Everything You Need to Know About ICO

ICO fintech cryptocurrency

On February 21, Sila hosted a webinar that featured Marcus Estes, CEO of Chroma, and Shamir Karkal, CEO and Co-Founder of Sila.

The in-detail discussion covered such topics as:

  • Regulatory issues associated with creating an ICO
  • Token economics versus using tokens for fundraising
  • How the ICO landscape looks outside of the U.S.
  • What the future of ICOs looks like


Watch the replay:


Shamir Karkal: Hello everybody. Thank you for joining me on this lovely morning here in Portland for another webinar in the Sila webinar series. My name is Shamir Karkal. If you guys don’t know me by now, you really should go watch one of the earlier webinars, or look us up on the website. So I’m not gonna tell you who I am. Because I’m really excited to welcome Marcus and he can tell you about himself in a minute, but before we go there I want to tell you the story of how I met Marcus. It was quite literally at my best friend’s wedding. Which he was officiating. And that same best friend had a kid last week which is an exciting development, but in the meantime I have been talking to Marcus and learning more about the ICO world, crypto world actually, and all of the kind of different things that are happening in it. He helped me a lot a year, 18 months ago, to just understanding everything that’s happening in the space and that’s really what I want to help you guys understand as well is sort of everything you need to know about ICOs or even about issuing tokens and token economics. Eager to get into that, but before we do, Marcus, why don’t you tell us a little bit about yourself and the story of Marcus.

Marcus Estes: Well, thank you Shamir, as a side note, if an old friend of yours ever hits you up and asks you to officiate a wedding and you don’t find yourself in possession of the proper licensure, I highly recommend the Church of the SubGenius. It’s pretty quick five or 10 day turn around. One can become a minister more easily than you might think, these days.

Shamir: Good to know.

Marcus: So the story of Marcus, I’ve become old enough that we don’t really have the time. But the…

Shamir: I know that feeling.

Marcus: The high points and low points I really like, I guess the one liners that I’m a high school drop out from Alabama, I have acquired most of my professional experience through just kind of hitting the books and trying to figure things out my own way along the way. I was, I’ve been in software for most of my professional career, and specifically started Chroma in 2013

Shamir: Oh wow.

Marcus: I know, it’s ancient in the crypto space. The notable thing about Chroma is that we were kind of bad about doing things much too early. But notably in 2015 we, seeing the structure of crypto assets and how they can be tied to potential investments. We saw that there would be some regulatory challenges ahead and we were, we were I believe first globally to find a regulatory path for doing a regulated ICO and that came out of Portland, Oregon in late 2015. We worked with the state of Oregon to get clearance for it. And then since then we essentially have been, we’re a small boutique shop, and we are essentially a picks and shovels aspect of the ICO industry. We don’t only focus on crypto, we also like other kinds of alternate assets. We help people raise money. We also build prototype crypto technologies for other firms.


develop next big financial app


Shamir: That’s pretty cool. So one thing that might really helpful is to sort of understand the history of ICOs themselves.

Marcus: Yes.

Shamir: And even, of course, I think everybody’s aware that securities issuance has been happening for centuries. And there’s the SEC, and pretty much every country in the world has some regulator equivalent of that which controls things like IPOs and creating of stocks and bonds. But it feels like the ICO phenomenon has really just taken off in the last five, six years, maybe even less than that. So how did that all end up coming together? You were clearly involved in it from almost the start.

Marcus: I well, yeah it did certainly, it predated us by a bit. So yeah, that’s a great question. So, breaking the semantics down a bit, it’s widely considered the first ICO was the Ethereum offering which was, I need to check my notes here, I believe that was 2014, if I’m not mistaken. You know, so here offering is kind of a consideration because of course the first modern cryptocurrency is bitcoin. Bitcoin wasn’t considered itself an ICO, using this nomenclature because famously if you were willing to be in touch with the original, Satoshi, there were bitcoin faucets, you could run a miner on a consumer CPU. There’s all these stories that if you ran that miner in the first year of that project you could easily net what today would be millions of dollars while running out for pizza. But the bitcoin project never, itself spun off the mechanism due to purchase bitcoin to fund bitcoin as a project. They simply released it into the world. And you know, the sort of supply and demand around bitcoin, it sort of worked out well given that the demand for bitcoin was low enough during that time that they found themselves properly able to centralize before all this sort of money interest sort of came into play. Now, with Ethereum, Vitalik Buterin, the sort of thought leader behind the project, the core developer, they found themselves in a bit of a pickle because they had a big ambition, they were inspired by bitcoin but they didn’t have the resources on hand to properly build and launch the mainnet network. So they found themselves in need of a funding mechanism. So Ethereum pioneered the model that we’re all still kind of using today, which is that they, you know, pre-sold allotments of Ether. So before Ether was available on a mainnet, you were able to invest in it with bitcoin. So Ethereum had, at the time was a very successful ICO. What’s funny is that the entire Ethereum ICO, given that they’re now between the number two and number three most valuable coins on the network. The ICO netted then, it was in the double digit millions, so I mean it was a wild success story. I believe that Vitalk himself was still a teenager at the time. Of course, the multiple, if you have, if anyone in the audience happens to have to be phoning in from your luxury yacht that participated in that. The multiples of the initial investors in Ethereum, it was a very wild return on investment. And it did a lot to kick of the ensuing mania. So the model that was used there has been improved in a lot of ways and of course a lot of the ways to discus the way the history developed from there is that as it became a more broadly participated phenomenon we had to start thinking about this is actually an investment. And so the history to date has a lot to do with technical improvement of the process, the kind of breadth of projects that are being financed and of course what the national governments of the world think about all of this funding activity.

