The DAO Ka-Ching!

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The Yin and Yang of Crypto Speculation

“Thirty spokes share the wheel’s hub;

It is the center hole that makes it useful.

Shape clay into a vessel;

It is the space within that makes it useful.

Cut doors and windows for a room;

It is the holes which make it useful.

Therefore profit comes from what is there;

Usefulness from what is not there.” [1]

In Crypto We Trust

Ka-ching! The DAO is big news in the startup world, shattering previous records for crowdfunding ventures [2]. With still another two days to go before the offering closes, The DAO has raised an astonishing sum, about $143 million so far, denominated in ether (ETH), the cryptocurrency of the open source Ethereum platform.  As a frame of reference, the median IPO offering raised $96 million in 2014—yet, unlike conventional IPOs, The DAO has no earnings and offers only an experimental business model [3].

Yin and Yang of The DAO

The DAO is the latest Decentralized Autonomous Organization, an innovative form of online collaboration, enforced by open source computer code. Some are predicting an untimely demise for The DAO based on a prior attempt to implement this new paradigm. Notably, Dan Larimer, founder of BitShares and early proponent and creator of the conceptual framework for DAOs, sounds downright disillusioned with the concept based on his experience at Bitshares [4]. Like Ethereum, Bitshares created its own blockchain and crypto-token, BTS. In fact, Bitshares did this years ago but never secured the market traction or prominence of Ethereum. Today the market cap of BTS tokens is less than $9 million vs. about $1 billion for ETH. Some of Larimer’s concerns about the viability of The DAO are well-founded, especially regarding the complexities of the built-in incentives [4]. However, Bitshares may have been merely too early in promoting its version of a Decentralized Autonomous Organization, lacking the network effect and buzz now enjoyed by Ethereum and The DAO. Perhaps more importantly, the development team at Slock.it, led by visionary Stephan Tual, has done an excellent job of conceiving “killer apps” for The DAO, promoting a Universal Sharing Network and Ethereum Computer that can help realize the potential synergies of the Ethereum blockchain and the emerging Internet of Things [5]. Bitshares never affirmed such a persuasive vision. Despite the risks inherent in any new venture, pairing The DAO token sale with the compelling Slock.it proposals is proving to be an irresistible combination for cryptocurrency speculators.

A New Era of Venture Finance

Digital currencies and blockchains are increasing the utility of the Internet beyond a mere information repository and means for communicating peer-to-peer. Andreas Antonopoulos, a prominent expert and advocate of Bitcoin, pointed out a recent turning point in the development of cryptocurrencies: rather than flee out of Bitcoin back to the so-called safety of fiat money during the most recent crisis in confidence affecting this nascent technology, people moved into ether, the cryptocurrency of the Ethereum blockchain [6]. For the risk tolerant and tech savvy, digital currencies are emerging as viable alternative investments, a way to further diversify standard portfolios composed primarily of stocks and bonds.

Clearly, the age of cryptocurrencies is giving birth to a new era of venture finance, one that mimics equity crowdfunding sites such as AngelList and CircleUp, but with two major differences: who can “invest,” and the accepted medium of exchange. Although crowdfunding is an ideal way to aggregate a large number of relatively small investments, in the US, until just recently only accredited* investors—those with a net worth in excess of $1 million, excluding their primary residence—could participate in offerings made through equity crowdfunding sites. On the other hand, anyone with Internet access and some tech-savvy, regardless of net worth or income, can speculate in The DAO. (Of course, that doesn’t mean they necessarily should…) No doubt—parts of the high-tech startup landscape are being radically altered by the advent of cryptocurrencies and blockchains such as Bitcoin and Ethereum. For those who have been following the evolution of crowdfunding, the rules of who can invest were just relaxed by the SEC as of May 16, opening the doors to ordinary retail investors, and removing the high net-worth restriction. This development is part of the 2012 JOBS Act, recent legislation intended to benefit small businesses. However, to curtail potential abuse, the SEC limits the amount of crowdfunding that can be raised from retail investors to only $1 million in any given rolling 12-month timeframe [7]—such a limitation would have clearly stifled the potential funding of The DAO.

Another remarkable divergence from traditional crowdfunding is the means of exchange. Instead of conventional fiat currencies like US dollars or Euros, digital value in the form of cryptocurrencies is being used by speculators to fund The DAO. At the time of this writing over 14% of the outstanding ether tokens have been invested in The DAO. The market value of The DAO is bound to fluctuate given the volatility of ETH compared to fiat currencies—and soon DAO tokens will be a tradable commodity on some cryptocurrency exchanges [8]. Nevertheless, it is interesting to deeply ponder the origin of this digital value. In August 2014, the Ethereum Foundation, a Swiss non-profit, raised about $18 million in a crowdsale of its ether tokens—purchased online using bitcoin [2]. At the time, it was a very noteworthy event in the emerging world of cryptocurrencies, promising an open source and decentralized platform for running smart contracts. Since then, as the potential of Ethereum shows ever more promise, and developers build experimental applications on this flexible and decentralized platform, the value of ETH has increased over 40-fold. Many early speculators in ether are likely seeking to diversify their gains, contributing to the successful crowdsale of The DAO.

