How to Sell US Federal Customers (& Investors) On Your Company?

Sarah Djamshidi, President and Managing Partner of SpeedShift Ventures asked me to be part of a panel at the AFCEA Small Business Innovation Summit. The title of the session is “Communicating Value” and it is described as a session where the audience will “Gain valuable insight and tips for crafting a persuasive elevator pitch to help you win more business. Venture capitalists and government decision-makers explain what sells them on a small businesses solution.” My role on the panel is to explain to the audience the entrepreneur’s perspective—net/net: What’s worked for me in the past. 

Here are my prep notes for the session:

The AFCEA organization primarily supports US federal government organizations and many of AFCEA’s Small Business members are professional services firms and product startups.  I’ll use the Solution Selling framework to outline an approach for selling to the Public Sector, but recognize, the context is a bit different than selling to the Private Sector.   The framework of Solution Selling — Pain, Power, Vision, Value and Control (PPVVC) works in both verticals but how it is approached is different.

I find that walking through all the elements of Solution Selling can be a good way to prepare a persuasive elevator pitch for any potential new customer (or investor).

Pain

In the Private Sector, pain is usually expressed as a specific, measurable dollar amount (example: employee turnover is costing the company $1M a year) with corresponding symptoms (15% turnover versus a goal of 4%).  In the Public Sector, the identification of “Pain” can be the same or even more drastic like loss of life—in any case, it may not be in dollars.   The key is that you need to understand your customer’s pain and have empathy for their situation and be credible in a conversation about the subject.

Power

You can’t sell something to someone who doesn’t have the authority/ability/money to buy. Talking to anyone else other than the decision maker is merely a sponsorship conversation to diagnose the pain and prepare to have a discussion with the decision maker.  However, what is challenging is that VIPs in the Public Sector are rarely the real decision makers.  The real decision-makers are the people who have the legal authority to spend our tax dollars, negotiate, purchase, and sign their name on the government’s behalf on the contract.  It’s very important for you to identify the real decision-makers and to spend the time to build strong relationships so that they feel comfortable doing business with your company.

Go to conferences, vendor outreach sessions, one-on-one meetings, every place that sponsors and decision-makers have the chance to meet, shake hands with and look eye-to-eye with the people who buy what you sell. These targeted people may have various titles such as contracting officer or specialist, technical specialist or program manager.

Value

The decision makers not only need to understand how your service/product performs within their organization but believe that the capabilities presented will solve their pain for less investment than the pain costs. (example: we will lower your turnover to 5% thus saving the organization $1M at an investment of only $50k).  As stated before, in the Private Sector this is usually Return on Investment (ROI), however in the Public Sector this could be saving lives or even being reelected.    The point is that you need to be able to articulate your value to the audience.

Vision

Sponsors and decision makers need to gain an understanding of how your solution will work within their organization to solve their “Pain”.  When positioning your company be efficient, but don’t talk fast.  Know your audience and stay natural, yet confident — not scripted.  Be able to articulate the problems you solve and the solution in your audience’s context, as well as, your competitive advantage. Use facts that resonate, talk about the team and most importantly talk about references.  Don’t get too technical, never get defensive and don’t lie–EVER! (if you ever heard the phrase ‘fake it till you make it, wipe it from your memory’).

For an example of positioning refer to this Shark Tank example.

For something more fun (yet less realistic) but related to Public Sector check out Tony Stark selling to the DOD here

Sit down and write out your company’s elevator pitch in the most efficient wording possible: The problem (Pain), your solution, your target market, your competition and competitive advantage.  Describe your team, your business model, your traction (references) and if appropriate your financials.   Then practice this elevator pitch over and over and over until you can pivot it confidently to any decision maker, prime-contractor, sponsor or investor in under 60 seconds. …BUT Here is the thing to keep in mind–The real world of sales doesn’t work like SharkTank.   If you started yammering about your solution to someone ‘on an elevator’ without context it will make them get off at the next floor.  Remember J. Gitomer’s saying “People don’t like to be sold to but they love to buy” “Rather than selling, take a look at buying. Would you rather know how to sell, or would you rather know why people buy?”–This is the Art of sales–you have to be comfortable, confident and casual in your approach to people.  Customers are not objects… They are people.  Here is an example of a casual approach that worked on me (an investor in http://www.gel-e.co):

  • Customer (investor): “So why are you at this meeting?”
  • Entrepreneur: “We’ve got a unique product that stops bleeding fast.”
  • Customer (investor): “Stops bleeding? Really?”
  • Entrepreneur: “Yup. Using safe, naturally occurring biomaterials too.  We design wound treatments for a variety of applications and patients, spanning from surgical gels to bandages for patients on blood-thinners experiencing routine nuisance bleeds.”
  • Customer (investor): “That’s an interesting idea, my son deals with bloody noses all the time.  Will it help with this issue?”
  • Entrepreneur: “Yes, and much more! Hey, would you like to see it in action?”

“Tell me, and I will forget. Show me, and I may remember. Involve me, and I will understand.”–Confucius

Control

This is where things get tricky regarding the process of selling to the Public Sector versus the Private Sector.   In the Private Sector, you would ensure your customer has a clear, written and agreed upon process about how to buy from your company at each step.  You would be presenting the buyer with a draft evaluation plan for their approval including a written checklist including what is going to happen in the process, when it will happen and who is responsible for deliverables.  In the Public Sector, there is a defined process set forth in laws and called out in the Federal Acquisition Regulation (FAR)—DFAR for the Department of Defense.   This set of laws both make the sales process longer and costlier but also drive you to ‘control’ the process in a different way.

Let’s review some of these differences beyond what was mentioned previously:

  • Government customers use purchasing vehicles–this vehicle could be as simple as a government credit card, it could be as complicated as a 200-page response to a Request for Proposal (RFP) or a pre-approved contract called a GSA Schedule. Certain types of contracts even limit the amount of profit you can earn and the amounts and types of costs you may recover.  You must know what purchasing vehicles your customer’s agency would use to buy your services and products and how to get on those contracts or partner with a firm that is already on them or better positioned to win a future contract.   Leverage the tools that the SBA, the Office of Small Business Utilization (OSBU) and the GSA provide to identify potential teaming partners (Subcontracting Directory and eLibrary sites to identify potential teaming and subcontracting partners) and stay on top of FedBizOpps.gov. Recently Other Transaction Authority (OTA) contracts seem to be the hip new thing in some acquisition circles.  If your customer supports OTA contracts you need to understand how to best leverage the vehicle because it could minimize the length of the sales process dramatically.
  • Government contracting authorities must require certain certifications and compliance such as FedRAMP and NIST 800-171. You must know what is required and have a plan to fulfill these compliance hurdles—you will be asked if you comply and if you do not have a plan you will not be taken seriously.
  • The Federal Government needs to spend their current fiscal year budget by the end of September. You need to understand both the timing of the contracts as well as the US Federal budget process and the opportunities and risks associated with the process (example: continuing resolutions).  The process is much slower than that of the Private Sector and you need to be able to financially make it thru the process.
  • The Federal Government has small business set aside goals. You need to understand what these are for your customer’s agency and if they are going to help or hinder your success.

