitcoin. Similar to William, and most people, you know, I heard about it on the internet, and I think the first thing I read about it was the famous Wired article in 2011, The Rise and Fall of Bitcoin, that described how Bitcoin kind of, you know, grew from nothing to over 30 dollars per coin and then crashed back down.

So I think, like a lot of people, I was kind of drawn in by the speculation and the discussions of Silk Road and things like that, but quickly, I, you know, fell down the rabbit hole and started engaging online in different communities, the main one being the Bitcoin sub-Reddit, and then in 2013, right when I started business school is when I kind of decided that I wanted to make a career out of it.

So in 2013, I basically talked to as many different entrepreneurs in the space as I possibly could, and a lot of the entrepreneurs that I talked to then are now either, you know, in jail or just not around anymore, but so that was kind of interesting and told me where the space was. I think the people element of this industry I think is massively undervalued, and there’s a lot of excitement, you know, about funding, and prices, but a lot of people don’t take the time to sit down and like, talk with the people that are kind of working in this space.

And that’s what I did in 2013, and identified Brian Armstrong as the most credible founder by far in the space, and so quickly, you know, ended up working for Coinbase while going to business school for about nine months, and then moved out to California from New Haven, Connecticut, and have been out here ever since. So that was kind of how I ended up…

Laura Shin:

And you were working in biz dev at Coinbase?

Nick Tomaino:

Yeah, a lot of different things in the early days. So I joined kind of working remotely when there were about five employees and you know, doing things like managing the Twitter account and most of the external communications on the block, things like that, and also in the early days, a lot of the merchant outreach.

Laura Shin:

Great, and then when did you leave and go to Runa Capital, and also when did you launch the control?

Nick Tomaino:

So I left about a year ago to join Runa, and launched the control about four months ago now, so right at the beginning of the year.

Laura Shin:

And what prompted you to launch the control?

Nick Tomaino:

I think it’s still very early in the space, and there’s a lot of education that needs to be done, and so, you know, I was writing a lot of our stuff at Coinbase in the early days, and I think Coinbase has done and continues to do a really good job making the technology kind of relatable to non-super-technical people, and I think there’s a lot more of that that can be done, and so that kind of prompted me, you know, to launch The Control, and it’s a reason also that we’re working on Token Summit and things like that, and I also think you do one of the best jobs of any in the journalism world of covering this space. I think there’s still not a ton of good journalism, and so The Control allows me to, one, stay kind of in the space as much as I can as, like, a side project, while also investing at Runa.

Laura Shin:

Yeah, because Runa does not invest in the space. Is that correct?

Nick Tomaino:

I wouldn’t say we do not invest in the space. We’re actively interested in the space, but we are a Series A venture fund, and the reality is there have not been a ton of Series A opportunities for companies with real business traction, and you know, within Runa, I am a big believer in the space, but other than me, there’s not someone who is just really excited about the future.

Laura Shin:

Okay. So I actually want to devote most of this episode to discussing the token trend in ICOs and all things of that ilk, and I’ve discussed this topic with multiple guests in different ways since last summer. Some of the previous episodes that touch on this were an episode I did with Jerry Brito and Peter Van Valkenburgh of Coin Center. Another one I did somewhat recently with Olaf Carlson-Wee of Polychain Capital, who is also a former Coinbase employee, and Brock Pierce of Blockchain Capital, and Stan Miroshnik of The Argon Group.

And for listeners, I’ll link to these past episodes in the show notes, but I would like to discuss the trend in depth with both of you since, William, you’re organizing the Token Summit that Nick mentioned, and that’s in New York on May 24 and 25, and Nick, you’re also a co-host for that event. Why did you decide to launch the summit? Like, very broadly, how would you describe kind of what is happening now and how it’s different from what we’ve previously seen in the crypto space?

William Mougayar:

Sure. I felt late last year in 2016, that there was a need to dive more specifically into the world of the token-based economy, which is something that Nick and I kind of talk about, and I felt that there was so much activity going on in the space, that I wanted to bring all of the top players, mostly the entrepreneurs, and the investors, and the whole sector, basically, that was at the forefront of this new sector, which is one of the sectors of the blockchain together.

