INVESTMENT IN PROTOCOL TOKENS MADE SIMPLE

Blockchain Coinvestors Newsletter

Vol. 3, No. 13, July 2021

INVESTING IN PROTOCOL TOKENS MADE SIMPLE

These days we are often asked, what are protocol tokens? These are the tokens like Eth from Ethereum, Dot from Polkadot, and Solana from Solana among others which are being used to fund the base layer blockchain operating systems.

In today's newsletter, we unbundle this discussion:

  1. What are Protocols?

  2. What is Decentralized, Open-Source Software?

  3. From Shareholder Backed to Community Backed

  4. From Emails to Smart Contracts in Token Form

  5. Do these Tokens have Value?

As always, we aim to keep this simple, which of course means we take some liberties of oversimplification to do so.

1. What are Protocols?
In our Blockchain Coinvestors investment thesis webinar and many of our writings we have introduced the notion that the blockchain ecosystem can be thought of as a technology stack with the foundational layer made up of the most fundamental layer of technology including the 'blockchain operating systems'. Just as the Internet sits on top of TCP/IP and other protocols, and as our mobile apps and solutions sit on top of their respective operating systems (Apple iOS, Android, Microsoft OS, etc), so any blockchain stack needs to sit on top of a base layer of computer software. In the world of blockchain, we call these protocols.

2. What is Decentralized, Open-Source Software?
To understand today's decentralized, open-source blockchain protocols, we think it helps to go backward a few decades to breakthroughs that are now so ubiquitous that we may have even forgotten about them:

  • In the beginning computer code was written by software engineers. It still is.

  • At first, software engineers worked for large companies. They received a salary, and they wrote their code. The company owned the software - including operating systems they developed - and captured the economic value from that work product. In the 1980's the companies had names like Apple, HP, IBM, and importantly, AT&T.

  • In those far away years, AT&T was the object of an antitrust case that banned it from playing in the computer space. As a result, it had to share its UNIX operating system with everyone, and eventually Bell Labs allowed anyone to propose modifications to UNIX.

  • The regulators had essentially launched the notion of open-source software development.

  • In parallel, a Finnish software developer called Linus Torwalds decided that he wanted to create a fully functional and free operating system. After some iterations of its license, they ended up with a body of code that he and other decentralized software developers called Linux.

  • This free operating system, built by a decentralized, open-source software development process, began as far inferior to the dominant operating system of that time which was owned by Microsoft.

  • However, as a centralized corporation, Microsoft extracted a great amount of value from other computer companies who had to use its operating system, and some of them, like Dell, HP, and IBM were not happy about this rent taking. So they decided to use Linux as the foundation layer for an open-source operating system(s) of their own.

  • Today Linux and decentralized, open-source software code is embedded in many of the applications that we and our companies and governments use. We may not know it, and we may take it for granted, but it is not a new idea. It has been going on for more than 40 years now.

However, the fact that we have known for a long time how to create decentralized, open-source software did not solve the software engineers personal challenge:

  • While they had used technology to change how they worked, they had not been able to use it to change how they were paid.

  • They mostly either earned their salaries as employees, or they volunteered their work for free in open-source initiatives during their moonlit hours.

  • A few of them figured out how to also be entrepreneurs and own the companies that they wrapped around their software. Those few became the richest people in the world creating companies like Alibaba, Alphabet/Google, Amazon, Apple, Facebook, Microsoft, and Tencent to name a few.

  • However, most software engineers were not people who were able, or interested in building large companies.

  • They preferred to write code.

So the world moved forward into the Fifth Era with software engineers writing software which was eating the world, but the engineers themselves only eating what they took home from their corporate paychecks.

3. From Shareholder Backed to Community Backed
The next big breakthrough was for the software developers to come up with a way to change the economic, value capture model of decentralized, open-source software. We don't know exactly how it happened, but at some point software engineers realized that their communities of users were the way to change the paradigm. 

We experienced this shift in the video game industry as follows (yes video games are just software too):

  • In the 00's we were backing video game companies and virtual worlds like Telltale, Unknownworld Entertainment, Mindfuse, and others in corporate structures with equity financing.

  • Then some of the teams we were working with came up with the notion of pre-selling their games. These were the ones who were already well known for creating great games, and their fan bases were willing to give them money upfront for games that they planned to launch.