Shamir: Yeah and it feels as if that original issuance of Ethereum people who can sell bitcoin and exchange for an allotment of Ether and then when the Ether mainnet went live they got the Ether for those bitcoin allotments. And then now its the Ethereum is the kind of the premier platform for doing ICOs and has been for the last, for at least the last three years.

Marcus: That’s right.

Shamir: And that’s why everybody else does ICOs and I don’t know the exact number but there were over 1000 ICOs at this point. And there was this massive boom through ’16, but really it was like 2017 and the second half of 2017 and the first quarter of ‘18.

Marcus: That’s right.

Shamir: That you had the big boom. And as frequently happens in almost any financial asset market, when you have a big boom, you have a bust after.

Marcus: That’s right, yes that’s right.

Shamir: And so now it feels like we are living not just in Portland’s winter but in the crypto winter.

Marcus: Yeah that’s right.

Shamir: Since kind of the spring of last year. When the bitcoin and Ether prices just kept going down. And the effect right now feels like almost nobody’s doing anything. So is that what you’re seeing as well? Complete kind of shrinkage of the issuance? And what does that doing to the ecosystem?

Marcus: Yeah, great question. So yeah this term crypto winter is kind of solidified, and you can measure it really in pure price action to begin with. I mean looking at Ethereum, which you’re right is the most common platform from which a lot of these other coins have used to conduct their, if not their offerings, sometimes their actual networks themselves are running on Ethereum. So the price of Ethereum has retraced, I mean, I think that the widest retracement is somewhere close to 90%. So it’s really quite a swift hollowing out of value. And so that price retracement had a direct effect in reducing demand for new issuances. That coupled with raising the bar for conducting an issuance has been raised. The cost to conduct an offering because now there is compliance with securities law, so it is much more expensive. You can’t just roll the coin out the door, you’ve got to hire lawyers, and get a PPM together et cetera. So there certainly are ICOs contemporary ICOs. You can look at the aggregator sites and see that there are perhaps, I mean depending on how you mesh them up, I would think there’s probably at least a dozen. You know, using a very low bar for credulity at least a dozen decent ICOs out there right now, as we speak. But that numbers down, I mean I think it’s probably, in terms of numbers of issuance it’s probably down by a tenth. It’s probably related to prices, strangely.

Shamir: Yeah.

Marcus: And then of course, the quality bar is been changed as well, the kind of, one thing that you’re not seeing is the massively ambitious sums that were being sought during the kind of boom. Famously val coin raised some 320 million in 20, that was 2017. Telegram is

Shamir: That is some billions.

Marcus: That’s right they crossed the billion dollar threshold. Which is fascinating. And of course it’s natural to want to roll your eyes at that, to think wow that’s a pre product launch company that’s raising, with the equivalent of a crowd sale, a billion dollars. You can just smell the mania on it. But you know, it’s interesting to note that traditionally to put together a billion dollars required all the collusion of the investment banks, and Wall street, and this is, again the mania at least showed that there was theoretical demand amongst a broader set of the population to invest in these early stage crypto companies. So we’re far from that height now but we all know that those kinds of things are possible, perhaps possible again.

Shamir: And you know this isn’t something that’s sort of unusual, if you look at ICOs, you look at the Nasdaq or NYOC, there was a huge IPO boom in the late 90s called the dotcom boom.

Marcus: That’s right.

Shamir: And then there was a bust, and NYOC and especially Nasdaq prices crashed and between sort of spring of 2000 and 2003, 2004 there were almost no IPOs. And then investment bankers have this term which is the IPO window, and you know they talk about the IPO window being open or being closed. It’s not like the NYOC is shut down. It’s just that the traditional IPO process involves getting a bunch of investment banks to underwrite the offering, as it’s called, and actually go out and sell it to all their clients and when prices are going down or there’s other problems in the market, you just can’t do that. So you get the, it just feeds, the crypto asset world is beginning to act like the traditional world where when there’s massive dislocations or price drops, new ICOs are, just like IPOs, much harder to do than when the market is booming and you can sell lots and lots of things. And so analogous to that it also feels like definitely for at least the first Ethereum quote un quote ICO, but for a lot of those early ICOs they basically acted, and I’m sure they felt, maybe even they had legal opinions, I don’t know, to the effect that they didn’t need to abide by any regulations and they just got in and made it.

Marcus: That’s right.

Shamir: And you could on a platform like Ethereum, and you still can technically just create your smart contract with all the kind of the mechanics of the ICO issuance into a token, into a piece of code that’s a smart contract, launch it on the mainnet and then it will create the ways it’s programed to create. So you could technically do it, the hard part of traditional IPOs is like you couldn’t just go into the NYSC systems and start issuing stock. There were a lot of sort of gatekeepers before that was possible. You can still go into Ethereum, just sort of download the node and run it once it sets up you can write your own software, really it is very hard for someone to stop you from doing an ICO, but the legal implications of that feels that people now understand that even if it’s technically doable, it might not be legally doable in a lot of countries. So what goes through the evolution of how ICOs kind of, maybe the standard ICO mechanism has changed given that people now understand that yes these things are regulated and there are things that you have to do in the U.S. And other countries?

Marcus: Absolutely, yeah. So this is really for, it sounds like such a dry topic then you’re even a few steps out of it in terms of

Shamir: It does?

Marcus: You know, financial security circulation.

Marcus: I do it actually is incredibly fascinating. You make a great point which is to say, you know, as a thought experiment, what if the Nasdaq had a self serve kiosk for issuance? What happens to society if you just kind of walk up and just sort of list something? And so you’re also right to say that the technology offered, for instance, by Ethereum, though you could certainly roll it up and using other technologies as well. There is the equivalent of a boiler plate code. You know, a few moderately experienced developers could technically prepare the offering itself in an afternoon.

