Venture capitalists hunt for ideas that will disrupt, disintermediate or democratize other industries, but the field’s fundraising model rarely undergoes any of the D words itself.
Blockchain Capital, a San Francisco venture firm focused on the still-arcane world of blockchain technology and cryptocurrency startups, is aiming to change that.
In April, the firm raised a portion of its third fund through a sale of its own digital tokens, the first VC firm to do so. Transformations in the VC industry are inevitable, according to Blockchain Capital’s partners, so investors might as well embrace them.
“Our choice is, do we disrupt ourselves or let someone else do it for us?” asked Bart Stephens, a co-founder and managing partner of Blockchain Capital. “The right call is for us to disrupt our own industry.”
For some investors, blockchain technologies like bitcoin can connote the online black market Silk Road rather than Sand Hill Road. But as more uses for the technologies emerge, interest among investors is growing.
Launched in 2013, Blockchain Capital has funded 43 startups in the sector. Stephens manages the fund along with his brother, Brad Stephens, and the digital-currency entrepreneur and former child actor Brock Pierce.
To raise cash, blockchain startups and open-source projects may issue an ICO, or initial coin offering, selling early investors cryptocurrency tokens that they can then trade on digital exchanges.
Part Kickstarter campaign and part IPO, they’ve surged recently. In 2015, 11 major ICOs raised about $10 million. In 2016, 68 major ICOs raised more than $100 million, excluding those that were hacked or refunded, according to the cryptofinance-research group Smith + Crown. Just in April 2017, eight token sales raised about $70 million.
Meanwhile, the number of IPOs in 2016 dropped to a seven-year low as small companies stay private for longer.
Others in the VC world have turned their attention to ICOs. In early May, venture capitalist Tim Draper, co-founder of DFJ, told Reuters that he would participate in an ICO for Tezos, a new blockchain platform created by Dynamic Ledger Solutions. Draper is considered the most high-profile venture capitalist to back the idea.
“The ICO process is a new tool in the toolkit of a small, fast-growing tech company,” Stephens said. “They can go public in a way, not on Nasdaq or the NYSE, but it fulfills a similar function.”
That might make some VCs nervous, since it enables small startups to sidestep the VC fundraising process altogether. But for Blockchain Capital’s managing partners, it was an opportunity to prove that VCs should embrace changes to their own industry.
As part of their third round, targeted at $50 million, they raised $10 million online in less than a day by offering investors digital tokens called BCAP. The rest of the round will be raised through its partners’ capital.
For Blockchain Capital, the ICO enables smaller investors to access the fund and begin trading the tokens far sooner than they might with a traditional fund investment.
“By doing an ICO we were able to crowdsource $10 million in less than six hours from more than 800 individuals in 79 countries and did it in a regulatory-compliant way,” Stephens said. “And Stanford and Harvard are not in there” as LPs.
U.S. investors must be accredited and must wait a year before they can trade their tokens. For international investors, the waiting period is 40 days.
Those restrictions stem from Blockchain Capital’s decision to tackle the question of regulatory compliance. Cryptocurrencies occupy a legal grey area in the United States, with securities laws still yet to explicitly address digital tokens and ICOs.
Instead of skirting regulations, Blockchain Capital decided to take the opposite approach. “We want to see this industry develop in a responsible fashion that’s compliant with rules and regulations,” Stephens said. “Even though the laws governing this stuff haven’t been written, we assume they’ll be written.”
Blockchain Capital worked with the digital-finance investment bank Argon Group to ensure its ICO complied with applicable U.S. securities laws, issuing the tokens in the U.S. under the usual Regulation D SEC exemption and internationally under the S exemption, which applies to offerings made outside the United States by both U.S. and foreign issuers.
“Most of the tokens coming to the market are structured in a way that they’re tripping the securities test,” said Argon Group Chief Executive Stan Miroshnik. The Howey Test was created by the U.S. Supreme Court in 1946 to determine whether a particular transaction meets the standards for federal securities laws to apply. “We’re the first ones to do it this way.”
Questions and uncertainties still abound in the blockchain ecosystem. Cryptocurrency enthusiasts are still looking for safe ways to store their tokens. Unlike fiat currency, cryptocurrency isn’t insured and crypto wallets, online exchanges and blockchains have been hacked.
And a proliferation of scams, Ponzi schemes and questionable ICOs attempt to lure the unsuspecting with fancy but unfamiliar terms like “distributed ledger” and “decentralized storage.”
Some observers have criticized the entire ICO process. Travis Scher, an associate at Digital Currency Group, is leery of digital coin offerings, with valuations alarmingly high, regulations still opaque, token holders’ lack of control over how the profits that are raised will be used, and implausible value propositions.
“Fraud and scams are inevitable,” Scher wrote in a Medium post. “And even the promoters with the best of intentions will be swayed by their self-interest and distorted incentives.” Scher did not respond to VCJ’s request for comment.
Despite the uncertainties, interest is growing. Since his company’s ICO, Stephens says he’s been approached by more than a dozen VC investors who want to know whether they can mirror his fundraising model.
“We did this as an experiment,” said Stephens. “A lot of people are watching us and trying to see if that is something they can incorporate.”
Photo of blockchain network concept and light bulb courtesy of JIRAROJ PRADITCHAROENKUL/iStock/Getty Images