Laura Shin:

And how do you describe this to people? You know, when you’re trying to explain to someone who isn’t really familiar with what’s happening, what do you say?

William Mougayar:

What I’m saying here, what we are saying here, is that the cryptocurrency is the first application of the blockchain. So that gave us Bitcoin, and it gave us Ethereum and many other cryptocurrencies, but that’s only one element. What’s really interesting, the real interest here is the intersection of the cryptocurrency with the business model. So when you hear about all of these new tokens or cryptocurrencies that are being raised right now, I’m not so excited about having new currencies and new tokens, per se, but I am more excited when I hear of a new business model that is enabled by the token or by the cryptocurrency.

So I’m going to use the words token and cryptocurrency interchangeably because they kind of are a very, very similar thing. So I am more excited about how a given token which is a kind of currency is going to enable us, users, society, government, whoever, to do things that we could not do before, and that’s the frontier that I think we’re barely scratching the surface on right now.

Laura Shin:

And what’s an example of something that it will enable us to do that wasn’t possible before?

William Mougayar:

So, for example, if you take doing the reputation markets where you vote with a token, so the token could be representative of an ownership for the user, and this is something we could not do before, at least not very easily. So the token is like a tool for the user that can be used as part of the application. There are other examples where the token is something that a user earns by giving their attention. So if you spent time, let’s say, on a site like Steemit where you are writing some content and the content is being upvoted or is being liked, it’s being shared, as you do that, you are earning tokens which you can not just earn, but you can spend.

So what’s going on here, I’m interested in exploring how mini economics, which I call circular economics, get formed, where a user is earning tokens and is able to spend those tokens in the same time, in the same setting. So if I’m earning tokens because users are giving me attention, I can spend those same tokens to maybe boost my content, or to promote it, or to buy services in that marketplace. So that’s kind of the more exciting element, and there will be many examples like that. In the past, just to give you an analogy, governments used to issue money.

So we are used to governments issuing sovereign money and currency, whether it’s the dollar, or the pound, or the euro, and so on, but in the future, companies are going to be issuing their own currency, and the currency that the companies will issue is going to have to be tied into their products, to their services. So the next trend I’m seeing is not just startups in companies that are issuing the token and starting something new, but we’re going to see established companies that already have millions of users issuing tokens, as well, and then linking that token with an existing usage that already is taking place.

But giving it a boost and allowing the users to earn currency via their actions, via their attention, via their data, via the fact that they have an ownership of sorts, whether they have a right to do something. Could be a vote. Could be an opinion. It could be an action. So we’re going to see a variety of these types of functions. So that’s really the incentive for the Token Summit. I want to explore all of these different ideas and models and functionality for the token. So the token is like a utility.

Laura Shin:

Yeah, and the reason that these developers or companies are not using an existing cryptocurrency, like the coin or Ether, is because they want to be able to control the incentives within their little mini economy or their circular economy? Is that the reason?

William Mougayar:

That’s one of the reasons. So these cryptocurrencies are their own, so they are like proxies to the backend currencies. Like, right now, the backend currencies, in my opinion, are either Ether or Bitcoin proper. So they are like the backbone of the crypto world. What’s interesting, if you have your own currency, you can have your own governance. So each currency now becomes their own kind of mini government, per se, and maybe government is a big world. It’s a body that is governed in a decentralized manner where users have a say, where there is oversight, and there is transparency.

So these companies are issuing these currencies so that they can have their own governance models, but also another reason is because it’s real money. So they are using this as a funding mechanism, as well, and hopefully we’ll talk about in the segment because there’s goods and bads about it. There’s some good elements about the fact that it becomes a new funding mechanism, but the caution here is that I’m seeing some projects getting funded just because it’s easier to raise money in a crowdsourced manner by raising of a token.

Laura Shin:

Yeah, I do want to dive into that in a big way, but before we do that, I just kind of want to give listeners a perspective on just how big this trend is. I did a little bit of math, and I think it’s like…and tell me if you have a different number, but I think it’s north of 350 million so far that have been raised in these initial coin offerings. Is that roughly your estimate?