  • Initially, the deal (contract) was that the fan sent in some money, in return receiving a future discounted version of the game, and maybe some other giveaway like a t-shirt or cap. Sometimes we gave them limited edition in-game names, badges, or even digital assets for their early support.

  • Then we realized that we could also ask the fans about how they would like the game to be built. We began asking the fans to help design the future game. Sometimes we asked them to contribute assets, levels, maps, and so on. We called this user generated content.

  • Over time this model became very powerful. The community began to fund the game, and we no longer needed as much, or in some cases, any equity capital. They also began to do substantial amounts of the development of some games.

  • With the emergence of product crowdfunding platforms like Kickstarter and Indiegogo, the video game software engineers even found a way to reach audiences who did not already know about them. And some very large rounds were closed.

The software developers had broken out of the Industrial Era model of corporate equity funding. Instead, they had unleashed a powerful new model of community based, pre-development funding. With added design based dialog between developer and future user at the outset of the project, we had the beginnings of community based governance too. And the rise of user generated content.

4. From Emails to Smart Contracts in Token Form
In those early fundraising experiences at Telltale and Unknownworlds we talked to the community through traditional communication approaches. In some cases we emailed the fans for their support and some way of transferring the money had to be devised. The fans trusted the teams so there was very little in the way of contracts and agreements. 

However, over at Kickstarter and Indiegogo and other crowdfunding platforms, trust needed to be codified into contracts, and there were simply too many situations in which the fund raiser took the cash and never delivered the promised software such that a more disciplined, trustworthy, and reliable solution was needed.

At about the same time, someone (Satoshi Nakamoto) had solved the issues of security, identity, and trust around digital money in the Bitcoin whitepaper by creating something called a blockchain. It seemed to be a way to resolve the issues of value transfer across large distributed and decentralized communities - on a global scale.

When the software developer team building the Mastercoin (now Omni) protocol on top of the Bitcoin blockchain wanted to raise capital to fund their project they decided to focus on community based funding and they wrote some software to encode the agreements between the fans and their software development project. The resulting software contract was given the name the 'Mastercoin Token' and in July 2013 the first token sale occured. It was sufficiently successful that others followed quickly. In 2014 the Ethereum project team raised 3,700 bitcoin - then worth $2.3 million, now worth $130 million - in just the first 12 hours of their offering.

Before we knew it, a vast number of whitepapers were issued in the 2015 to 2018 period for what had become known as Initial Coin Offerings or ICO's. These were software tokens encoded with agreements for how a community might buy the tokens and get rights in the creation of future software. Many of these ICO's were never real, and/or their project teams never planned to build the promised software - they planned to take the money and run. However, don't throw out the baby with the bathwater. Among those ICO's were also the world's best software developers planning powerful new decentralized, open-source software protocols including Ethereum, Polkadot, and Solana among others which are being used to form the base layer blockchain operating systems that are now changing the world of computing globally.

5. Do these Tokens have Value?
So that is how we explain the notion of protocol tokens in as simple a way as we can manage:

  • They derive from a long history of open-source software development.

  • They enable decentralized and distributed teams of software developers to capture the value of their coding.

  • They allow a community of fans to provide capital to those same software development projects.

  • They are enabled by smart contracts in token format which include the agreements being made between development teams and fan buyers.

  • Because they are software, the agreements can include all sorts of utilities that the software team will give to the buyers over time. They can also be made dynamic and can unlock or evolve as needed, too.

  • The tokens can be sold, but they can also be earned - for community activities like developing code, mining, being an advisor, marketing the story to other people, and so on.

  • There is no limit to what the tokens can be encoded with - they are truly flexible smart contracts.

Once the project goes public, these tokens become publicly traded too. At which time potential buyers are not just the community that believes in the software development project. Suddenly buyers may be speculators too.

Which comes to our final question. Do these tokens have value?

As long term investors - which is what we are at Blockchain Coinvestors - we believe that among these tokens are the ones created by the world's leading software engineers building the foundational protocols that will drive computing globally. So yes, we believe their tokens have value.

However, and conversely, we know that many tokens do not have value since they are being issued by people who are not leading software developers, and/or who do not have the interest or capability in seeing their whitepaper visions to completion.

Also, we don't understand the world of speculation, and so we can't talk about price once tokens go public. Which is when the speculators move in. So we confine our own investing activities to private early stage token funding rounds when high quality teams are getting their projects funded by the inner circle of their community and by selected long term investors.