Sales is 49% art and 51% process (“Control”) …   The 49% art is defined in how good you are at articulating value plus how well your team can deliver value.  The 51% process is how you project manage all the nuances of the sale and make more money than you invest in the process.

A great elevator pitch can only come from a person that understands, and has empathy for, the customer’s Pain; can articulate a confident Vision with Value to ALL decision makers; understands the procurement landscape enough to project manage the sales process (Control).

Georgetown — what’s wrong?

We found the end of the rainbow… the pot of gold was at The Wharf, Capitol Hill, and The Navy Yard…

Something is going on in Georgetown that doesn’t make any sense to the residents–Even with the strong demographic data and the strength of the “Georgetown” worldwide brand–retail businesses are pulling out and real estate prices appear to be stagnating… Why? Poor city leadership? Other areas (The Wharf, Capitol Hill, 14th Street, Navy Yard etc.) pulling all the investment away? Unreasonable landlords?  Retail, in general, is hurting? The Business Improvement District (BID)? Other?

The “Georgetown” Brand

If you travel outside of the United States everyone knows about “Georgetown”–Maybe it’s the movies… the university.. or just the legacy of the area.    Georgetown’s brand is almost as strong as that of “Washington DC”–and more stable from the looks of Google Trends.

georgetown trends.png

Demographic Data

If you review the stats Georgetown (20007) is one of the best demographics in the city.  The area has a higher income than other more trendy zipcodes and pays more taxes per resident.

Here is how we compare to The Wharf (20024) and Capitol Hill (20002):

more from BID on demographics of the area.

So why is retail pulling out? 

Commerical Real Estate Issues

If you read the Georgetown Business Improvement District’s (BID) market report and annual report things seem great but if you just walk up Wisconsin Ave you will see that it’s starting to look like a ghost town.  Here are a few pictures from my jog one morning–you can see all the open properties here.

Here are also a few from M Street that just popped up

If you compare Georgetown to other “hot” parts of Washington DC such as The Wharf and or Capitol Hill in regards to Commercial Real Estate here is what you will see:

  • 20007 has 111 commercial real estate spaces for lease, representing 299,768 sqft space. 12 buildings are available for sale.  In the last 30 days, 20007 has had 15 new spaces come on market.  https://www.officespace.com/zip/20007
  • 20024 has 13 commercial real estate spaces for lease, representing 210,929 sqft space. 2 buildings are available for sale.  In the last 30 days, 20024 has had 3 new spaces come on market.  https://www.officespace.com/zip/20024
  • 20002 has 148 commercial real estate spaces for lease, representing 836,116 sqft space. 37 buildings are available for sale.  In the past 30 days, 20002 has had 5 spaces leased and 28 new spaces come on market.  https://www.officespace.com/zip/20002

…it doesn’t look that bad overall but if you walk up Wisconsin Ave you will see that the numbers don’t make sense–something else is eroding this area.

…AND you might not find a convenience store like WaWa replacing high-end Restoration Hardware at The Wharf or in Capitol Hill. (more)

Is the same issue impacting residential real estate? 

Residential Real Estate Market Stats

It’s starting to look as if what is going on in the commercial market may also be impacting residential real estate prices.   Let’s compare Georgetown to The Wharf and Capitol Hill on Zillow–ouch! Georgetown comes up as “Cold”.   Zillow’s algorithms are not always great on prices but this indicator is just a bit troubling…

https://www.zillow.com/washington-dc-20007/home-values/

1

https://www.zillow.com/washington-va-20024/home-values

https://www.zillow.com/washington-dc-20002/home-values/

If you read articles like this https://www.bisnow.com/washington-dc/news/neighborhood/georgetown-gaining-momentum-with-office-retail-activity-despite-new-waterfront-options-77816 in Bisnow you will think that things are going great but then again, just take a walk on Wisconsin Ave north of M Street and you will think you are in Detroit.

Is the poor maintenance of the side streets a result of the same problem? or is it unrelated?  

Taking care of the sidewalks

I saw one of our older residents fall on the sidewalk the other day due to a loose brick–given Georgetown’s aging demographic this can’t be good.  …Then there are the trees that no one seems to be trimming.

Where is SMS Holding’s Block by Block –when is their contract up for renewal?

What about the increase in the homeless population–is this related too?

Taking care of the homeless

…this is sad and seems to be getting worse.  The city numbers reflect it getting better but for any resident of Georgetown that is out on a Friday night, it sure seems like it’s getting worse.

So, What is going on?

Plain and simple, there is not enough attention being focused on the details.  At a macro-level there seems to be no issue but if you have lived here long enough you realize that something is wrong.   The city needs to have a dialog, with action, about 1) the retail issues in Georgetown–specifically on Wisconsin Avenue 2) maintenance of side streets 3) the homeless.  Washington DC, in general, is booming (it’s Number 8 in the Best Places to Live in the USA).  Hot areas like The Wharf, Capitol Hill, 14th street, The Navy Yard are getting the city’s attention.   It’s almost like city officials see Georgetown on autopilot–and why not… the Georgetown BIDs numbers look great —but the city needs to look deeper… it’s about the details.

Details Matter:   “The first thing Wooden did was sit them down and teach them how to put on their shoes and socks. Doing this properly, Walton said, was the initial lesson for “everything we would need to know for the rest of our lives.”

Recommendations

Separate out Wisconsin Ave and M Street in Georgetown from the broader area and focus attention on the retail issues–Spend time on some of the innovative concepts outlined in this paper ‘How to revitalize your city or town’ (here) specifically for these 2 streets.  Another idea is to work with Georgetown University’s MBA program.

Some items that stand out in other publications:

  • How To Revitalize Your Local Main Street (here)
    • “Encourage Entrepreneurs”
  • 12 Strategies That Will Transform Your City’s Downtown (here)
    • “Does your city have public policies (like tax abatements, grants, and other special incentives) to promote downtown development?”
    • “Create a permanent public market”
    • “Create a branded downtown entertainment district”
  • How cities can revitalize dying urban spaces (here)
    • “Details Matter” <<this is why BID needs to be addressed.
  • Street Life After Retail: 5 Scenarios That Imagine the Future (here)
    • “A legislated tax-penalty for street-level vacancies”
  • How Cities Can Save Small Shops (here)
  • Street Retail Looks to Malls in Figuring Out Ways to Cope With Big Rents (here)
    • Idea for retailer: “ask for terms long found in shopping centers—low base plus a percentage rent (meaning the retailer pays the landlord a certain percent of every dollar in sales over a certain threshold).”

What are your ideas?

Blockchain: A lot of money, momentum and hope… but what is real?

This ‘note’ is to help me (as a long-term investor & entrepreneur considering an investment of time and other-peoples-money) know what variables to consider before moving forward with a blockchain &/or cryptocurrency project.