Shamir: I think that is a medium course of how to do an ICO in an afternoon or something like that.

Marcus: Yeah.

Shamir: I remember reading, and there might be more than one, but it is possible to do, you know the basics of programming to provide a small contract and push it on the mainnet in a day.

Marcus: Right, yeah. I mean even less. And so yeah, ThemeForest website with a countdown. And you receive 20 contract templates, open Zeplin. Previously, initially, and we will get to your real question, where does the regulation come in. Part of it was that the number of issuance at the beginning was constrained by, in a sense, the wizardry available from the talent market. How many people knew enough to launch it. Cryptocurrency, it seems like an innate more complex technology than say a SAS application. You’re dealing with more novel concepts so they seemed to be at first, that if there were simply an actual feasible technical offering that the market itself would have said well here’s another one that’s been made possible. Ethereum actually commoditized that process. So you didn’t necessarily have to write your own proof of work algorithm or your own mining node, you know, you could actually just say well actually this is just a smart contract, right? So as demand increased because you saw these wild returns, and then of course the mechanism of the offering commoditized the process, you got this sort of ramping up of course issuance that is just increasing as more and more money is being poured in. And with that swerving of capital and more rapid issuance and of course more and more risk is leaking into the system, I mean wildly. That absolutely drew the attention of regulators from around the world. But of course in the entire globe perhaps one of the more ferocious and aggressive financial regulator is of course the United States SCC. Because of course they’re looking after a lot of capital. So the history of how this space began to sort of go more in lines with traditional capital markets. I would point to, actually, I would point to Filecoin which I mentioned earlier. So briefly, Filecoin is a great project, a great technical underpinnings, it’s basically distributed storage. So if you can think about Amazon’s S3, it’s the distributed version of that, simply stated. So great technical team. Now they knew that they needed a huge amount of capital, it’s an ambitious project, much more than a smart contract. It’s a whole sort of layer one, as they say, solution. Need a lot of capital to build it. So they decided to seek, again, a few hundred million dollars. They had amongst the first of the attorneys that they hired, finally talked some since into them and said hey, listen with any given issuance a lot of interpretation here. At the time there was a lot of immature legal reasoning. A lot of ICOs that were not seeking any form of exemption from securities law they had these kind of back of the napkin check lists going around to say, well if you’re distributed, you’re decentralized then you’re not really an investment because of these reasons. As these companies sought more established, global law firms say what is your opinion on whether were going to be sued out of this capital if we raise it? They eventually convinced them to say look, you really should just be safe here. The SCC is not, at the time of again we’re talking 20, I’m trying to remember I think it was 2017, if I’m correct.

Shamir: Yeah, 2017.

Marcus: So right at the height of the mania. Given the sum raised and the soundness of the team, they decided to make the sacrifice of saying, you know what? Let’s find an actual regulated path to doing this in the U.S. That was the debut of a set of legal documents that we refer to as the SAFT, the Simple Agreement for Future Tokens.

Shamir: So Filecoin did a SAFT?

Marcus: That’s right. They essentially financed the creation of the SAFT. A number of law firms, it was a kind of witches brew, Cooley was a firm that has gotten a lot of attention for the release of SAFT. Behind the scenes a lot of firms were collaborating on that. And basically they said look, here’s the deal. We should presume here, especially because the network is not live, that your arguments about the decentralized sort of nature of this potentially evading classification, well not today, as of today you’re forking over cash. And they didn’t do a bitcoin swap primarily U.S. dollars. So that’s interesting. And secondly you’re gonna have to simply wait and hope that we launch this network and that it’s successful. You know, frankly, of course that is the definition of security.

Shamir: That’s what happened, but again that is how the Ethereum worked as well except that they did launch their network, and they did use bitcoins for cash.

Marcus: Absolutely. And so the distinction between the two, it’s really interesting to break down. So again with Filecoin you basically, they said because this is an investment, and we have this legal document that explains essentially they modeled after the Y Combinator SAFE. So its similar to the safe mechanism. Give me some cash today. I’m going to promise you later when we’re live, you’ll get your token. So by shifting that exchange of value of time, you basically flip faced yourself with the dreaded accredited investor questionnaire. They were the first big project to say we’re going to legally accept this, using this model but you really have to be an affiliated. And there a huge shift took place. Because if you made a pie chart of the sources of capital, I would believe that Ethereum, I’m sorry to say this actually, you can do some on chain analysis. The theory being that the early ICOs were being driven by, what we consider retailer-individual investors. And you kinda want that in a centralized network. A larger number of people invest in smaller amounts. With Filecoin it sort of signaled the introduction of larger sources of high net worth capital. You also saw more hedge funds, more family offices, and some institutional capital, venture capital getting involved. And so as the regulation kicks in they admitted, you know, we’re going to have to do this in this way. They also, the gates kind of closed some of those early fan boy and fan girl, boosters. So a lot of people that would have liked to invest in Filecoin could not. And then from there the transition has kind of continued at pace. I would find, oh yeah.