For the rest, 'Caveat Emptor'.

Thank you for reading.

Alison Davis
Matthew C. Le Merle

ABOUT BLOCKCHAIN COINVESTORS

Launched in 2014, our goal is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and capture superior returns through investments in the leading blockchain venture partnerships. The strategy is now entering its 8th year and has to date invested in 25 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of more than 300+ blockchain and crypto projects including 30+ blockchain unicorns. Headquartered in San Francisco with a presence in London, Menlo Park, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.

FUND PERFORMANCE

Blockchain Coinvestors Funds are continuing to generate strong returns. To date, over 80% of the funds we are invested in are performing as top quartile funds against the Cambridge Associates benchmark. This remarkable performance results from powerful tailwinds driving the world towards a future in which digital monies and digital assets are ubiquitous and the businesses and projects providing blockchain and crypto products, services, and infrastructure benefit disproportionately.

BLOCKCHAIN COINVESTORS FUNDS

Blockchain Coinvestors’ goals are to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and to capture superior returns from investing in the leading blockchain venture partnerships:

  • Fund III is open only to investors who meet the Qualified Purchaser definition with a minimum subscription of $250,000.

    • A “qualified purchaser” is an individual or a family-owned business that owns $5 million or more in investments. The term “investments” shouldn't include a primary residence or any property used for business.

  • Fund III Parallel is open to investors who meet the Qualified Client definition with a minimum subscription level of $250,000 at the discretion of the Manager. Please contact ir@blockchaincoinvestors.com if the minimum is of concern.

    • Currently, an individual or entity is a qualified client if he, she, or it: (i) has a net worth of $2,100,000 prior to investment in the fund (excluding the value of his or her primary residence).

While the two funds are substantially the same, there may be some funds and investments that are only available in the Qualified Purchaser vehicle. Blockchain Coinvestors funds can take investments via IRAs. We support several providers, including AlgoIRA, Kingdom Trust, Millennium Trust Company and Pacific Premier Trust Company (Pensco).

Please visit the Blockchain Coinvestors website to learn more about our offerings. You can also reach our Investor Relations team directly at ir@blockchaincoinvestors.com.

BLOCKCHAIN COINVESTORS SWISS

We are excited to announce that Blockchain Coinvestors Funds are now available through Swiss certificates for those of our non-US investors who prefer this approach. The underlying fund is the same, however, our Zurich based team at Blockchain Coinvestors Swiss, who will introduce in future weeks, can provide detailed information regarding this investment option. Email us at mlemerle@fifthera.com to learn more.

LINQTO
'Private Investing Made Simple'

While our funds are only available to Accredited Investors who are also Qualified Clients we believe in the democratization of investment access to all investors and look forward to that day. In the interim, we have partnered with Linqto which is an easy to use Mobile and Web app that makes it exceptionally easy to invest into attractive opportunities. The provide access to Accredited not Qualified Client investors as well as much lower minimums. Go to Linqto.com or download the app from your App store to use this approach.

BLOCKCHAIN COINVESTORS ANGELLIST SYNDICATE

Continuing the theme of the democratization of investing, we have a rapidly growing Blockchain Coinvestors syndicate on AngelList providing access to selected coinvestments. Please join us and our partner Lou Kerner on AngelList.

Click here to receive the insightful weekly crypto newsletter and webinar invitations from our Blockchain Coinvestors partner Lou Kerner.

REGISTER NOW FOR UPCOMING WEBINARS AND CALLS

Our investment team hosts bi-monthly webinars and calls to help educate our community about the Fifth Era, fintech, blockchain and crypto. We discuss important trends, tailwinds and investment themes including what we have learned and how we are using our knowledge to inform our own investment thesis and actions. Below is a list of upcoming webinars for which you can register by clicking the links:


Meet the Blockchain Unicorns - Mid-Year Update

- July 12th, 7:00am PST

- July 12th, 12:00pm PST

Investing in Early Stage Tokens

- July 19th, 7:00am PST

- July 19th, 12:00pm PST

Options for Investing in Blockchain & Crypto

- July 26th, 7:00am PST

- July 26th, 12:00pm PST
 
Recordings of past webinars and calls can be found at www.fifthera.com/webinars.

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