It isn't every venture capitalist who would declare that he hopes to put the tried-and-true model of his industry out of business. But this is exactly the ambition of Brock Pierce, who intends to raise 20% of his firm's next fund by selling a digital token to investors.
Like other so-called initial coin offerings, or ICOs, Blockchain Capital's $10 million fundraise will take the form of a monthlong crowdsale, with the Ethereum blockchain automatically distributing to investors the tokens they have bought. Each token will represent a fractional ownership in the new fund.
Last year, dozens of ICOs raised a total of $236 million—much of it for an investment vehicle called the DAO, which soon went belly up after a flaw in the code exposed its funds to theft.
But the failure of the DAO (for decentralized autonomous organization) did little to slow the ICO trend. Pierce, whose San Francisco firm has invested in 43 cryptocurrency and blockchain startups since opening its doors in 2013, firmly believes that such token sales are the future of funding—not only for cryptocurrency projects but for all startups, and finally, perhaps years in the future, for nearly all organizations whatsoever.
On Monday, Blockchain Capital released the offering memorandum for its ICO, which is due to kick off on April 10. American Banker recently caught up with Pierce, who serves as a managing partner of the firm, for an in-depth conversation about the promise and perils of this new funding model, and why he wants to lay down a road map for others to follow.
What follows is our interview, which has been edited for length and clarity.
Why is Blockchain Capital choosing to raise its next fund through an ICO?
BROCK PIERCE: I don't need to do an ICO to raise my fund. Arguably, it's not the right thing to do, because I have a traditional general partners/limited partners structure. But this is the future of how startups will be financed. I've been aware of it and following it, but I have a serious concern about how this stuff is being regulated. Most of the people doing ICOs today are creating very convoluted structures with the purpose of circumventing securities law, and in a lot of cases I don't think it holds up. I think a lot of these deals have substantial regulatory overhang. Rather than circumvent regulations, let's look at it and say, "Is this something that can be done within the rules? Can you do this compliantly?"
That's what we set about doing over the last year. Timing is everything for me. I've been in the ICO market since day one [as a founding board member of Mastercoin], and it became very clear over the last year that the future is now. We're off to the races. And so the question is, how does one do it legally? In 2014, the Monetary Authority of Singapore gave guidance around how does one create tokens, or virtual currency, so we are incorporating the entity doing the ICO in Singapore. And then we are utilizing the Regulation S and D exemptions with the SEC to raise money from international investors as well as domestic investors.
I believe in practicing what you preach—eating your own dog food. Our third fund is going to be investing in traditional startups like we've done in our first two funds, but we're also going to be financing ICOs. So, hey, if I want to go after this space and I'm talking about how important this space is, I might as well be participating in the space. I'm showing people the path forward because I want to finance the deals going forward, and I'm more comfortable financing them if they're compliant. I'm a fiduciary of other people's money. How do I explain it to a limited partner if one of these projects goes out of business in two years and the entrepreneur gets indicted because of how it raised its money? I don't want to have to answer that question.
Why do you want to disrupt the traditional model of venture capital?
Venture capitalists have been investing in innovation and disruption for a very long time, but as an industry they rarely innovate themselves. If you're in the blockchain or bitcoin space, our view is that we're trying to decentralize the world, we're trying to democratize the world in a way that creates a level playing field where everyone has equal access. Crowdfunding was the first major leap in the democratization of the world of early-stage finance. I believe the tokenization of it—what we're doing—is the next, even larger leap. Since I'm a VC, and I believe in the concept of disruption, and of disrupting yourself—you know, someone can come and do it to my business, or I can do it to myself—I hope to put the GP/LP structure out of business. That is my goal over time. And I tell my investors, you're better off investing in my token than my formal fund, because our token is a digital, liquid venture fund. My traditional GP/LP structure is not.
But this takes time. Most of my LPs are not ready to invest in the token. There's a learning curve. I'm hoping that by fund four, fund five I won't even have a traditional fund any longer. But there's a process of migration. It's my belief that in the next 10 or 20 years no startup in the world will be financed in any way other than as a token.
Is venture capital unique, or will ICOs have a similar impact on other industries?
It's not just venture capital; it's private equity, it's real estate. All of these illiquid asset classes are going to get disrupted by this model, and it's going to start, naturally, in the industry that's providing the technology. My phone has been blowing up by VCs saying, "I want to do this with my next fund." If you're a VC, you understand the biggest problem in the ecosystem is a lack of liquidity. This model is solving for it. For us this is an experiment more than anything else, but I believe that this is the beginning of something huge.
How does an ICO work, exactly?
The Ethereum smart contract says, "I'm investing one bitcoin"—let's say it's worth $1,000—"and at the end of the crowdsale I get $1,000 worth of that token." The smart contract is actually doing the issuance of the token to the investor. Instead of having the [chief financial officer] send you share certificates, the smart contract is sending you tokens that are representing the security in that company.
Ethereum is still in many ways a prototype. But we have finally figured out what its first killer application is: ICOs. A big part of the reason why Ethereum's price is where it is, and it's doing as well as it is, is that it has now a killer app. When you did [Ethereum's own] crowdsale, you literally had to keep a ledger, a log, of what everyone's investment was and manually issue them the coins. Ethereum is now being used frequently and successfully for doing a crowdsale and getting the tokens in the hands of the investors. And that's why over 80% of the ICOs are happening there today. Even if Ethereum does nothing else, it has become the platform for financing the startups of the future.