<These notes assume you understand Bitcoin, Public/Private & Permissioned/Permissionless & federated blockchains, consensus concepts, side chains, ICO/STO, stable-coins, utility/app-payment/security tokens and smart contracts.  If you don’t please review the following notes.>

I’m sure we will look back on this time and ask how we got here… History may likely unfold something like the following:

  • 2010: Bitcoin engendered the anti-establishment types
  • 2012: Bitcoin’s growth engendered the speculators
  • 2013: Bitcoin’s blockchain technology and opportunity caught the eye of the Silicon Valley entrepreneurs (‘can we build a better cryptocurrency’ and ‘what else can we do with blockchain’)
  • 2014: Marketers and VCs saw the opportunity then smart money became interested
  • 2018: Smart money gets in
  • 2018: Everyone is talking about “Blockchain” regardless if they understand it or not
  • 2019: The market went boom and the bubble burst
  • 2020: Startup-survivors, corporation and governments began to use the technology for huge productivity gains

…but who will survive and why?  What variables do we need to keep an eye on to ensure we are not a casualty of an impending market disruption.

Variable 1: Trust: Bitcoin engendered the anti-establishment types

Nakamoto’s Bitcoin whitepaper pushed on a major anti-establishment hot button by pointing out that Bitcoin operates outside of government control: “The root problem with conventional currency is all the trust that is required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust”.

Other’s hope that the underlying technology ‘Blockchain’ will allow for any transaction or data transfer to be completed through peer-to-peer computer networks, with no need for third parties like Central Banks, Amazon, Facebook or Google (see more here). Early on, it attracted those who distrust established authority.

However, it’s not just fringe anarchists any more… Citizens across the globe are losing trust in government, media, and businesses.   Just take a look at Edelman’s latest Global Trust report.

It could be the perfect time for a bit more flattening of our world by software…  Trust in the institution is a variable to keep an eye on – as it is at the heart of what drives blockchains success.

Variable 2: The amount of money speculators are investing in the market

From a cryptocurrency market cap perspective, we are talking about billions of dollars. See here.

…but we are still nowhere near the size of the problem we had in 2000-2002 (Dotcom bubble).  More here. However, the speculators continue to move the momentum forward regardless of risks of the market.  This momentum in many ways helps make the hard changes required a possibility.

Variable 3: Developer interest

If you follow the developers, you will know where the tech market is going.   Here is a quick graph from Google Trends that shows blockchain job searches versus devops job searches—currently there is a lot of growing demand.

Variable 4: Venture Funding

From https://www.coindesk.com/bitcoin-venture-capital/ you can see that there is a healthy growth curve:

Variable 5: Smart money (Institutional Investors)

Keep an eye on what groups like Fidelity (more), Wellington (more), Morgan Stanley (more) and others are doing in the crypto space.

As an example, Barclays and Mastercard are both filing and getting awarded patents (more here and here).

Variable 5: “Blockchain” hype – everyone must have one…

In looking at Google Trends again you can see a clear hype cycle with blockchain in regard to searches in general as compared to other technologies shaping our future such as IoT and Machine Learning.   Clearly, mid-2017 was the start of the generalist mania.

Never forget what a blockchain provides: an immutable & decentralized ledger and a blockchain needs to keep those properties using a decentralized network with the following prerogatives:

  • Distribute the ledger — Validate
  • Append to the ledger — Work
  • Incentivize the user’s needs — Token

If it’s anything else, be skeptical…

I always say follow the developers but in this case, it’s tricky because so many entrenched camps have formed primarily due to how much money is at stake.  Once the big money (examples: Tim Drapers, Andresen Horowitz, financial svc) get involved they promote what they have invested in and then the social networks/media outlets jump on the marketing bandwagon.

The key to seeing through the hype is to follow the key mindshare leads in each area and not the media/venture capital/financial market promoters.  Follow key industry projects as close as possible (examples). Follow what governments are doing around the world.

You also must understand the tension that blockchain and cryptocurrencies create in the marketplace and watch how they respond to the threat.  Some examples:

  • Centralized institutions that are vulnerable to disruption, such as banks, will dig in. They are protected by existing regulations, which are ostensibly imposed to keep them honest but inadvertently constitute a compliance cost for disruptive technology. Those regulations, such as the burdensome reporting and capital requirements that the New York State Department of Financial Services’ “BitLicense” imposed on cryptocurrency remittance startups, become barriers to entry that protect incumbents.
  • Large companies like Google, Facebook and Amazon won’t sit idly and let their central portals be replaced by decentralized platforms. (more here)
  • Government’s won’t allow their currencies to be replaced by cryptocurrencies. Especially those government’s whose currency is the reserve currency.
  • Government’s won’t let their privacy laws be broken, for example, the new General Data Protection Regulation in the EU.

Variable 6: Timing – we are early!

In general, you must be cautious when:

For now, let’s go with Victoria Lemieux’s definition from the Verge article linked above until we have something official from the ISO: “In general, if the transactions are gathered together in blocks, and it is blocks that are secured on the chain using cryptography, and it is designed to be tamper-resistant and produce immutable records, the system qualifies as a blockchain.”

Variable 7: Count the REAL ‘use-cases’

For a list of blockchain use-cases refer to this article—you can choose if they are REAL or not.

In general, what can we do now, that we could not do before?  For example, before Bitcoin, nobody could own an asset in the digital realm. Since copying digital content is easy to do and difficult to stop, providers of digital products such as audio files or e-books never give customers outright ownership of the content, but instead lease it. Bitcoin showed that an item of value could be both digital and verifiably unique. Now we can represent any property title or music track as an entry in a blockchain transaction.

Variable 8: Architecture flaws in the underlying platforms

Always keep in mind that paradigm shifts have architectural issues—but it doesn’t mean those issues will stop the momentum—these issues just need to be understood and risk assessed.   For example, the internet was built on an insecure foundation, Linux had platform fragmentation issues, Open Source had many issues.   As you see with all elements of crypto and blockchain there are strong arguments about underlying flaws across the board.  For example:

  • Ethereum & block size – Ethereum has an architectural flaw that may catch up to it and all that runs on it—its’ no cap on block size https://hackernoon.com/the-ethereum-blockchain-size-has-exceeded-1tb-and-yes-its-an-issue-2b650b5f4f62 –What does this mean for all the tokens built on top of Ethereum? More here on Ethereum’s scalability issues.
  • Bitcoin’s block time – The average block time for Ethereum is significantly less than Bitcoin’s: 12 seconds versus 10 minutes. This translates into more block confirmations, which allows Ethereum’s miners to complete more blocks and receive more Ether.

Variable 9: Decentralization

Blockchains need three properties:

  • Scale – The ability to support many users
  • Consensus – The agreement between each node on the validity of transactions.
  • Decentralization – A state of affairs in which there are many nodes and no one entity controls the system

In most cases, blockchain developers are only able to focus and succeed in two of the three properties necessary for decentralized blockchains.  For instance, blockchain developers can have a system that scales and reaches consensus, but it will be at the expense of full decentralization.

Its relatively easy to see how distributed the major coins are in the crypto-market (here is a good example: https://arewedecentralizedyet.com/ ) but what are the right ratios for new tokens or permissioned networks?

As blockchain matures measuring decentralization will be key.  Read here and here and here for more.