Shamir: And for those of you not intimately familiar with the SEC regulations, in the U.S., securities. Its an interesting, whole interesting question of what exactly is a security? Which we can go into separately. But securities have to be registered with the SCC, and once they’re registered they need to have certain things that they follow. You have to have prospectors, you have to do an offering, and you know, disclose stuff. It’s complicated. It’s not, it’s far from trivial. There are a few exemptions, and one of the ones that pretty much every start up out there has used at one point or the other is that you can issue securities to rich people. And the definition of rich people is what’s called an accredited investor. An accredited investor, the threshold I believe, is $250,000 in annual income or a million dollars in assets, excluding your primary residence. People who qualify can actually just, you can meet them at a cafe, and take their money and issue them a certificate of share certificate or more commonly some type of security like there’s a few common ones. That’s what is called a convertible note, which the National Venture Capital Association has kind of a standard set of those convertible notes. And then there is what is called a SAFE, a Simple Agreement for Future Equity, which was pioneered by an accelerator in San Francisco called Y Combinator, which is one of the most famous ones. So those, a lot of start ups have been funded as SAFEs, including Sila, by the way. But before that a lot of startups were funded as convertible notes, like StartupCentral. So that is very common and it’s well understood, but you do have to do that only with accredited investors. And that was not something that at least the early ICOs did. Because they didn’t feel like, they didn’t think that they needed to comply with the securities law so they didn’t have to, they didn’t need to get an exemption. But what Marcus is saying is that Filecoin was one of the first to actually say hey, we do feel like we are subject to those laws, which means that we should come under some sort of an exemption. And by setting up this SAFT, analogous to the SAFE, we should be under the same exemption. But that does mean that we can only take money from accredited investors.

Marcus: That’s right. And thus the maturity of the field was beginning to set in. And you know, that does of course, you know, increases safety which from some a certain perspective, which is the goal of the regulators. Also it triggered the end of a kind of wild, romantic Wild West viewing of this space. Which again, was that you could kind of sit at home and try to get your way in without much diligence being done on that investment. And end up holding an asset privately with a private key. And as of today you’re increasingly talking to a wealth advisor or a broker, some hedge fund guy trying to put you into a deal.

Shamir: Oh, I did not realize that. Has it come to that now?

Marcus: You’d be surprised. You know, it’s hard to have data on this because it’s private investment. So investors are not necessarily disclosed. But there’s, as someone who’s kind of been on the fundraising side, a bit professionally. Yeah, there’s a lot of that going on.

Shamir: Interesting. So a system that is designed to, originally designed to sort of get almost like a cult funding aspect into it, people who have actually used the end product, putting in their money, and then eventually using that to use the product at some point in the future.

Marcus: Yes.

Shamir: Has now transformed into sort of more investment bankers, guys in suits selling a security or something that very much looks like a security to rich people.

Marcus: You’re exactly correct, Shamir. So here’s something that I always like to point out. Chroma was originally founded with this excitement around crowdfunding laws. So we had, of course, I don’t know if your audience is aware of this, we have something in the U.S. called a regulation CF, it’s essentially a thing that allows for a very constrained kind of populous investing. Which is to say, you can raise up to a million bucks this way. There are a lot of controls around the, you know, when it’s part of a JOBS Act, I don’t know if this rings a bell for anyone. There was a lot of excitement around this stuff. It took years for it all to happen, you know, the laws were put into place back in 2012, and then you know, the SCC took a huge amount of time figuring out, oh gosh, how are we gonna let all of America participate in private investments? It’s gonna destroy the economy if we don’t to it correctly. So then here’s the thing. They put so many restrictions in place, that there was kind of a gating effect. Which is that if you were a company that needed to do it in this way, you had to check all these boxes. There weren’t a lot of exciting companies willing to do it. And so for all the excitement around “Crowd investing”, the regulated approach to crowd investing was kind of a flop. So then, here’s the thing. Not long after that was sort of flailing, this completely wild west approach in ICOs showed that, there was actually from an investor perspective, it wasn’t as if the demand wasn’t there in the populous. You could chart, you know, the amount raised through the regulated SCC approved approach and it’s a fraction of what the wild west economy had all these home desk jockey’s doing. So for a moment there we had a really interesting experiment in the U.S. in particular.

Shamir: In 2016 I think was probably I think when the reg SF was there and you could go out and create money under it, or you could do an ICO. Everybody did an ICO.

Marcus: Absolutely. And of course all the investors were excited by the ICO stuff, as well. So I would say that in short there what we showed is that, now I’m not saying that this proves that less regulation would necessarily be good. But if one wanted to argue that the JOBS Act stuff was a failure because investors, retail investors, not accredited investors, don’t care about private investments, technology investments, they’re wrong. They just needed to be shown either the mechanism or the kinds of deals, the kinds of projects that would be exciting to them. So now of course, unfortunately, that little window, kind of closed again. So we all need to kind of remember that there is a theoretical pool of capital there even though it is kind of hard to access once again.

Shamir: Yes, and that is, you know that sounds like a, that’s disappointing to me in some ways. That that original promise of the, you know, the democratizing finance or whatever you want to call it, seems to have been lost a little. Is there any way to issue tokens, securities, whatever, money, more than a million dollars, from retail investors legally in the U.S.?

Marcus: There is. It’s called Regulation A+. It’s another part of the JOBS Act. Now, it’s been, I wouldn’t quite call it a failure, but it’s been a fraction of the capital raised using that method, and here’s why. The SCC will allow you to raise up to 50 million dollars, from the general public, but, you have to really, it’s like a little mini IPO. So you’ve got to really disclose everything to them. And really the way to consider it from an economic perspective, the cost of capital to raise 50 million from the crowd is very high. So unlike the turn key process that we mentioned, a very quick and painless right to the market. The SCC, you know, as you increase the sum, you increase the cost that you pay your lawyers to deal with the SCC. So there’s just no clean and easy path toward the retail market, you’ve got to, it’s gonna cost you. Either you can’t raise much, or it’s gonna cost you a lot to raise more.

Shamir: So SCF is relatively easy to do, but it only gives you a million.

Marcus: That’s right.

Shamir: That doesn’t really go far. But A+ gives you up to 50 million but it is a lot of work.

Marcus: That’s right.

Shamir: Or you go to the SCFD.