William Mougayar:

Yes. That’s pretty close to…yes. Between last year, 2016, and more or less the first quarter of 2017, we’re close to that number. I had predicted originally just two months ago that we would reach 600 million in 2017, and I am pretty sure that we’re going to exceed that number.

Laura Shin:

Wait, raised only in 2017 or for all…

William Mougayar:

’17, yeah. In ’17 only.

Laura Shin:

Including twenty…oh, wow, okay.

William Mougayar:

Oh, yeah, I think we’re going to reach a billion dollars very easily. There are some big raises that are coming on the horizon that I cannot talk about yet, not announce yet, but they will be announced in the May and June time frames, and for the rest of the 2017 year, some companies are getting ambitious. So I wouldn’t be surprised if we reached 1 billion dollars in money raised via new cryptocurrency offerings in that year alone.

Laura Shin:

And what other stats really stick out to you as the most eye opening?

William Mougayar:

Almost on a daily basis, there is a new one. I mean, right now, we are able to monitor them and count them, but there’ll come a point where it’s going to be like another startup has been founded. So, like, big deal. So if you look at the traditional venture capital world, there are hundreds of startups being founded on a daily basis on a global basis. So founding a startup and raising money is not a big deal anymore. There are VC companies that don’t even announce anymore fundings because it’s a, okay, so what kind of event. What’s more important is what’s getting done with the money. So I wouldn’t be surprised that, at some point in time, it won’t be news anymore that a company is raising 10 million dollars or 12 million dollars via a token offering.

Laura Shin:

Okay, yeah, I also feel like this trend is moving in that direction, at least for now. We’ll see, but let’s hold that thought and go to an important word from our sponsor, Onramp. The best companies in the world obsess about branding. Killer branding will transcend your company and strategically and competitively position you in the market. Done well, a remarkable brand will affect buyers and their purchase decisions and give your organization a voice that sets you up for long-term success.

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I’m speaking with William Mougayar, General Partner at Virtual Capital Ventures, and Nick Tomaino, Principal at early stage venture fund Runa Capital, and Founder of The Control, both of whom are hosting the Token Summit on May 24 and 25. So let’s quickly run through some of the details around tokens. Who are the people launching them? What is the process for launching them? What kinds of entities are they creating to launch them, et cetera? Just run through that quickly.

Nick Tomaino:

Yeah, so I would say that this is kind of rapidly evolving, and it’s still very early in how these entities are forming, and I think, you know, people call them companies, and the analogue in the traditional world is a company, but they’re really not companies, and I think it’s best to think of them as decentralized, autonomous organizations where there’s an entrepreneur and a founding team, but there’s no legal entity, and there’s a number of different participants that play different roles in kind of bringing this entity to the world.

But I really think of these structures as internet tribes, and they’re tribes that are focused on different user cases and have different beliefs, but at the end of the day, they’re selections of people from all over the world that own a token and have ownership in a product and kind of want to bring the product to the world. So that’s how I view what’s happening. I think the problem with now that’s happening is the over 350 million in funding over the past 12 months. The vast majority of these projects are getting funding before there’s an actual product.

And if you look at, like, the past 10 years in startups broadly, outside of the blockchain world, pretty much every company that has raised a lot of money pre-product has failed. Some of the famous examples are Clinkle, which was a mobile payments company that raised 25 million before products in the seed funding and disappeared in two years. Color and Airtime are other examples of this that raised kind of massive rounds before an actual product, and I think right now, the token sales, like William said, are, in a lot of cases, being used as funding first.

And I think this model, over time, will change, and we’re already seeing it change to some extent where a founding team is raising a small seed round from more traditional investors, getting to a product, and then doing a token sale to give users access to the product, and this is kind of…again, it’s still very early, and we haven’t seen kind of best practices for how these organizations are structured, but this is how I see a best practice playing out in the future.