Also, keep in mind that decentralization is at multiple levels–for example, ~70% of the Bitcoin (12k) nodes are in China (more).

Variable 10: The single point of failure

When building a private blockchain you must look closely at the architecture and the business model to see if there is a ‘single-point-of-failure’ (SPoF).   For example, if you are using Hyperledger’s ‘ordering service’ does it create a SPoF—some think so?  What’s the value of a distributed database if there is a SPoF?  You have to also look at the business model –as an example: In a regulated environment the regulator has to be able to roll back a trade and that inherently makes them a SPoF.

Variable 11: ‘Store of Value’

Old school billionaires like Gates and Buffet say cryptocurrency has no ‘store of value’ so they are not currencies.   Others challenge the argument (more here and here).

The US Federal Reserve Chairman Jerome Powell made it clear (here) during testimony in front of Financial Service Committee of the U.S. House of Representatives (“The House”) with the following comments:  “if you think about what currencies do, they’re supposed to be a means of payment and a store of value, basically, and cryptocurrencies are not really used very much in payment. Typically, people sell their cryptocurrencies, and then pay in dollars… In terms of a store of value, look at the volatility, and it’s just not there.”

From a worldwide banking perspective, you can review the Bank for International Settlements (BIS) Annual Economic Report found here where they specifically call out “The second key issue with cryptocurrencies is their unstable value”.

Variable 12: Is the token/coin a security? (The SEC on tokens and Howey test)

The US take at the moment (from SEC William Hinman) is that Bitcoin and Ethereum are not ‘securities’ but most all ICO tokens likely are..  What does this mean for companies like Ripple with XRP?  Who knows but the impact of how the SEC deals with these companies and regulations needs to be watched closely.

Variable 13: The success of tokenizing a physical asset

There is a lot of discussion around tokenizing physical assets such as land, art, diamonds etc. however there are many issues such as how different countries laws impact ownership of assets.  Many of the issues are outlined in this article: here.

 

Words Matter…

Great leaders don’t lie and categorize/label whole groups of people as bad. Do great presidents? What we have going on right now is a bit surreal and worthy of debate.  Regardless of your support or hate for President Trump, the question I am asking is — are the POTUS’s words having a negative impact on society?

I’m quite surprised that more CEOs, organizational scientists, executive coaches, and leadership development consultants are not broadly discussing the consequences to society of poor ‘Integrity and Honesty’ and ‘objectifying’ entire groups of people.

In a recent HBR.org study “Has high ethical and moral standards” was the number one competency expected of a leader. Given the large number of false statements made by the current POTUS and the competency’s recognized importance, I would have expected more of a debate on the subject. I recently read a great book by Dan Ariely, author of The Honest Truth About Dishonesty that leads me to believe that the impact on society is bigger than one would expect.   “Once an environment has had dishonesty introduced, that new normal spreads.” People start thinking things like, “Well, everyone else is doing it”.  “It’s been proven that you can take someone who is basically an honest person, put them into a system where the person running the system is corrupt, and they conform. They cheat more and start stealing. If the leader of the system is saying things are corrupt, the leader sets the tone.” Any good leader knows that if a Sr. manager in an organization is dishonest the managers under that person need to be looked at as well.  What does this say about the future ethics of our executive staff, Congress, and future state/local leadership? If the behavior that at one time made society feel uncomfortable starts appearing reasonable and standards start loosening to fit common, lesser standards, then our society is on the descent.

Here is an example of where lack of ethics takes our society… other leaders failing us: Democrats call out Maxine Waters for encouraging incivility

Now… then there is the ‘objectifying’ large groups of people…  What is the impact on society of the leader of the free world by referring to large groups of people as “rapists” and “terrorists” (some of this can be found here)? Another great book I read long ago is “Leadership and Self Deception: Getting out of the box” by the Arbinger Group.  The essence of the book is that when people categorize others in a society as objects versus human beings with feelings, thoughts, and needs then it’s easier to hurt them.

Here is the result of prominant leaders treating entire groups of people as ‘objects’ versus human beings: Charlottesville: Race and Terror 

Anyone that has ever lead an organization understands that words have a tremendous impact.  Our public sector leaders need to shape up or ship out.

Using Ripple to understand valuation, risk and the SEC in the brave new world of blockchain

Given XRP is one of the more successful cryptocurrencies and Ripple (the XRP sponsor) has an incredible list of backers/board members and has been in business since 2012, they seem like a good company to use to take a deeper dive into the mechanics of the crypto market and analyze where some of the liabilities exist.

First, let’s go through a little background-In September of 2016 it was announced that Ripple raised $55 million USD in funding at a valuation of $410M USD.  The XRP token according to Chainfx was trading at $.007 USD on Sept 1, 2016.  Given there are 100B total tokens & 39.25% are in the market.  The market cap of XRP would have been $700M near the time of the valuation.  Today the XRP market cap is near $53 billion USD.

More from Quora.com on Ripple’s valuation from David Schwartz, Chief Cryptographer at Ripple  “As Michael Nadolillo point out, Ripple did not create XRP. XRP existed before Ripple did.

As for how you value a company like Ripple, it comes down to two components. First is how to value the XRP that Ripple holds. The second is how to value whatever else Ripple might do that might materialize as shareholder value.

Presumably, the current price of XRP reflects some fair prediction of the value of XRP. If it was an unreasonably low estimate of XRP’s value, we’d expect people to buy it and cause the price to rise. Similarly, if it was an unreasonable high estimate, we’d expect people to sell and cause the price to drop.

So we can take the amount of XRP that Ripple holds and multiply it by the price of XRP to get a fair market estimate of the value of Ripple’s XRP. But you have to remember that Ripple will have to use some of the value of that XRP to incentivize partners, pay employees, and so on. It will not all materialize as value to Ripple’s shareholders.

Of course, some of that expenditure may translate into revenue beyond XRP for Ripple. For example, Ripple might trade XRP (or use revenue from XRP sales) to acquire equity in other companies. Ripple might use XRP (or revenue from XRP) to form new ventures that generate value from sources other than XRP.

So some multiplier has to be used to represent what fraction of the value of Ripple’s XRP you think will materialize as shareholder value. The challenging thing is that there doesn’t seem to be any good, objective way to agree on what this multiplier should be. I’ve seen knowledgeable people place it at 15% and I’ve seen them place it at 85%.

The market cap of XRP is not really a meaningful number for computing Ripple’s value though it does give a general idea of the economic importance of XRP compared to other digital assets. Ripple doesn’t own all the XRP, so the value of all the XRP doesn’t really relate to Ripple’s value.”

Ripple is essentially a high-value service that provides the ability for institutions to send money globally using the power of blockchain.   They have the RippleNet messaging systems for enterprises to use for cross-border payments and it does NOT require XRP–Ripple execs have even mentioned that XRP is not essential to Ripple’s business case (it’s just an add-on).  The execs have also mentioned that the ‘old’ cross-border payment systems cost ~20 basis points but with Ripple, customers could have a 6-basis point improvement using their platform without XRP.  With XRP there is an additional 2-basis  savings (note: this doesn’t take into account volatility of the XRP currency).

