Funding Your Blockchain Project – Guest Editorial
In general terms (and very simplistically), a company or startup will have an idea “I want to make talking Barbie dolls that take comments from their owners and put them on the block chain, thus making them available to all the other Barbie dolls therefore making the doll more enjoyable for longer” says virtual exchange IT executive Paul Foley
By Paul Foley, Head of IT for Liquex, a Virtual Asset exchange based in Malta and Cyprus
I’ve been talking to lots of people in the financial services sector and IT over the last few months, telling them about the project that I’m involved with and invariably there are a few questions that come up – the most prolific of these relate to funding. So here’s a brief overview.
You may have noticed that at present there’s a gold rush going on. People are launching pretty much anything using block chain technologies and seemingly the world is throwing money at them for doing it.
So how does that work?
In general terms (and very simplistically), a company or startup will have an idea “I want to make talking Barbie dolls that take comments from their owners and put them on the block chain, thus making them available to all the other Barbie dolls therefore making the doll more enjoyable for longer.”
The idea doesn’t need to be world changing it just needs to be new and interesting (for now).
The company will then come up with a way to achieve this and create a white paper – The white paper is a way of explaining to anyone who’s interested what the company is doing, what they plan on doing, how they’re going to use the funds that they raise and what the roadmap is for the product or service that they’re going to offer.
You could also consider the white paper to be a sales pitch or brochure to entice investors in. If the company is in Malta then the white paper has some additional requirements such as specifying who the directors and advisors are, what makes them qualified to run this type of business and a more detailed financial breakdown (this requirement came into play a few weeks ago now which means that Malta is currently one of the most demanding places in terms of the white paper – which is a good thing).
So we now have a company that has a product or service that they want to offer, they’ve got their financials on paper, have directors/advisors in place and have all of this information available in a white paper that they can send out to the market.
So how are they going to finance the project?
The company are going to issue their own crypto currency.
BUT – perhaps a better question should be Where are they going to finance and launch the project. That probably sounds like a strange question in this day and age. This is another occasion where the company could make life easy for themselves or take a more interesting route.
If the company decide to launch their crypto currency in the USA then they could fall foul of the SEC. The SEC have a test called ‘HOWEY’ and this is how they decide if a company’s crypto currency is a security or not – and if it is a security then it (and the company) are subject to the full attention of the SEC which makes the project a lot more expensive and time consuming.
If we assume that the company has decided to incorporate in Malta and launch their crypto currency from there, then life will be a lot simpler.
Now lets get back to the finance question.
There are a few ways that the company could finance its project but at the time of writing the most common way this happens is that the company will perform a round of private investment and this is followed by an ICO (Initial Coin Offering).
The private financing is typically a means to raise the funds required to get the company to a successful ICO. The money isn’t typically used to pay salaries but is instead used to pay for a large marketing effort and to pay for infrastructure and legal fees. It potentially also finances the creation of the MVP – minimum viable product.
So if the company has already raised money in private finance what happens during an ICO?
Prior to the ICO the company will have had their own coin created (it’s not a physical thing). They will have chosen a platform to base the coin on such as Etherium or Bitcoin.
The company will undertake a massive marketing effort in an attempt to create some interest for their new crypto currency and the underlying project.
The company’s ICO website will have a signup area and allow people to buy coins at a predetermined price and depending on how they choose to do things they will either take the money now or on the day of issue (I’m not going into smart contracts in this piece).
At this point the company will also have to perform KYC/AML lookups on the potential clients – so they need to ensure that there are no politically exposed people buying from them and that if I say I live at Buckingham Palace then I can prove that I do. This takes time and money (although can be done quite cheaply and fast if you know how to do it).
One of the interesting things at this point is that the company has set the initial price of their coins – let’s say for arguments sake that they have specified 10 cents.
I’ve just plucked that number out of the air and you’re probably wondering where it came from – well that’s pretty much how the issuing company could do it (if they wanted to).
Prior to the ICO and whilst they were preparing their white paper they would have prepared a document entitled “Tokenomics” (that is a real word honestly).
The idea is that in this document the company will specify how many coins it plans to make available, when and how much they will be valued at and this will be the way the company does its’ initial financial planning (normally a company will work backwards – i.e. how much do we need, how much do we think the market will think we’re worth, how many coins does this equate to – and then move the figures around until they’re comfortable).
An example of this might be:
- Private investment Round
- 200,000,000 coins valued at 5 cents each and awarded at 2:1 for investors
- ICO Round
- 200,000,000 coins valued at 10 cents each and awarded at 1:1 for regular clients
- Post ICO
- 400,000,000 coins valued at 10 cents each and awarded at 1:1 for regular clients. Release as required
What does this mean in real terms?
The Private investment round is selling 100 million coins whilst issuing 200 million. The value of these coins is 5 million (100 million x .05 dollars). Each coin has cost the investor 2.5 cents due to the bonus. The bonus is a way of enticing the investor in to what could be a high risk investment (although there are other methods).
The ICO round is making available 200 million coins at 10 cents each – this equates to 20 million dollars. This sale will live or die by the marketing effort – if the company hasn’t generated a buzz about their product and nurtured a community then it’s unlikely that they will get anywhere near closing the ICO with the required funding.
The post ICO sale of coins involves the company releasing coins into the market as and when they need additional funding and at ICO valuation they’re worth 40 million. At post ICO prices they could be worth more or less.
So what could go wrong with this model?
Well I think perhaps the most obvious thing that can go wrong with this model is that there’s insufficient interest in the ICO and the company sells very few of it’s coins. There is subsequently very little interest in the coins and the value decreases – meaning that any further sales are worth less than was initially planned for (coin value can potentially go down to zero If there is no interest at all). If we add on top of this that the company needs to perform KYC/AML checks on the potential clients then there’s also a cost associated with each client on top of pure marketing costs.
One of the benefits of this method is that the company will have a good idea before it’s too late if they’re going to succeed or not and will be able to take steps to correct any short comings.
Once the company has created the coins they also need to get in touch with a few exchanges – there’s no point having a coin that can’t be traded.
Depending on the technology of the coin this will be an easy sell or a little harder – so for example if the coin is based on Etherium pretty much any exchange should be able to offer the company’s coin with very little effort – if the company choose something new or exotic it’s going to take the exchange more effort to list the coin and so there’s a greater risk of refusal – and of course the exchange has to consider that there will be a taste for the new coin or it’s not going to be interested in listing it either.
From a simplistic view this is how companies are raising funds with ICO’s for block chain projects at present. I should mention that I have deliberately not talked about the underlying technologies beyond acknowledging that they exist, I haven’t talked about alternatives to the ICO process itself or indeed methods that can be used to quickly/easily/cheaply perform KYC/AML tasks and I know that I haven’t mentioned wallets or trading bots at all. I plan to discuss some/all of these issues in later pieces.
This piece was aimed at providing an overview for those who haven’t been involved in the block chain revolution – which is actually the majority of people on the planet.
It is my belief that by providing education, for free, to the masses we will all be able to benefit from the innovation that is out there whilst also helping to nurture a community that allows us to move away from some of the less desirable traits that we are accustomed to in the financial services industry.
Disclaimer: FinanceFeeds does not endorse investment and any activities related to cryptocurrencies, crypto-assets, initial coin offerings, digital assets and tokens. The views expressed in this article do not reflect FinanceFeeds’ views on the matter.