William Mougayar:

Yeah, that’s true, Nick. So there is no right or wrong way to do the token sale. It could be before the product is ready. It could be after. It could be before funding from a traditional VC or after, and the way I’ve divided the phases, to answer your question, Laura, is I see four phases. There is the launch, but in this case, the launch is really the launch of the token itself or of the funding, if that is the case, and there’s a development.

In many cases, the funding will allow the development to take place, the software development, and that could take 1 or 2 years, and in that development phase, I’m referring to the third phase, which is it goes into a darkness period. So we don’t really know what goes on despite transparency attempts from the startup, because at the end of the day, these companies are like startups, whether they are a protocol, or in a distributed organization, or in organization with a new product.

They are really like a startup, so you cannot escape the startup characteristics, which means that it takes a while for the product to become more mature. It takes awhile to acquire users. It takes awhile to iterate on the actual vision that you have, because nobody is right from the beginning. Time will tell, really, what happens, and then the last phase is really the rollout, which is the market entry, and that could be a year or two years and sometimes three years after the initial fundings.

Laura Shin:

Okay, yeah, Nick, when you were saying that oftentimes, or in history, we’ve seen that companies that raise a lot of money initially before they have a product tend to fail, I wondered how that compares to Kickstarter and those types of things where, oftentimes, they did kind of, you know, dream up some vision for something and then get a lot of people on board and crowd fund. Do you have any stats on that, on how successful it’s been in the crowdfunding world?

Nick Tomaino:

I mean, the failure numbers, I don’t know them off the top of my head exactly on Kickstarter, but they’re relatively high, and I think, you know, Kickstarter’s done a lot to improve this over the years, and so I’m sure it’s kind of trending in the right direction, but yeah, I think, you know, Kickstarter is a good model to look to in terms of getting funding on an idea, and that hasn’t played out well for Kickstarter.

Laura Shin:

Okay. All right, and then just nuts and bolts for listeners who aren’t familiar yet with these token sales, what is typically the process for buying these tokens? Like, if I’m a novice and I have a little bit of Bitcoin or Ether, maybe like a Coinbase or something and that’s it, and I see some token sale I want to invest in, what do I do?

Nick Tomaino:

All you do…and this is why it’s happening so quickly around the world, is Ethereum makes it dead simple to do a token sale. All you do is create a smart contract and have people, anyone in the world, send Ether to an Ethereum address. Kind of at a very high, simple level, that’s what you do. So you have, you know, Ether in a Coinbase wallet or whatever wallet you have, and you send a certain amount of Ether to an address, and in return, you get a given token for whatever the project is.

Laura Shin:

And then where do I hold those tokens? Like, if I receive them, I’m holding them where, on what address?

Nick Tomaino:

In the address that you sent from.

Laura Shin:

Oh, okay. So you can hold this new token in the same Ethereum address?

Nick Tomaino:

Yes, and by the way, I wouldn’t do this from a Coinbase wallet because at least now, from what I know, they’re not supporting SUB tokens. I think that will change in the future, but yes, you send from…if you have a ledger wallet, or the Ethereum Mist client, or whatever the wallet is, you send the funds, and you get tokens, whatever the token is, in return.

Laura Shin:

Okay. So let’s talk more about investing, and before we do that, let’s caveat this section with the statement that no one listening to this podcast should take anything that we are saying here as investment advice. I covered personal finance for a long time and can tell you that if you want advice on your financial picture, you need to talk to a certified financial planner who can look at kind of like everything in your life and figure out what your goals are and all that. Given that, though, there is a lot to talk about from the investment angle. So what is the investment thesis here? What gives a token value?

Nick Tomaino:

The way I see it, there’s two types of tokens, and I think, you know, everyone has different frameworks. I think William likely has a different framework than I do, but I really think there’s two types of tokens that make sense to me right now. One is called a usage token, and one is called a work token. So a usage token is a token that is required to use a service, and I think the term protocol is used a lot, and I think it gets overused, and I think, you know, at a high level, it’s simpler to think of these as services, and so Bitcoin is the best example of a usage token.