You have to wonder, does Ripple want to be the first non-sovereign private central bank leveraging cryptocurrency?

Ripple says they have 100 banks using their platform however it’s difficult to tell if those institutions are just kicking the tires or are they building out production systems.   You would think that these customers already have a ton of resources engaged in the ‘old’ way of moving money around for multi-national corporations and they make a ton of money doing it the ‘old’ way.   Also, these old-school banks and corporations are mostly risk-averse and if they think there are regulatory issues they will wait until those are clearly worked out.

Is XRP centralized or decentralized?

As opposed to Bitcoin, XRP does not seem all that decentralized–that may be a huge problem for the SEC… or maybe not.

  • Ripple says they are committed to decentralizing the XRP ledger and divesting operating control and giving up control of their validator nodes.
  • Bitmex did a report on Ripple / XRP where they downloaded the node software and all keys came from Ripple and they are in control of the consensus system.
  • Past CEO Chris Larson (17% of total) and current CEO Brad Garlinghouse (6.3% of the company) own a large share. (see here)

The most important point here is that most all cryptocurrency projects are going to start out centralized and then go to decentralized—it just seems to be taking Ripple a while to get there (it must be difficult). What makes this troubling is the market cap is huge and MOST IMPORTANTLY – the SEC has recently reported the following.  In this speech, William Hinman emphasized that “decentralization” is what makes Ethereum and Bitcoin NOT securities (absence of a “central actor” or third party who meaningfully determines “the enterprise’s success.”).  That can’t be good for Ripple.

Does Ripple need XRP?

Ripple may be a different animal (if they are really building a non-sovereign private central bank) however their platform seems like a permissioned system (private Blockchain) and tokens are not even necessary given the actors involved trust each other.   A permission-less system needs a token to incentive behavior because there are no middlemen.

If this is the case, the issue here is that they sold XRP to retail investors when was meant to be used by banks.

Is having a cryptocurrency worth the headache?

I guess all this boil down to is having XRP worth all the hassle when it only provides a 2 basis point saving for customers?

It seems that Ripple already has a great deal of interest and momentum from industry (MoneyGram is even interested). However, the cryptocurrency model seems to have lead to plenty of legal headaches (beyond what the SEC may bring in the future).  There is a lawsuit with R3 where Ripple granted options for billions of XRP at less than 1 cent in 2016 to incent R3’s banking network to adopt the platform.  Ripple canceled the option and now it’s in court.  There is also a class-action lawsuit against Ripple (see Bloomberg article here).  And there are other strange troubling issues–See the case of Jeb McCaleb family member froze funds at node level to get 1m back…

On top of all this, it also seems that even with all the success this company is having they are having difficulty getting listed in the most powerful exchanges (more here).

Bottom line – it may be worth the headaches IF the currency is what is funding the growth and the company can use this momentum to actually change a giant old school market.   It’s difficult to tell from the company’s quarterly reports where the revenue is coming from but you have to believe (after reading some of the background articles listed below) that the primary source of revenues is from the sale of XRP.

Net Net: If Ripple can steer clear of the SEC then maybe it was worth it and they will accomplish a sea change in the financial market.   …and just maybe the SEC sees the long-term upside in having this industry change!

Background reading:

11.6 million people are going to die next year by something that can be prevented

  • 11.6 people–it’s quite incredible when you think about it…
      • 21% of global deaths can be attributed to diets high in red meat and sugary drinks, and lacking in fruit, vegetables, and whole grains (link)
      • 55.3 million people die each year (link)
  • No one really dies of old age. What kills people according to the CDC (at least in the USA) are primarily diseases that have connections back to a person’s lifestyle.

h1

  • Even with all our great healthcare life expectancy is lower in the USA than in many other countries. (great read at NYT)

h2

  • 70% of Americans take prescription drugs and more than 50% take 2 (Mayo Clinic). This is an increase from 44% in 2000.
  • What you eat matters—A LOT!

“Healthy eating may be best achieved with a plant-based diet, which we define as a regimen that encourages whole, plant-based foods and discourages meats, dairy products, and eggs as well as all refined and processed foods. We present a case study as an example of the potential health benefits of such a diet. Research shows that plant-based diets are cost-effective, low-risk interventions that may lower body mass index, blood pressure, HbA1C, and cholesterol levels. They may also reduce the number of medications needed to treat chronic diseases and lower ischemic heart disease mortality rates. Physicians should consider recommending a plant-based diet to all their patients, especially those with high blood pressure, diabetes, cardiovascular disease, or obesity.” – Kaiser Permanente

 

Food for thought in regards to the bullets above–Could the US life expectancy be lower because of the amount of financial influence that the pharmaceutical, processed food, meat, dairy, sugar and poultry agribusiness lobbyists have on congress?

  • Among U.S. adults, more than 90 percent of type 2 diabetes, 80 percent of CAD, 70 percent of stroke, and 70 percent of colon cancer are potentially preventable by a combination of nonsmoking, avoidance of overweight, moderate physical activity, healthy diet, and moderate alcohol consumption. — Willett So, if the most common diseases that kill people “are potentially preventable” why does the US diet score so low on the international diet quality index? (summary) –the answer is ‘dopamine’.  The higher in calories the food, the more dopamine is released in the brain.  Read more here about dopamine…
  • Oxford University found that moderate obesity (BMI of 30 to 35) reduces life expectancy by about 3 years, and severe obesity (BMI of 30 to 35), can shorten a person’s life by 10 years. Here is a BMI calculator.
  • Only 22.9% of adults meet the Department of Health and Human Services national and state-wide exercise guidelines (18.7% of women and 27.2% of men) yet it’s been proven that exercise extends life expectancy by as much as 4.5 years. – link and Strength training (lifting weights) has been proven to extend life expectancy… Lifters have a 46 percent less risk of early death than people who don’t lift.  Lifters also have a 41 percent less chance of having a cardiac-related death and a 19 percent chance of dying from cancer. –Penn State College of Medicine.

Other reading:

Blockchain changes everything…

Back in 2012 I put in $1,000 into Bitcoin and started trading on MtGox – I was fascinated by the technology but in February 2014 I was burned when MtGox went bankrupt and changed my interests to cybersecurity.   Now several years later much has changed and I’m digging in again.  Here are my notes:

Introduction – Blockchain changes everything…

The world found cryptocurrencies like Bitcoin interesting (more about that below) but when they examined the cryptocurrency iceberg they realized how big of a disruption lies under the water—Blockchain is huge and can wreck every ship that runs into it…

Where are we on the Blockchain maturity curve? –Think 1993 when the Internet was just beginning to get the non-techs excited. Reference this great article by HBR.org about how foundational technologies take hold here.

Blockchain has the same disruptive potential as the internet but will take time to mature—likely a decade or more.  However, some industries such as finance will see disruption sooner while others will take longer.