Marcus: That’s right. And thus you, you are really marketing that investment to a different community, at this point

Shamir: Yeah, marketing it to people who are relatively well off to begin with, right?

Marcus: That’s correct.

Shamir: Interesting. So in the middle of all of this there has been a massive start up war. If you look at the start up economy in the U.S. but definitely globally there was the dotcom boom in the late 90s which was really an IPO boom. Back then companies like Amazon for example or PayPal were founded and then went public within 18 months of legal founding, 24 months, right? So and a lot of companies went public, a lot of companies went bust during the IPO, the dotcom bust in sort of 2000. Famous names Webvan, Pets.com, and all these stories, right? And then the startup world didn’t end, right? It started up companies like Google, for example. Or Facebook. In that kind of ’99 to 2006 period.

Marcus: That’s right.

Shamir: And then there was another little burst of like growth with like Google going public in ’04. And then Ebay acquired PayPal, Google itself acquired Youtube.

Marcus: I think of Flickr of being triggering moments. Flickr was launched in the startup winter and you know, it’s actually founded by the same CEO of Slack, who’s recently benefited by his sort of story in place of this ecosystem. Flickr sold to Yahoo for 40 million, if I remember correctly, in like 2005, maybe 2006. I remember it kind of sent this kind of, that feeling of like greed kicking back in.

Shamir: Yeah.

Marcus: Because it seemed like, it’s funny now given the sum, but is seemed like a big sum. They just kind of whipped together this photo sharing app, and built a network and by God, they’ve developed all this value in this short period of time. Of course that sum was quickly dwarfed.

Shamir: Yeah it seems almost laughably small.

Marcus: I think of it as the spark that kicked off the web 2.0. If you remember Yahoo was kind of doing this series of acquisitions.

Shamir: Yahoo was huge and seemed to have for a long time, it seemed like their thing was acquiring promising start ups and killing them.

Marcus: That’s basically, yeah that’s what they were really good at, intrinsically good at.

Shamir: But then just as that was beginning to take off in like ’06, ’07, you had the financial crisis. And that basically killed the IPO market. Nobody was doing IPOs between ’08 and ’10. And then from sort of 2010 to now there’s been growth in the start up world, in the private market. And there have been a few IPOs on mostly Facebook. And of course companies like Alibaba have been some massive IPOs. But what has happened, is that if you look at kind of the Amazon IPO was like less than 100 million.

Marcus: Yes.

Shamir: And you saw Google which was a huge IPO at something like a 4 billion market cap in ’04. Then Facebook in 2012 was like 40 billion, it was massive, right? And so companies are going public much much later than they used to.

Marcus: That’s right.

Shamir: That’s completely non controversial, everybody agrees to that. What’s really happened is a lot of money and investment that used to happen in the first five years after IPO, public market buyers, have moved into the private market.

Marcus: That’s right.

Shamir: And now you have, you know, like SoftBank started with like 100 billion. Which is fine, right? I mean the people can go public, it’s up to entrepreneurs, and their companies, and their teams. But you could as a retail investor go to Nasdag or NYOC and buy Amazon stock or Apple stock in ‘99.

Marcus: That’s right.

Shamir: Or Google stock in ‘05.

Marcus: That’s right.

Shamir: Or Facebook stock in 2012. All of those would have been great great investments, if you held them long enough.

Marcus: That’s true.

Shamir: Now, it’s not really possible to do that in whichever start up of this generation that you want, right? Uber, AirBnB, and all of those guys, by the time they go public would probably be 20 billion plus in valuation. Maybe hundred billion in some cases. So all that growth has moved from the public market to the private market.

Marcus: Exactly.

Shamir: So as a retail investor your public market options have gotten less and less exciting I would say.

Marcus: Yes.

Shamir: Especially if you want to do bank investing. Unless you’re rich, you’re private options never really existed and doesn’t feel like they still exist either.

Marcus: Yeah I think that’s exactly right Shamir. It’s funny that we’re playing this role because in theory I’m the picks and shovels ICO guy. And so I’m going to make this kind of counter obvious point. Inside of this dialog, the fate of so much, sort of the future of capitalism is on a line here. Now all these things are true. Regulation essentially has the effect of restricting growth of capital to those that are already in possession of capital, and so taking that alone you think screw that. Open the flood gates, wild west, my own knowledge of technology and the markets should permit me to participate. However, now the ICO market was also a good demonstration of what happens. You had a completely wild west situation. I would say that investing in ICOs is kind of like truffle hunting in the trenches of World War One. In that it is almost literally dangerous. Before the oversight, and really after the oversight, the ratio of pure scams, I mean not even well intentioned screw ups, but just pure multilevel marketing scams. 10, 20, 30, 50, 100 to one for honest projects.

Shamir: Yeah, wow.

Marcus: So now, you really saw the worst of humanity in a lot of the ICO boom. A lot of money was grifted, a lot of the later money that came in, they didn’t really know anything about launching technology, they just heard that you know, they heard at like the grocery store with their bag boys said hey what kind of coins are you in right now? So basically there is the trade off. On one hand the regulation increases inequality. On the other hand in the absence of any regulation whatsoever the retail markets are fleeced. And so I think that the ICO has kind of helped, I think it’s been very educational since we have not really found a good equilibrium, and we’re not sitting in a good place of equilibrium right now. I think what’s interesting, we have an STC right now that’s open to hearing this, and I think it’s interesting if we can look at our recent history, make some informed calculations about how regulation can help this issue on both sides. We might have some dialog with our regulators locally and I think this is happening on a global level right now. And so this cryptocurrency movement may help actually push the structure of regulation a little bit by having performed this well. Having this experiment on the operating table.

Shamir: It’s interesting you says it’s like a Wild West.

