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24/12/2018
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by Christian Meisser

From Donation ICOs to Tokenized Securities

A Crypto Christmas Tale of Charity, Honesty and Value Investing

"And if you give yourself to the hungry And satisfy the desire of the afflicted, Then your light will rise in darkness And your gloom will become like midday." – Isaiah 58:10 

“Never invest in a business you cannot understand.” – Warren Buffett 

The first wave of blockchain-based fundraising has been marked by complex legal structures that have strangely blended donations and investments. We look at what happened and dare to predict that the next phase will be a return to simplicity, untangling charity and investments, and merging the strengths of traditional securities and blockchain technology. It's time to provide the next generation of Warren Buffetts with secure and efficient long-term investment opportunities, so they can, just like their idol, eventually donate the proceeds to charity.  


 

Charity

The past years have seen the meteoric rise of a new form of donations, labelled Initial Coin Offering (ICO), or Token Generating Event (TGE) by those worrying that the term ICO may confuse donators with its similarity to the term IPO. Confusing times it has been indeed: Regulators have alleged that the generous beings that have donated billions to ICOs did not wish to give at all, but were driven by pure and simple greed (or investment purpose in legal speak). Some donators sued foundations to repay their donations because the donators claimed not to have known that their donations to foundations were just that, donations to foundations. Notably, many of the ICO teams also confused the nature of their offering: Even those teams that did not wish to accept donations but wanted to give investors actual enforceable rights often ended-up with a donation scheme: Most utility tokens and profit-sharing tokens do convey donators certain rights, but these rights can be circumvented so easily by the issuing company that it is hard to label it anything but a donation.1 Well, what has been driving force behind this altruistic outburst?  

 

Honesty

Many people have won a lot of money, and a lot of people have lost a lot of money with these donations. What happened? All beginnings are messy, and Crypto Winter is a great time to reflect on what we can learn from this first wave of blockchain-based fundraising. Let's start with a bit of honesty: Nobody ever believed that most ICOs or TGEs had anything to do with actual charity. Once the party got started with a few outstandingly successful fundraising projects, the siren call of quick and easy money lured in ICO teams as well as investors. But why not give investors enforceable rights? One reason is certainly because ICO teams did not have to – as long as investors pay to receive a token full of hope, there is no reason to give enforceable rights. The other reason why almost all teams structured ICOs as donations or equipped their tokens with a similarly ineffective form of investor protection was regulation: Even the teams that wanted to give enforceable rights often opted for a very limited set of investor rights, simply because regulation made it more attractive. So ironically (but not quite surprisingly to the many crypto-libertarians), regulation quite likely has had a negative impact on investor protection by shifting the market to less regulated and less investor-friendly token structures.2 However, the market seems to have entered a phase of self-regulation, with 'investments' into donation ICOs dropping markedly and the focus shifting to Security Token Offerings (STO). But beware, many STOs are not what they seem. 

 

Value Investing

Simplicity is the friend of honesty. And the basic tenet of value investing is simple: Invest in things that trade below their intrinsic value. To determine intrinsic value, the investor needs to understand the investment object, hence the quote of Warren Buffet. Now, most STOs have not exactly excelled at simplicity. Not only are the conferred profit-sharing rights highly doubtful (see footnote 1), but the financial modelling is often needlessly complex with discount schedules, future conversion rights, and only partial token distribution. The new custom to give steep discounts to private and wealthy investors runs anyhow counter to any egalitarian notion and has, as far as we know, no precedent in traditional finance.  

But there is a silver lining: Traditional securities, such as shares and bonds, can be tokenized, at least in Switzerland. Having tokenized securities merges the best of traditional finance with the incredible potential of the blockchain technology:  

  • Traditional shares and bonds are relatively easy to value as an investor, and their issuance does not require much legal and financial engineering by expensive consultants. But it gets even better: The regulatory and tax consequences of issuing shares is well-established and does not require a tax ruling and a long wait for a FINMA no-action letter. A Swiss company can issue tokenized shares or bonds within weeks at very low cost.  
  • At the same time, tokenized shares are everything you could wish for in a tokenized asset. They can be issued with relative ease, they can be transferred peer-to-peer without any intermediaries, and they confer actual enforceable rights to investors.  

Sounds too good to be true? Fortunately not, as both LEXR as well as Switzerland's largest law firm Lenz & Staehelin have already shown that it can be done (simply DuckDuckGo the token offerings of Alethena or Mt. Pelerin).  

In this spirit, we wish you an honest and simple 2019, in which donations are for charities, and investments for businesses. Both donating and investing are complex enough as it is, and if you are looking for great advice on how to donate effectively, we suggest you contact Effective Altruism Zurich (Disclaimer: the Zurich chapter was founded by one of our team members). 

 

 

The setup for the typical profit-sharing token is that if the company decides on paying out dividends, a certain percentage thereof will be paid out to the tokenholders. Even in the rare case that a startup would pay dividends (Amazon, for example, has never paid any dividends), there is an easy way around this. The company can simply decide on a share buy-back instead of a dividend payment: The economic effect for the shareholders is the same and tokenholders don't have to be paid a single dime.

2 The same has arguably happened with the credit default swaps that circumvented pre-financial crisis regulation, and is apparently happening again: According to some accounts, the now regulated credit default swaps are shunned by financial institutions in favor of less regulated financial instruments.