To use the Bitcoin payment network to send, you know, money anywhere, you need to own Bitcoin, and that’s really what gives Bitcoin value, is the ability to be used in this distributed ledger that anyone can participate in and no one controls. So usage token is one type of token, and then the other is what I call a work token, and I think it’s still very early in work tokens, but kind of at a high level, a work token is a token that users own that gives them the right to contribute work to the network and earn in exchange for that work.

So an example here is reputation, which is the native token to Augur, the decentralized prediction market, and if you own REP, you can essentially be an oracle in the system and earn fees, and so you’re owning a token not to use a service, but instead, to contribute work to a decentralized, autonomous organization, and so, yeah, I’m sure William thinks about it slightly differently than I do, but to me, those are kind of the two reasons that tokens have value.

William Mougayar:

That’s very good, Nick. No, I agree with your classification, and actually, I talk a lot about the work token, and I did that at my last TEDx, but aside from that, I think the way to think of value beyond the way that Nick describes it is really, at the end of the day, if you think about it, it’s about adoption. So forget for a minute about all this kind of new jargon about usage, and work, and rights, and tokens.

Really, at the end of the day, if there is no adoption by the users, there’s no value no matter what the vision is, because all of these companies, or ICO projects, or startups, really, they are all based on assumptions. They are based on a hypothesis that if we issue a token, if we give certain rights to users, if we allow them to do this and that, then they will come, and they will use it, but just like any other startup, if there is no usage, there’s nothing.

So there is a lot here that rests on whether there will be engagement with the users, whether there will be a semblance of a network effect going on. Network effect means every time a user comes into the network, the value of the network increases, and this is something we’ve been used to for the last 10, 12 years with the internet, but now it’s another version of network effect where the users are part of the infrastructure. So the users are all kind of supporting the infrastructure of the network because they are a node on the network.

Laura Shin:

But right now, when so many new tokens are launching every day, like when networks haven’t really been built out, how does a potential investor decide between them? Is it just, you know, you try to invest in as many as possible and hope that if you went out and even if the rest fail, you still make some money, or I mean, how do you do that, or do you just wait until the networks get built?

William Mougayar:

No, I mean, it’s not any different than investing in startups. You have to have a hunch, a gut feeling for the team, for the idea, for the product, and then you support them.

Laura Shin:

I mean, is there anything kind of more quantitative than a hunch that you can offer people?

William Mougayar:

It’s really experience. I mean, people think that…I am seeing so many ICO projects now that want to reinvent everything. So one of the trends is that we are moving off centralized services. So the other big umbrella theme here behind all of this is there’s going to be a decentralized version of everything you can think about, starting with Facebook.

So there is, like, a half of dozen companies now that want to do a decentralized Facebook or decentralized Reddit. Steemit is one of them, and there are five others. Companies are doing decentralized whatever, decentralized banking. So banking without a bank, or Uber without Uber, or a stock exchange without the exchange, because it’s decentralized exchanges from peer to peer directly. So there is validity in the fact that there will be a lot of decentralized services that will emerge, and some of them will replace the centralized flavor.

Laura Shin:

But if I’m trying to figure out where to put my money, then how do I decide between one ICO versus another?

Nick Tomaino:

So, Laura, I’ve got a perspective on this. I think, like, ICO is a misnomer generally because it evokes IPO, and to your question about how do you decide, when you’re investing in an IPO, there’s a lot of data that you can decide, right? The company’s been around for, presumably, many years, and it has revenue and you know, all sorts of traction that you can look to. In this case, it’s often a founder with an idea and a website, and William is talking about you decide like you do early-stage startups, which is right, but most people are thinking about this as investing like in IPO. In startups, the most important thing is the people, and the reality is, like, most people don’t have the time to meet the founders of these projects, and so are basing it…

Laura Shin:

So does that mean, like, the crowd really shouldn’t be investing in this space then?