Marcus: Yeah.

Shamir: Because I checked, in fact, that’s exactly how the Wild West was.

Marcus: Yeah.

Shamir: I mean we are living, I mean, you and I are sitting in what used to be the Wild West about 100 years, 150 years go.

Marcus: Right.

Shamir: Portland was as far West as you could get in the U.S. Before you got to the ocean.

Marcus: Yeah.

Shamir: And if you look at the history of the Wild West you’d think it’s all about cowboys shooting each other. There was much less of that than you might think. But there was definitely, almost like clock work, every seven to 10 years there was a boom and bust cycle in the economy of the U.S. between the Civil War and World War One.

Marcus: Yeah.

Shamir: 1865 and 1917, really. And as with each of those boom and bust cycles, you would see waves of business failures.

Marcus: Right.

Shamir: But waves of bank failures, because banks were the, there wasn’t really, the stock markets were like tiny little New York, Chicago sort of thing back then. And there would be stock market booms and busts as well, but what really, the average cowboy lost his money on the local bank failure, not because some company in New York went bust or went public, right?

Marcus: Right.

Shamir: And in fact that cycle of boom and bust led to, initially, the creation of the federal reserve and then there was another period of that there wasn’t a bust for a while and then you had the biggest one of them all. You had the crisis of 1929 which then lead to the creation of the SCC and the FDIC and all the modern security circulation.

Marcus: That’s right.

Shamir: First the banks got regulated, then the busts moved into the public market, then the public markets got regulated. And now the boom and busts seems to have moved into the crypto market.

Marcus: Yes.

Shamir: What do you see coming down the pipe in terms of crypto regulation?

Marcus: So this is a great question. Now, and I have been wanting to say, you know, as I said in my intro, Chroma has always taken a regulation centric view on the market. It’s constrained our growth in a way because we missed out on a lot of the Wild West stuff. We just thought, that can’t last. There’s no way I can, we’re a C corporation, right? So I can’t.

Shamir: On the bright side, I’m sure you have much less on your conscience.

Marcus: Yes, that’s true.

Shamir: And you’re not in jail either! It’s really good.

Marcus: I count my blessings. Every morning I wake up and I’m not in jail, I feel great. Terrific.

Shamir: Great humor there.

Marcus: Yeah so I think coming ahead. What I was going to say is that I’ve always said, hey what regulations we’re going to see to govern this market. I’ve always said the securities act and the exchange act already do this. So in other words the first step in regulation is figuring out how the current regulations apply. I think people have been too, they’ve been too excited to think that we’ve got new laws coming down the pipe. Now that said, the first thing I want to say again, is case law that will help apply the current regulations. You know, one thing I’ll point out here is that it’s been a very interesting time to watch the SCC. Last year one of the commissioners, last name Hinman, made, now people have gotten this a bit wrong. It wasn’t actually new regulation, or even new case law, new interpretation, it was just a public speech. But we are looking for these kinds of things, these kind of tea leaves, to see what is the SCC thinking, what do they see is in their future. It’s a guessing game. Hinman, they have these remarks published on the web, so if you google Hinman SCC crypto, you’ll see this. It’s a very nuanced speech, it shows that these regulators, a lot of times we get sort of from the issuers perspective we get mad about these dullard bureaucrats. There are the enforcement actions, the public speeches they are making, they are very very surprisingly sophisticated about the tech and the law. And what Hinman said was kind of a shock to people. His personal feeling and interpretation was that given the regulations as they stand, he said that, I guess to compress it, he said the Ethereum ICO was probably a security. Of course we didn’t know what to call it, it happened, we’re not going to go enforce it now. However, what he said was that today Ethereum as it stands today, Ether is not a security. So what this means is that this is really mind bending, but through Hinman’s view, it’s possible that when something is young and that the risk is high and the network has not launched, if you want to raise money then, you’ve got to talk to us. Because you are talking about an investment. But once, unlike a corporate stock, it’s not the case to say that when Coke Cola was young it was a security but today it’s not. No, it’s still a security. What he is saying is that there some fundamental natures of a decentralized network. What he says is that when you look at Ethereum it’s not so clear that the Ethereum foundation is the beneficiary of all the growth and value of Ethereum. It’s a cluster of computers running and synchronized throughout the world. And the value creation is distributed as well. So it is that thing that the crypto enthusiasts have always thought, say this isn’t really a company man, it’s a coin. And that’s something completely different. And this is Hinman saying, actually you’re right. Once you hit this decentralization, this inflection point, yeah you can go ahead and trade Ether and it does still seem to have some properties in that you can buy and sell and you’ve got a price chart, you can do inter day trading, you can also use Ethereum to execute software.

Shamir: And you do.

Marcus: And so it may be that we, and Hinman is just one piece of the SCC, but if the Hinman interpretation becomes more established we may get some sounder footing on which we can have a sort of crypto economy where you don’t have to be an accredited investor in order to buy and sell coins, and use coins once they’ve reached a certain point of option. Of course the point here being, how do you launch the network if its a security to begin with? One counter effect of this is that the coins that launched and got their decentralization accomplished before the SCC came to stop them, this is you might have the effect and say well these older coins have an advantage. And that’s true as well. In the sense that the SCC may be essentially defending layer one encumbrance bitcoin Ethereum.

Shamir: That is interesting.

Marcus: It’s interesting.

Shamir: Yeah it is because then it’s like hey, if you manage to do, if you manage to get through the phase where you were a security, before the SCC was actively enforcing securities laws in the crypto space. Then you’ve got, you managed to kind of sneak in and you are grandfathered in.

Marcus: Yes.

Shamir: Because they’re not going to go back now and it doesn’t look like they’re going to go back now at Vatalik and charge him with SCC violations.