The DAO’s Success Attracts Attention

The incredible success of The DAO’s crowdfunding campaign, that big ka-ching sound, may eventually attract the scrutiny of the SEC in the US. On the daohub.org website, it states: “The DAO is a for-profit DAO that will diligently use the ETH under its control to create value and provide benefits to its members while collaborating and improving the decentralised ecosystem as a whole.” It is hard to dispute, purchasing The DAO tokens, even though consummated with ETH, is akin to buying equity in a business venture—such speculators hope to profit from their participation in The DAO and the proposals its membership chooses to sponsor. Given that technology moves faster than the law, the statutory status of The DAO is unclear. Legal experts warn both creators and participants in DAOs of the murky regulatory waters and the risks associated with such organizations [9]. Despite these concerns, programmers are creating a new kind of collaborative structure, ruled by logic and enforced by computer code, and speculators are clamoring for a piece of the action. The decentralized nature of the Ethereum platform, and hence The DAO, shields these endeavors from the inherent vulnerability of centralized organizations. Of course, for The DAO to succeed as a profitable enterprise, it must interact with external contractors, who may be hesitant to deal with such an extralegal entity. On the other hand, a new breed of contractors may emerge, willing to forgo the usual ways of conducting business, and embracing an online ecosystem of distributed trust and digital currencies. As an interim measure, Stephan Tual of Slock.it recently announced DAO.LINK, a means to bridge the gap between traditional brick-and-mortar companies and blockchain initiatives such as The DAO: “DAO.LINK has set up the legal framework to give real world companies the ability to work for DAOs while still being able to fill out the necessary documentation required to stay compliant [10].”

Full Circle

Time will tell if The DAO succeeds or not. It is clear, given the means employed and sheer magnitude of the crowdsale, we have entered a new era of venture finance. As expected, the legal system is lagging behind technological innovation, and will sooner or later be required to better account for cryptocurrencies and DAOs. In the meantime, we have come full circle. The digital tokens, bitcoin and ether, are fueling a growing number of tech ventures which embrace the new paradigm of decentralized collaboration, enabled by the Bitcoin protocol and Ethereum platform that spawned these very same tokens.

DISCLAIMER: CryptoIQ does not give investment advice. Readers are encouraged to do their own due diligence before speculating in any type of cryptocurrency venture.

* As an alternative to the net worth test, there is an income test that can be met to qualify as an accredited investor—a minimum income of $200k for the two previous years with the expectation of the same earnings in the current year. Together with a spouse, the income limits increase to $300k per year [11].

References

  1. Lao Tzu, Tao Te Ching, Chapter 11, translated by Gia-fu Feng and Jane English
  2. List of highest funded crowdfunding projects. Wikipedia. Retrieved from https://en.wikipedia.org/wiki/List_of_highest_funded_crowdfunding_projects on May 18, 2016
  3. Wilmer Hale. 2015 IPO Report. Retrieved from https://www.wilmerhale.com/uploadedFiles/Shared_Content/Editorial/Publications/Documents/2015-WilmerHale-IPO-Report.pdf
  4. Dan Larimer. (May18, 2016). Is The DAO going to be DOA? Retrieved from https://steemit.com/crypto-news/@dan/is-the-dao-going-to-be-doa
  5. Slock.it UG Proposal #1 Overview. For a Universal Sharing Network, the Ethereum Computer Reference Design and its Ecosystem of Applications. Retrieved from http://download.slock.it/public/DAO/Proposal1.pdf on May 18, 2016.
  6. YouTube. Bitcoin Q&A: How does Bitcoin differ form other altcoins? – The Cryptocurrency Economy. Retrieved from https://www.youtube.com/watch?v=37e01sJ3Tfk&feature=youtu.be&a on May 18, 2016.
  7. Investment News. (May 22, 2016). The perils of investment crowdfunding. Retrieved from http://www.investmentnews.com/article/20160522/FREE/160529989/the-perils-of-investment-crowdfunding
  8. The DAO website. The Creation Process. Retrieved from https://daohub.org/creation.html
  9. Tim Swanson. (September 7, 2014). CoinTelegraph. Mitigating the Legal Risks of Issuing Securities on a Cryptoledger. Retrieved from http://cointelegraph.com/news/mitigating-the-legal-risks-of-issuing-securities-on-a-cryptoledger
  10. Stephan Tual. (April 26, 2016). Announcing DAO.LINK, the bridge between blockchain and brick-and-mortar companies. Retrieved from https://blog.slock.it/announcing-dao-link-the-bridge-between-blockchain-and-brick-and-mortar-companies-9510ba04d236#.twdazz2np
  11. Investopedia. Accredited Investor. Retrieved from http://www.investopedia.com/terms/a/accreditedinvestor.asp?layout=infini&v=5D&orig=1&adtest=5D

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