Nick Tomaino:

No, I wouldn’t say that, because I think, you know, being inclusive is one of kind of the fundamental principles of this space, but I think maybe the crowd shouldn’t be investing before there’s execution risk. Meaning, you know, when there’s a product, I think it makes a lot of sense for teams to give users their product, but I question whether the crowd should really be investing pre-product when, in most cases, they’re not doing a lot of diligence. Ethereum is the best counter example to this, right? They raised, you know, 16 or 18 million before product, and they’ve executed phenomenally, and there’s certain counter examples to my belief, but I would bet that Ethereum is more of an outlier than kind of the norm moving forward.

Laura Shin:

And what about examples where the network launches right when the crowd sales happen? How do you categorize that?

Nick Tomaino:

That, an example may be Zcash. I think, you know, that’s an interesting model because when the product launches, that’s when you give access to people, and I think, yeah, a model like Zcash is a good one, rather than raising 15 million dollars before you have anything, and I think that will, over time, be proven to be the healthy model for the space.

Laura Shin:

So another thing I was wondering about is sometimes these networks seem to have good business ideas or maybe not so good business…it really depends, but then that kind of analysis is separate from whether or not the token makes a good investment, because in that instance, then there’s a lot of other factors involved, like how are they distributing the token, or how is the token used in this system, or just other things. So how should potential investors differentiate between those two things or assess those factors?

Nick Tomaino:

Yeah, that’s a good point. I think that’s why it’s not all about just, like, getting traction. You have to be thoughtful about what the token actually represents, and it’s why I think kind of a framework for thinking about, you know, is it a usage token? Is it a work token? And I’m sure there’ll be other types of tokens that emerge, but yeah, the crypto economics, if you will, is really important, and I think it’s still super early in crypto economics generally, but there’s a lot of really smart people that are thinking about this. That’s part of the reason I’m so excited about Token Summit, is there hasn’t really been an event where most of the leading minds that are thinking about these things are in one room talking about, you know, things like crypto economics.

William Mougayar:

Another factor, Laura, for investing is having a thesis. So one way that investors make decisions is they have a thesis that they believe in, which is a particular view of where the world is going, and that, I mean, if you believe in it and then when you start to see companies that fit the model that you envision in your own mind after your own analysis, then you start to say, well, this is the kind of company that I’d like to support because I believe in this particular field. So it could be decentralized content.

So if you belief that content is going to be owned by the users themselves and that the publishing and the way it gets distributed is going to be more decentralized as opposed to centralized, then you would invest in such companies, or if you believe that storage, like computer storage or computing infrastructure, is going to be more decentralized and if you believe that users will be able to rent a small part of their computers, let’s say, on a distributed manner and earn a few cents or dollars here and there, and each sector is seeing now 2 or 3 players.

Like the example I just gave, there’s a company called Storage. There’s a company called Sia, and there’s a company called Filecoin. They’re all kind of vying around the same area of cloud storage. So that’s kind of one example. If you believe in that, you would invest in it. There will be cloud-computing resources that will be going towards the blockchain, like Golem and others, and so these are kind of like some sectors that are emerging based on a belief of a particular vision that an investor might have.

Laura Shin:

So I want to jump back to something that Nick mentioned briefly, which was he was talking about…well, I mean, he referenced it, and we actually discussed it a little bit, how some of these developers are launching crowd sales before they have a product, and one of the more extreme examples of this recently was the Gnosis crowd sales which sold 12.5 million dollars worth of tokens in less than 15 minutes, and they only sold, like, 5 percent of the tokens, and so at the price it sold, that gave this reputation market a valuation of 300 million dollars, which is pretty ridiculous, frankly. So what do you guys make of something like this? What kind of lessons can we learn from this?

William Mougayar:

Well, the way I explain this is that there is some financial engineering going on here, and the token issuers are getting very creative because there are no best practices. There is no right formula yet. So there’s lots of iterations and variations. So this particular one was very creatively done, and I mean, theoretically, you could say that the valuation was 300 million because so many tokens exist and the ones that were issued are worth so much.

But again, this is all very assumptive, very…we’re just assuming that this is going to be the case. So the proof is going to be in going to the market and getting users and getting a product to the market. Now, in the meantime, the markets are speculating on this, and this, in return, is funding. It’s funding these companies. So I don’t mind a little bit of speculation because it is helping to fund these projects.