“distributed ledger technology could reduce
banks’ infrastructure costs attributable to cross-border payments,
securities trading and regulatory compliance by between $15-20 billion
per annum by 2022.” –
link

Blockchain frees transactional records from the need for verification by a centralized authority.   This doesn’t sound that transformational until you realize that almost everything relies on verifications from different central authorities (banks, retailers, iTunes, governments etc..)

The Internet enabled new entities to provide instantaneous access to information by digitizing information and making it accessible—mainly from the same (banks going online) or new central authorities (Google, Facebook, Amazon):

  • Email vs. the post office
  • Wikipedia vs. the encyclopedia
  • Amazon vs. the department store
  • Online banking vs. going to the bank

Public Blockchains in some ways disintermediates the concept of these centralized authorities and has the potential to replace the trust-providing function of traditional institutions like banks, escrow agents, and even the county courthouse.  (more here on disintermediating Apple, Facebook, Microsoft, Amazon, and Google)

Will Amazon be replaced in the next few years? Probably not, but https://openbazaar.org wants to try…

The Value of Blockchain

Ripple calls Blockchain the “Internet of Value” (link).

“Our vision is for value to be exchanged as quickly as information. Although information moves around the world instantly, a single payment from one country to another is slow, expensive and unreliable. In the US, a typical international payment takes 3-5 days to settle, has an error rate of at least 5% and an average cost of $42. Worldwide, there are $180 trillion worth of cross-border payments made every year, with a combined cost of more than $1.7 trillion a year.

With the Internet of Value, a value transaction such as a foreign currency payment can happen instantly, just as how people have been sharing words, images and videos online for decades. And it’s not just money. The Internet of Value will enable the exchange of an asset that is of value to someone, including stocks, votes, frequent flyer points, securities, intellectual property, music, scientific discoveries, and more.”

For more on valuation: here.

What is Blockchain?

As stated previously, blockchains remove the need for trust in a system, ensuring that users can transparently interact with reduced reliance on third-party authorities.  When parties enter into a transaction, the transaction is broadcast across the network of computers. The network validates the transaction, using collectively pre-agreed, trusted consensus protocols. Once validated, the transaction is recorded in a new block of data, which is in turn added to the existing blockchain. Once added, it is permanent, immutable and resides across the entire network.

A blockchain is essentially a distributed ledger technology (DLT)

Imagine a company’s banking statement (ledger) with all the deposits and deductions and ever-changing balance existing on numerous machines versus at a centralized authority (bank).  Imagine then multiple mutually untrusting suppliers exchanging value (appending records or ‘blocks’) without a central coordinator (bank).  This network of computers would need to agree at regular intervals on the true state of a distributed ledger.

How Blockchain Works

On a blockchain, transactions are recorded chronologically, forming a chain (can be more or less private depending on the implementation. The ledger is distributed across many nodes in the network (versus in one place). Copies are simultaneously updated with every fully participating node in the ecosystem. A block could represent transactions and data of many types (currency, digital rights, intellectual property, identity etc..).

Public vs. Private Blockchain Networks

blockchain2

The difference between Public and Private blockchains comes down to who can participate in the network, execute the consensus protocol and maintain the shared ledger.

Public “Permissionless” Blockchain networks are completely open and anyone can participate in the network.

Private Blockchain networks or “Permissioned Blockchains” combine centralized user authorization with a decentralized blockchain transaction ecosystem.  The downside is that users still must place trust in an authority granting permissions as well as the consensus mechanism being utilized by the system.  Example: JP Morgan’s QuorumChain.  The upside is that the Permissioned Blockchain usually permits a couple of orders of magnitude greater scalability in terms of transactional throughput.

You can also have a “Federated” blockchain that operates under the leadership of a group. As opposed to public Blockchains, they don’t allow any person with access to the Internet to participate in the process of verifying transactions. Federated Blockchains are faster (higher scalability) and provide more transaction privacy. Example: R3 (Banks), EWF (Energy), B3i (Insurance) and Corda.

For more information see the coinsutra.com article here.

Consensus models

The most traditional way to reach consensus is a Byzantine Agreement where nodes on a blockchain validate blocks of data by reaching consensus on the solution to a given problem. A Byzantine Agreement is reached when a certain minimum number of nodes (known as a quorum) agrees that the solution presented is correct, thereby validating a block and allowing its inclusion on the blockchain.

More here.

When to use Blockchain

This graphic from Wesley Graham @ Berkeley does a great job of showing the use cases to consider for blockchain:

Another great site that helps you figure out if you need to use Blockchain is http://doyouneedablockchain.com and other models here.

Examples

  • Nasdaq Linq (link) to power capitalization tables
  • Stellar.org (link), a nonprofit that aims to bring affordable financial services, including banking, micropayments, and remittances, to people who’ve never had access to them. Stellar offers its own virtual currency, lumens, and allows users to retain on its system a range of assets, including other currencies, telephone minutes, and data credits.
  • Estonia prescribes blockchain for healthcare data security (link)
  • Musician Imogen Heap used blockchain to release a single directly to her fans (link)
  • P. Morgan (link) payment-processing network
  • BNY Mellon’s BDS360 for U.S. Treasury Settlement
  • Japan Exchange Group (link) is exploring blockchain for capital market infrastructure

We will see a great deal of innovation across all verticals in the years to come.  Here are a few you can expect:

  • Manufacturing and supply chain vertical – Use Blockchain to confirm the origin and movement of materials through the manufacturing process before and after actual production to reduce fraud and delays in the process or to improve financial reconciliation.
  • Healthcare vertical – Use Blockchain to improve transaction monitoring, identity services, and investigation of suspicious activities.
  • Public sector verticals – Use Blockchain to improve data sharing across agencies (examples: tracking birth and death certificates, citizen eligibility for benefits, and enabling the sharing of government employee profiles across government departments).

The Downsides

Public Blockchain network downsides

  • Competing blockchains – Currently there are a multitude of competing blockchains which do not connect with one another allowing assets to be exchanged like information, but industry standards will start to form (example: https://interledger.org)
  • Power – A substantial amount of computational power is necessary to maintain a distributed ledger at a large scale. To achieve consensus each node in a network must solve a complex, resource-intensive algorithm called a “proof of work” to ensure all nodes are in sync.
  • Privacy – which implies little to no privacy for transactions and can be a detriment to a company’s involvement
  • Security – Deep topic—let’s ask MIT: here.
  • Scalability – There are limits currently in the maximum number of transactions some networks can process (here and here)

Private Blockchain network downsides

  • Decentralization – Allows big organizations to retain their control of a market
  • Connectivity to existing systems
  • Regulations – Example: HIPAA, SOX, FDA, and GLBA
  • Privacy – The distributed nature of blockchain ledgers can make it hard to provide the privacy that some customers expect

For more on this topic see the Investopedia article titled Public vs Private Blockchains: Challenges and Gaps or Sorting out the advantages and disadvantages of public vs. private blockchains and Understanding Layer 2 Side-Chains for Scale.

Smart Contracts

A computer protocol intended to digitally facilitate, verify or enforce the negotiation or performance of a contract. Smart contracts allow the performance of credible transactions without third parties. These transactions are trackable and irreversible. Smart contracts were first proposed by Nick Szabo, who coined the term, in 1996.