Marcus: I don’t think so, yeah.

Shamir: I hope not. I do like him, he’s quite funny.

Marcus: He’s an interesting guy, isn’t he?

Shamir: Yeah but if you’re doing that today, you know trying to launch whatever. Ethereum 2.0 and you go out and you follow that process, there will be a period of time, well at least some, where your token is going to be a security.

Marcus: That’s right.

Shamir: You do have to follow the process of, and there are a few different ways, whether it is a CF, A+ or the SAFT, or maybe an STO, but you do have to kind of follow the securities laws if you are issuing in the U.S. So tell us about STOs.

Marcus: Sure, so technically STO stands for Security Token Offering and it’s kind of an umbrella term. And really I would say that each, whether a SAFT, well a SAFT generally uses regulation D which is the common start up financing exemption. You could use regulation A+ and wedge it into a SAFT, as well. It’s a bit complicated. So basically the STO movement is a way of saying, okay, here are the kinds of coins that are using securities laws properly. And so this movement is the post Filecoin movement, and again a lot of the larger ICOs today should be classified as an STO. If they’ve gotten approval from some regulatory body for the offering then that’s an STO. Another thing to note is that you could use the security token, this is really complex stuff here. You could use the security token structure to do a very traditional kind of offer. In other words, not even necessarily a crypto network. You could get STO financing of a traditional SAFT startup. But if you use the technology, which is to say investors will hold a token, and that will be representative of, that digital asset will represent their equity stake, then that’s part of the STO umbrella as well.

Shamir: Exactly and so if you kind of think about it, a start up might choose to go up and say we’re going to raise money and we’re going to raise it in the traditional way of doing convertible note, a SAFE.

Marcus: That’s right.

Shamir: And we’re going to quote un quote rich people called accredited investors and raise money from them and you know, there’s Angels, there’s BCs, there’s seed funds, but instead of giving them the PDF documents saying that hey so and so has signed, you’re going to give them a token instead.

Marcus: That’s right.

Shamir: Which is equivalent. And there’s no reason why that can’t be legally equivalent, and that would technically be an STO, as well. When you’re doing something that’s very traditional process but just adding a new layer of technology which might be better as well. Typically though I think the, many of those processes, especially Reg A+, or Reg D, come with limitations on trading. That might be more problematic if it’s issued in a tokenized form.

Marcus: That’s true, however Reg A+ does allow for unrestricted resale.

Shamir: Okay.

Marcus: With it, it’s the only of the tier that really fits all of those properties. But you’re right Reg D, generally those restrictions are a year plus lock up. Which doesn’t work well if you want to immediately see immediate liquidity.

Shamir: Yeah.

Marcus: But Filecoin owners for instance, there is no liquid market for Filecoin, the SAFT placements, you’re just, the investors are just sitting on them for that one.

Shamir: It’s a SAFT placement, got it. So can you speak about the current, and looking at the questions here, I think we kind of addressed Jimmy Dorsey’s question here on about a coin representing a haircut. Why if anyone can buy a haircut why would the haircut coin be a security. A haircut coin might not necessarily be a security. It would very much depend on the process and the way that it was issued and what it represented from a legal purpose.

Marcus: I agree, the interesting question there is that you’ve got a one to one purchase of a good, you’ve can make a strong argument of Kickstarter presale model there. Unless, here’s the distinction, I think. If the barber shop exists, and those are priced already, and there’s an established price for that.

Shamir: And you can buy it on the blockchain and walk tomorrow into the barber shop.

Marcus: It sounds like a gift card to me, and I don’t believe that is a security. However if the barber shop doesn’t yet exist, then you’re hoping to finance instruction of the barber shop with the sale of the haircut coin then that starts to look more like a security.

Shamir: Okay, good to understand. And about the current ICO landscape outside of the U.S., that might be interesting. We’ve been very focused on SCC and U.S. laws here.

Marcus: That’s true.

Shamir: Outside the U.S. it’s very different.

Marcus: It is.

Shamir: Wild East, maybe.

Marcus: That’s true, I’ll say that I’m a pretty domestic guy, in that given basically just my own perspective, in my own mind to fully grasp an offering it because I say I really need to understand the regulatory landscape. There’s a huge barrier to be going and really understanding, you know, the UK para dime and beyond. So but I do know a few things. One thing to note is that there’s a big movement within both ICO issuers and also operators to domicile themselves in places that are more amenable to these kinds of things. So a couple of territories have been of interest, of course. In Zug, in Switzerland which has also been a haven for a lot of interesting sort of banking operations, as well. For traditional reasons. The Cayman Islands, you’ll see this a lot. Now I’ll say this, as I throw out these kind of jurisdictions that are hey you can more freely get stuff done on these islands, it’s one to one in relationship to the kinds of things where you also see shady off shoring and various, a lot of those offerings, a lot of them sound legit. One thing for instance, a crypto network I like a lot, Augur, who part of the Augur network called Veil, which launched just a few weeks ago, they’re headquartered in the Caymans, I don’t necessarily think it is a stroke against them, because it’s involving gambling regulations as well, it’s the prediction market. You know, it’s just interesting to note. The domicile of the operators and the regulatory environment there has influenced a lot of the sort of global activity. And then another thing I’ll note is that it’s not just a question of purely regulated states versus mostly unregulated area, there are just a lot of very legitimate groups that are just coming out of Europe. I mean I love Francis Marterium which is based out of London, its Veene Gupta and they’re just dealing with different, you know, I can’t speak as articulately about the exact nature of the way that they are getting those exemptions or registrations done. I think in a lot of the more, basically here’s the thing. Where you have capital, you have regulation. And increasingly to invest in ICOs today, if you want to find an overseas offering if they’re in an unregulated market, expect some extra hoops, there as well.