Laura Shin:

But do you think that this indicates that there’s kind of more like bubble activity happening? Because a lot of projects have been raising money without going to this extreme, I would say.

William Mougayar:

Yeah, well, I mean, there is going to be a point where the market will retract. So we are going to be pushing the envelope and pushing the boundaries to the most extreme limits, but if you go back in history of all of the major technological cycles, nothing really ever great was done without some crash of some sort, without some sort of irrational exuberance, without some kind of euphoria at some point in time. We have to push the envelope beyond the possible and to think that we can reach the moon before we can just realize what is possible, and then things will grow again. So the crash of ’99 / 2000 back with the internet, back in the internet days, yes, it was bad unto itself, but then later, it kind of paved the way for a lot of prosperity that followed.

Laura Shin:

So, right now, there’s kind of like a wide spectrum of, I would say, anything ranging from kind of like scams. Like on the episode I did with Jerry and Peter of Coin Center, they talked about Paycoin, which was an outright scam that the SEC pursued, and then there’s kind of less easily detected ones. Like, you know, maybe the developers raised money, but they never really seemed to launch anything.

They’re always just working on their projects, and I mean, frankly, it’s kind of incredible to think, like, oh, wow, they could just easily raise millions of dollars and just fund their lives, but never really do anything that they offer to their investors. So, short of regulation, is there anything that either the community can do now or that investors can do to avoid these types of situations?

Nick Tomaino:

I think it’s just important to push best practices, and you know, I agree with William that the speculative activity kind of fuels the ecosystem, and it’s natural to some extent, and I also think even from something like the DAO, which, you know, last year, raised 150 million and quickly disappeared, it was a complete failure by all accounts.

But even that led to something like the Ethereum hard fork, which I think was a step forward for the whole ecosystem because there had never been a hard fork in a project that was so significant as Ethereum, and it showed something new that could be done. So I think there’s a lot of learning to be done from even the failures, but I do think it’s important to continue to be, you know, highlighting best practices, and something like Gnosis which, you know, it was the first experiment of a Dutch auction in the space, I think not necessarily a bad thing that they tried it, and I don’t know…

Laura Shin:

And just for listeners who don’t know, can you just quickly describe about the Dutch auction?

Nick Tomaino:

Yeah, it basically lets the market decide the valuation. So the valuation is where the complete allocation which, in this case, was 12.5 million, wherever all the bids gets filled, and so rather than kind of setting a valuation, it lets the market decide the valuation, and in this case, the market was very excited about the project and decided that the valuation should be north of 300 million, and that experiment hadn’t been attempted before.

And I don’t think it’s necessarily a bad thing that it was attempted, and I don’t know, you know, the intentions of the founders and whether it was greed or something else, but I think it’s clear to me at least…and again, this has only been…it’s still very new for…this is a couple weeks old, but it’s clear that a Dutch auction is likely not a best practice moving forward, but to come to that conclusion, we needed to see it happen before, right?

Laura Shin:

And what are some other things that you would recommend as part of best practices?

Nick Tomaino:

I don’t know all of them, and these are just kind of my ideas. I think it’s still very early, and I think that’s part of what we’re going to discuss with a lot of people that’ve actually done it before at Token Summit, but to me, what I discussed earlier, I think raising a small round prior to doing a big crowd sale is likely better long term than doing a 10-million-plus crowd sale before there’s a product. So, to me, that’s one of the best practices. Another is crowd ownership. So I was looking at the data the other day, and in the case of Gnosis, the team only sold 5 percent, roughly, to the public, and I think a best practice for public ownership of a token is more like, you know, 60 to 80 percent, something like that. So those are I guess a few examples, and I don’t claim to know all of them.

Laura Shin:

William, do you have any to add?

William Mougayar:

Yeah, actually, it’s funny. I don’t want to mention the Token Summit too many times, but we have a session specifically talking about best practices, and the ones that Nick has mentioned are really good ones, as well, and again, this is nothing different than how a startup really takes shape, and there is a conventional wisdom that more money, especially initially, does not mean…it’s not necessarily better. So less money gives more discipline to teams.