Since your token, BCAP, will live on the Ethereum network, do investors first have to acquire ether and then swap ether for BCAP?
No, you can invest in our crowdsale using a combination of bitcoin, ether or fiat money. We can accept wire transfers and things of that nature. I'm not aware of anyone else who has done that. The reason why no one took government money previously was out of concern for being labeled a security. We're admitting that we're a security. We're the first ICO that's KYCing anything. We're the first ICO that's compliant. We're the first ICO of a fund. We're breaking the mold on many fronts.
Historically, the ICOs have accepted only bitcoin, or bitcoin and ether. They only took crypto because, mistakenly, a lot of people in the ecosystem think, "Well, if you're only dealing with digital money it's not really regulated." That's not really true; that's not how regulations work. I've been communicating to the ecosystem very actively since 2013. People would say, "Bitcoin's not regulated." I'm like, "Yeah, it is." There are a lot of regulations that existed prior to the internet that are applicable. They're not bespoke, they're not tailored. They may not be great regulations. They may be regulations you'd prefer to change. But just because you don't think it's regulated doesn't mean it isn't. There are a lot of laws in place that are applicable to the things that we do, and I highly recommend that before you do things you get some good advice from attorneys. Be innovative, be disruptive, go out there and change the world, but do it the right way. If you're going to take risks, at least understand what they are.
Some have suggested that ICOs are something of a legal gray area in the U.S., and that the SEC may eventually move to restrict or regulate them. What do you say to that?
The regulatory arm is slow to react. Do you know when it reacts? It reacts when these ICOs, the first wave of them, run out of money and go out of business and the coins go to zero, and there's no one left working on them, and eventually they say, "Oh, you guys raised $10 million from a bunch of nonaccredited investors. Everyone lost their money. Now people are pissed off and complaining." That's when the SEC does something. They're not in a rush.
Most of these entrepreneurs have the best of intentions at heart. They just don't know any better. And, again, that's one of the reasons I'm doing this, because I want to show people the right way to do things. I've been telling most of the people who have approached me in the last three months, "Don't do your ICO until I show you the road map." It's going to be the difference between being part of wave one, where everyone did things gray, and wave two, where people did it right. That's the way the first waves of these things go. People don't know what they're doing. The second mouse gets the cheese. The first one runs in and—snap.
How can someone who wants to do an ICO do it right?
There are only two jurisdictions that have issued guidance on tokenization, and those are Switzerland and Singapore. It doesn't exist in any other jurisdiction in the world. But Switzerland's guidance was only applicable to Ethereum. And so now all of these other companies have gone and incorporated in Switzerland using guidance that's not applicable to them. It's like they didn't hire lawyers or do their research.
Switzerland is great for Ethereum. I think it's an awful jurisdiction for everyone else. Ethereum took a really long time to launch, and that's because they said, "We're going to spend half a million dollars on lawyers to make sure we do it right," which was wise. They said, "We know what we're doing is a big deal. We know it has enormous potential. So rather than rushing it, let's take our time, let's be thoughtful, let's be methodical and let's do it right."
A lot of these ICOs are saying, "Hey, if I launch now I can raise $10 million," versus spending six months to make sure that they've dotted their i's and crossed their t's. And that's the problem with a lot of these: They're just saying, "Oh, Ethereum did it in Switzerland; let's do it in Switzerland," without doing any actual research. There's no ifs, ands or buts about it: Singapore today is the far better jurisdiction, unless you're the Ethereum Foundation or your structure looks almost identical to Ethereum. It's a huge point, and everybody has done it wrong.
Your token will be available within the U.S. only to accredited investors but, in the rest of the world, will be available to retail investors.
That's correct. That's a Regulation S exemption for the rest of the world. Regulation D, for the U.S., limits us to accredited investors and we're capped at 99 investors. Our U.S. investors have a one-year lockup. Those are the rules we have to follow under the Regulation D exemption. The international investors can't sell a token to a U.S. user for the first 40 days. So there's a 40-day lockup on all of the international investors. And the structure is, the ICO is a closed-end fund out of Singapore issuing a token under those two exemptions. It will be very interesting to see how this all pans out.
Beyond the blockchain industry, who will be next to adopt the ICO model?
The next wave of these types of deals are going to be groups that are consumer-facing and have big user bases and want their users to have ownership in their network, and they want that ownership to become a currency within that network. And it's also going to be very relevant to intentional communities. I think those are the next two ICO markets that will emerge in the next year or two. Eventually, every fund and every company will operate this way.
But since the BCAP token will trade on exchanges once the crowdsale ends, unsavvy retail investors in the U.S. could still wind up holding a digital asset that was originally available only to accredited investors. Isn't that a problem?
That could be a problem from the U.S.'s perspective, but that's not a problem we've created. If someone were to do that, it's not something we can prevent. If you buy something from me, how do I prevent you from going and selling it to someone else? We're restricting people and putting in place lockups to create the most compliant structure possible to ensure that we've operated within the rules to the extent possible. At some point there's only so much control that we have.