Shamir: On the flip side, if they’re based in the Cayman Islands or Zug or Bermuda or wherever.

Marcus: That’s right.

Shamir: That might be less regulated than the U.S. On the flip side that could also be a problem because there might be more scammers there.

Marcus: I think you could say that for sure. I don’t mean to suggest that it’s a scam, but the ratio of scams, of those groups trying to play that kind of artful dance, there’s going to be a higher propensity of scam projects taking that approach.

Shamir: And so then it goes back to being a buyer beware contract, right?

Marcus: That’s right.

Shamir: If you buy stock on Nasdaq or NYOC, you know that there’s a reasonable likelihood that it’s a legitimate company. There are still the Endron and Worldcom and other sorts of scams that very large companies have planned, yet they are one in thousands, right?

Marcus: That’s right.

Shamir: The company failed but they failed for traditional reasons like they’re business didn’t work well.

Marcus: That’s right.

Shamir: But in the less regulated the market, the higher the likelihood of there being a scam but that’s then up to you as a buyer or an investor to do your due diligence.

Marcus: That’s right.

Shamir: Completely. So any other questions here from the audience. You guys have more questions feel free to fire them at us. I have a couple of topics here I’m looking at, I want to make sure I hit. One things is token economics, whereas using tokens mainly as a fundraising mechanism. Well we set this up as a talk about mainly ICOs, and people have been using ICOs like kinda like IPOs, right? Like kind of a way of raising money. But reality is that that’s not what the original vision of the bitcoin token was for sure.

Marcus: That’s right.

Shamir: And arguably I don’t think it was the vision of the use of the bitcoin, it’s not much of the usage of Ether either. And that’s not necessarily what tokens can be used for, it’s purely for fundraising lots of other things. So talk to us about that a little bit.

Marcus: Yeah absolutely. So yeah I think that Ethereum when it launched it was trying to describe itself in one peppy line. It’s a global computer. Turns out it’s not really yet become that. You don’t want to use Ethereum to calculate Pi.

Shamir: That’s an interesting thought. You actually could but it would be expensive.

Marcus: It would be very expensive and it’s not very efficient for that purpose.

Shamir: Oh, God no.

Marcus: It turns out that Ethereum’s first use case was actually ICOs.

Shamir: Yeah.

Marcus: The primary thing it was being used for, it wouldn’t have really have had the same ring to it if they said hey, Ethereum, it’s coin for making other coins with. So but it turns out to be that that’s an early use case that sort of you know, turns out a tremendous amount of action velocity was formed around that case. So for the raising of the coin. Of course, if that’s all it’s good for then we have a recursive problem in that you can’t, there’s no reason to invest coin if the functionality can’t perform some other business value. Basically here, all of this energy discussion, all of these millions of dollars being poured into these projects, it’s great to turn around and say for what purpose? What are we doing? What’s the business value we’re trying to get beyond that? And I think one of the, we have some pure innovation. That at least written about since in white papers within the space. You know we talked about all of the interesting trade offs in society about safety and you know equity. Another thing is a lot of experimentation around economics. And specifically token economics. So the majority of quality projects, in order to make their pitch to the public, they have to say why does this coin, why does the price going to go up? Because I understand the equity is sort of a projection of future cash, in a very simplified sense. It’s something that you can look at a balance sheet of a company and sort of connect the values to equity. Form a fundamental analysis, that way. Well so we have a new company here. We have no balance sheets to speak of, so where does the coin derive it’s value from? So in order to find the answer there you have to look at the economics of the token. And gosh this is an interesting topic but you know, really concisely stated we’ve been talking about Ethereum. The token economics of Ethereum were like this. In order to do any of the things for instance, prediction market, or an advertising network, that project. You know, Ethereum itself. These projects that run on Ethereum, in order to execute that software, you have to spend gas, you have to spend Ether, in order to make it run. You’re essentially paying for the computing power. That’s the premise of Ethereum. So outside of the speculation of what other hedge funds think Ethereum will do in the future, the fundamental value of Ether is fun, you can run these little software scripts using this resource. So in theory the more people that run these scripts, that’s the fundamental demand for the coin. And that’s why in theory if the demand for that coin outstrips the supply of it, and given, and there’s the other part of the equation, these coins all have this sort of different sense of an algorithmic supply. There you have a way of describing fundamental value. And I have to say it’s just a crazy playground for economists to sit and think about. And inherent in every project is some different twist or experiment here. And none of it’s been very well validated, I’ll admit that, certainly.

Shamir: That part of it is super early stage, I mean, we’re looking at this ourselves with Sila right now because we’re launching our smart contract on the mainnet probably end of this month, early next month.

Marcus: Great.

Shamir: And then you know, we’ll have to start paying in Ether as well, trying to understand how to manage that.

Marcus: Right.

Shamir: It is interesting. And I’m sure we can check much more about that but I do believe we are out of time now. I see that we do have a few more questions. Unfortunately, Jimmy Enerlato I don’t think that we’ll be able to get to that today.

Marcus: I’ll tell you what, Jimmy, I’ll hang out and type an answer to you. We still have the chat window open. I’m interested in that.

Shamir: And by the way you can find both Marcus and me on Twitter. I’m sure there’s others, telegram, whatever other platforms as well. But feel free to follow Sila on Twitter or me or Marcus. And ask us questions and yeah, this is a fascinating topic and one that an hour isn’t nearly enough to get into to really all of the details of it. Thank you so much, guys. It was a pleasure having you. Thank you for being engaged and asking questions and everything.

Marcus: Thank you, it’s a pleasure.


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