But from what I’m seeing, discipline is not really the first thing that comes to mind here with a lot of these ICO projects. Many of them see this window, and they want to swing for the fences and see it as a one-shot deal where they can raise money at once and then see what happens, again, trying to emulate what Ethereum did. They raised a bunch of money, and then they ran with it, but then, luckily for them, there was a big vision behind it, and everybody was rallying behind it, but not every project is like Ethereum. Not every project is like Bitcoin.

These are the outliers, or these are more the exceptions, in the same way that in the startup world, not all companies are going to be Facebook, or Google, or Amazon. These are giants that have become what they are today because of many reasons and many characteristics that were very unique to them, and so, yeah, we are going to see more of those big companies emerge in the next two years, but again, at the end of the day, it doesn’t look any different than what the startup ecosystem looks like today, because many of them are startups, and just one more thing I want to say is that have we learned everything? Not yet.

I expect us to make even more mistakes for the rest of 2017 and maybe into ’18 easily before we figure out what the real best practices are, and there’s nothing really stopping these mistakes from being made, no matter what people like me, or Nick, and others talk about, and even if we show a bit of restraint and warn people, none of that is going to matter. I think the train is moving at such a rapid speed that right now, this mechanism is seen as a low barrier, as a low entry point of raising money, and then everybody’s rushing to it.

Laura Shin:

So, to wrap up, what particular tokens or networks are you most excited about?

Nick Tomaino:

I mean, I could share. Again, tying back to Token Summit, a lot of them, the founders of the projects will be speaking at Token Summit. So for anyone that’s interested in hearing directly from these people, Token Summit would be a good event, and again, to me, the people behind these projects are much more important than any idea that anyone has, and so a few examples. One, you know, I discussed earlier Augur. Augur is a decentralized prediction market, that they actually did one of the first crowd sales several years ago and have been quietly building since, and I think a lot of people are wondering, you know, what is going on, but I’m really excited about what they are going to be bringing to market in the next 6 to 12 months.

Laura Shin:

And William, what about you?

William Mougayar:

Well, I’ll mention the ones that I own, so I have to make that disclaimer. The ones that I like that I own include Sia and Storage for cloud storage. I own and I like Steem, which is decentralized content with users being able to earn based on their attention. I like ICONOMI because they are going to be a fund management platform. Basically, they’re going to allow fund managers to manage a portfolio of cryptocurrency tokens very easily.

And I think Ethereum, obviously, because they are a new decentralized platform for writing applications, and I like Bitcoin. I also own Bitcoin because they are the backbone currency of this new world. I mean, there are others that have some emerging models. I’m very intrigued to see what happens with the reputation markets with Gnosis and Augur specifically, and then I continue to be amazed by how many new ones are being created on a daily and weekly basis.

Laura Shin:

Yeah, so we’ll see by the end of the year kind of which ones have taken off. So where can people learn more about you and get in touch with you?

William Mougayar:

So, for me, William, I write on a regular basis on my blog, which is at StartupManagement.org/blog, and that’s really where my thought leadership is being published.

Laura Shin:

And Nick?

Nick Tomaino:

Best to find me on Twitter. I’m quite active, and certainly, if you tweet me, I’ll get back to you. My Twitter handle is NTMoney.

Laura Shin:

Okay, great. Well, thank you both so much for coming on the show.

William Mougayar:

Thank you, Laura.

Nick Tomaino:

Thanks for having us.

Laura Shin:

Thanks, everyone, for joining us today. Before you switch off this podcast, don’t forget, go to SurveyMonkey.com/R/Unchained. Let me know who you are and what you want to see in the show. If you’re interested in learning more about William and Nick, check out the show notes which are available on my Forbes page, Forbes.com/sites/LauraShin. Thanks so much for tuning into Unchained, which comes out every other Tuesday, and please share the podcast with friends and on social media, and also remember to review, rate, and subscribe to it in iTunes or your preferred platform. Thanks again for listening.