Ethereum implements a nearly Turing-complete language on its blockchain, a prominent smart contract framework.

More on smart contracts can be found here: Smart Contracts: The Blockchain Technology That Will Replace Lawyers

Example, consider the case of domain name escrow. Currently, if A wants to sell a domain to B, there is the standard counterparty risk problem that needs to be resolved: if A sends first, B may not send the money, and if B sends first then A might not send the domain. To solve this problem, we have centralized escrow intermediaries, but these charge fees of three to six percent. However, if we have a domain name system on a blockchain, and a currency on the same blockchain, then we can cut costs to near-zero with a smart contract: A can send the domain to a program which immediately sends it to the first person to send the program money, and the program is trusted because it runs on a public blockchain.

Solutions

Most Enterprise Cloud Providers (Microsoft, AWS, Google, IBM and Oracle) will provide APIs that allow customers to build enterprise private blockchain solutions leveraging their proprietary distributed ledger and smart contract frameworks.   Like machine learning APIs from these same platform providers, once you use the APIs you are locked into this cloud platform.

There are also many open source Blockchain platforms available.  For example: HyperLedger, Monax/Eris, HydraChain, MultiChain, Corda, and OpenChain

Technically… How does it really work?

Sean Han did a great job explaining blockchain with an example app he published.  You can find the article here.

Haseeb Qureshi also wrote a great article titled “The authoritative guide to blockchain development” that you can find here.

 

Blockchain Business Models

Most Blockchain businesses make money in one or more of the following ways:

  • Software as a Service –  charge a fee for using their infrastructure.
  • Flat Fees & Transaction/Subscription Fees – Maintain networks between a consortium of partners.
  • Service Level Agreements – Host infrastructure for enterprise customers (Microsoft, AWS, IBM etc…).
  • Cryptocurrency Speculation – Issue their own token. These companies do work that makes the market value of their token increase and then sells the token to speculators. <<More on this in the next couple sections…

 

Crypto Currency

You can’t dig into blockchain without mentioning cryptocurrencies as they are what drove blockchains current momentum and much is coming out of this momentum such as smart contracts and ICOs.

Start with this video: https://www.youtube.com/watch?v=bBC-nXj3Ng4

First, let’s define what is money?

Money is not a thing (gold or a dollar bill).  Money is a record adopted by society to record who owns what.  If you use your credit card or PayPal real dollar bills and/or gold is not transferred—ones and zeros are…

FIAT Money (link) – “Fiat money is a currency that a government has declared to be legal tender, but it is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on the faith and credit of the economy.”

What is Cryptocurrency?

A Cryptocurrency is a medium of exchange, created and stored electronically in the blockchain, using encryption techniques to control the creation of monetary units and to verify the transfer of funds.   It has no intrinsic value in that it’s not redeemable for a commodity such as gold.  It has no physical form.  Its supply is not determined by a central bank as the network is completely decentralized.

Common Native Cryptocurrencies

  • Bitcoin — The first decentralized digital currency
  • Ether – A cryptocurrency whose blockchain is generated by the Ethereum platform (a blockchain-based distributed computing platform and operating system featuring smart contract (scripting) functionality).
  • Ripple — Unlike most cryptocurrencies, it doesn’t use a Blockchain to reach a network-wide consensus for transactions. Instead, an iterative consensus process is implemented, which makes it faster than Bitcoin.
  • Litecoin — A cryptocurrency that was created with an intention to be the ‘digital silver’ compared to Bitcoin’s ‘digital gold.’ It is also a fork of Bitcoin, but unlike its predecessor, it can generate blocks four times faster and have four times the maximum number of coins at 84 mn.
  • NEO — It’s a smart contract network that allows for all kinds of financial contracts and third-party distributed apps to be developed on top of it. It has many of the same goals as Ethereum, but it’s developed in China, which can potentially give it some advantages due to an improved relationship with Chinese regulators and local businesses.

There are many others such as Bitcoin Cash, NEM, IOTA, Dash, Qtum, Monero and Ethereum Classic.

Is this the future of money?  Undetermined.  According to Buffet and Gates, it’s a strong NO (link).  …and if you ask an esteemed economist like Paul Krugman he will tell you “to be successful, money must be both a medium of exchange and a reasonably stable store of value. And it remains completely unclear why Bitcoin should be a stable store of value.”.

…but what if, a country adopted a cryptocurrency as it’s official currency?  Venezuela tried… the Marshall Islands is trying (link)… Sweden (link).  Estonia (link).  Japan/Canada/Germany/Holland (link)…  and to note: Japan recently recognized Bitcoin as legal tender (link).

Net/Net: Cryptocurrencies are not going away as Gates/Buffet/Munger are predicting, however, they are probably correct in the assumption that it won’t replace the US Dollar as the reserve currency any time soon.  More on this argument here.

Pros and Cons of a global cryptocurrency (Coin) as an alternative to FIAT

Pro:

  • Medium of exchange without the use of an intermediary (bank):
    • Rebuttal: Artificial scarcity is essential to cryptocurrency’s speculative value but works against making it a viable medium of exchange. Why would you buy a soda with Bitcoin if one day it’s $1, the next $5, and the day after that $10?
  • Low-cost international money transfers: This is a multibillion-dollar industry that’s mostly set up to exploit working-class immigrants with fees (Western Union, PayPal or Plimus skimming 3-10%). With cryptocurrency, the transfer fees are negligible, and the transfer times are near-instant (usually less than 30 minutes).
  • No government intervention: Allows citizens to not have their capital tracked by governments as a means of control in the case of 1) Seizure resistance by badly acting governments and 2) Ease of transport of currencies across international boundaries (cryptocurrencies allow you to cross a border with literally a billion dollars in your pocket)
  • Ability to sell a digital good: For example Music & Photography
  • Replace central banks:
    • Rebuttal: Well-run central  banks  succeed  in  stabilizing  the  domestic  value  of  their  sovereign  currency  by  adjusting  the  supply  of  the  means  of  payment  in  line  with  transaction

 

Con:

  • Speed: Public permissionless blockchain networks are slow and will not scale to yield transaction throughput on the scale of Visa/Mastercard
    • Rebuttal: Layer 2 solutions (Lightning & Raiden)
  • Use enormous resources: Public permissionless blockchain networks require enormous resources (bandwidth, memory and CPU). The ledger is shared and maintained by every node of the network. To be a node in the network, one needs to download the whole ledger/blockchain and keep it on their system. Distributing a ledger potentially consumes over a hundred times the energy of single databases. Scaling up from relatively niche use could be impossible.
    • Rebuttal: Proof of Stake consensus systems and Layer 2 solutions
  • Won’t pass regulatory scrutiny: Governments won’t tolerate the loss of monetary control. The US government specifically is not going to allow wide-scale movement of money within the United States in which it can’t identify the sources and uses.  Governments also won’t tolerate illegal commerce (especially if used for terrorism).   Eventually, societal pressure to regulate cryptocurrency will increase as more fraud (example: market manipulation) is discovered. Most people want strong governments, and strong governments want to control their own currencies.
  • Cryptocurrencies are not a “stable” store of value. They operate less like a “currency” and more like a “stock” whose price fluctuates. What % of today’s BTC is being used to purchase services? Less than 1%?
    • Rebuttal: In economics, something has value if it checks the following two boxes: scarcity and utility. Scarcity means that something has a finite supply. In the case of bitcoin, the cryptocurrency has a set cap of 21 million bitcoins. Cryptocurrency’s utility lies in the fact that no government, bank or single person has control over it hence it can’t be toppled by corruption at the top.  Gold has underlying utility value in applications such as semiconductors and jewelry. Real estate has underlying value for building, farming, and mining, among others.  Cryptoassets have an enormous amount of potential underlying utility value, promising to disrupt just about everything, including payments, record keeping, legal contracts and many other industries.
  • Country-specific monetary policy is required for a stable society, to offer benefits (Social Security, Medicaid, Medicare) to its population and to finance wars
  • Credit and cryptocurrencies play poorly together.
  • Deflation is bad. Bitcoin caps out at 21 million total BTC in circulation; Litecoin at 84 million LTC. These fixed supply mechanisms give them deflationary characteristics over the long term.
    • Rebuttal: Ethereum (ETH) chose to uncap the total supply of their coins and opt for long-term, pre-determined issuance schedules. No-cap cryptocurrencies are thus inflationary in nature. The risk with inflationary cryptoassets is that new, future coins entering the market will reduce the value of existing coins by increasing the supply relative to demand.
    • Rebuttal: A cryptoasset with deflationary characteristics could theoretically be a better store of value because existing coins are protected from future supply-based dilution.
  • Quantum computing: The entire blockchain assumes that hash problems take a constant time to solve. If someone can solve a hash problem even slightly faster, then the whole blockchain system fails to work.
  • Fragmentation: like Linux, many cryptocurrencies are open-source causing new currencies to appear quickly.
  • Lost keys: Cryptocurrency stored in a public permissionless blockchain can be lost forever if someone loses their key. Hence, most people won’t want to maintain their own private keys, and if you don’t maintain your own private keys, cryptocurrencies are essentially no different from fiat money held in banks.
  • Economics of Proof of Work: For cryptocurrencies that using proof of work (mining) as their consensus mechanism–If the market value of the reward for mining drops below the cost of mining, then miners will stop mining, and nobody will process transactions.
    • Rebuttal: Proof of Stake

 

ICO – Initial Coin Offering or “Token Sale”

It’s import to understand what a “Token” because it is one of the ways that a company can build a business model to fund a ‘Public’ blockchain network.   It’s also important not to confuse a “Token” with a native “Coin” (Bitcoin, Ether, Ripple, Litecoin etc..).

In an ICO a company will sell a quantity of cryptocurrency to investors in the form of “tokens”, in exchange for coins (other cryptocurrencies such as bitcoin or ether). These tokens become functional units of currency if/when the ICO’s funding goal is met.  Most companies develop a decentralized application (Dapp) where the custom token provides a unique utility in using the company’s product.  However, tokens are exchanged freely using the native coin protocol, so users can trade them in for other cryptocurrencies or fiat.

Tokens, in general, are not the same as shares in a company as they do not provide an ownership stake (voting rights) in the company. Tokens are simply vehicles with which to conduct transactions for the goods or services within the company from which they are issued. After the ICO where the company sets the price for the tokens, their value is based on supply and demand.

A token is like a concert ticket. Tickets are bought and sold, and their value depends on the popularity of the band.  The exchanges (StubHub) facilitates the buying and selling of tickets. There are limited numbers of tickets just like there are a limited number of tokens. An ICO is like pre-purchasing tickets for future concerts at a very low cost. The band may or may not be around in the future but if you can spot the diamond in the rough, your tickets could be very valuable in the future. If you pre-purchase tickets to a band that goes nowhere, you lose everything.   <here is another funny analogy that explains and ICO/Token sale>

If a company creates a token in Ethereum, it is created as a smart contract, with each token being governed by a single, unique governing contract.

Types of tokens

  • Utility Token – Provide exclusive access to software utility (or service) by having the token or in exchange of token.
  • App-payment token – Provide means of payment in a technological ecosystem where more than two parties are involved.
  • Security tokens – Provides a return on investment through profit or revenue sharing, it includes voting rights, constitutes a part of equity and may provide buy-back guarantees.

The advantages and disadvantages of a token sale

Advantages:

  • Quick and low cost – ICO’s do not require intermediaries to get involved (in contrast to typical venture capital) so raising funds can be fast and low cost
  • Liquidity – Investors can sell at any time
  • Real-time risk pricing – Investors always know where they stand in regards to the value of their tokens
  • Visibility on an exchange can help the company attract developers and users

Disadvantages:

  • Getting listed on an exchange can be costly (link).  Access to the best exchanges carries a premium because the bigger the liquidity pool, the higher the potential market value of a coin, and the higher the chance of success for a project.  You can find a list of exchanges here https://coinmarketcap.com/exchanges/volume/24-hour
  • Once a cryptocurrency project is launched and listed on an exchange it trades live and faces the public scrutiny that comes with being a publicly listed company
  • The nature of ICOs can attract speculators that do not believe in the long-term potential of the company

 

The ICO Steps

  1. Release a “white paper” which details the plans for a given cryptocurrency, including what it will do, why it is useful, the roadmap for building the project, and a plan to use the funding raised. More on whitepapers can be found on this blog post.  Here are some example of whitepapers.
  2. Allow people to register for the whitelist to gain access to a pre-sale round.  More on whitelists can be found here.
  3. When the pre-sale period occurs investors will contribute funds by sending Bitcoin (BTC) or Ethereum (ETH) to a designated wallet address. If the project reaches its funding goal, tokens of the new cryptocurrency will be sent in return when the coin is launched. If the project does not meet its funding goals, the contributed funds will be returned.
  4. If the project reaches its funding goal and distributes the newly created coins, it will launch on an exchange where it can be traded.

Stable Coins

a ‘Stable Coin’ is a cryptocurrency that is pegged to another stable asset, like gold or the U.S. dollar. It’s a currency that is global but is not tied to a central bank and has low volatility.  For more on stable coins: here.   More on asset-backed tokens (ABT) found here.

Tokenizing real-world assets

More here.

If you are “Long” on Cryptocurrencies then you should really really really read this great article: The Natural Order of Money and Why Abstract Currencies Fail by Roy Sebag.

 

Note: Currently the legal state of an ICO is undefined. Is a token a financial asset (a security) or a digital good? What is the SEC going to do? (link) I’m sure we will hear something soon (link). –“The Securities and Exchange Commission and the agency that Mr. Gensler led from 2009 to 2014, the Commodity Futures Trading Commission, are in the middle of determining how to categorize and crack down on many of the virtual currencies created in recent years. Most of the focus has been on smaller currencies that were issued through so-called initial coin offerings, or I.C.O., a method of fund-raising in which entrepreneurs sell custom virtual currencies.”.  Keep an eye on the Swiss too (FINMA).

Related Reading: