THE COMING WAVE OF ASSET TOKENIZATION

Blockchain Coinvestors: Letter from London

Vol. 1, No. 2, August 2022

THE COMING WAVE OF ASSET TOKENIZATION

Before the launching into the substance of this month's Letter from London, we would like to update our current LP's about two important matters:

  • We have now successfully completed closings of Fund III (Fund of Funds) and Fund IV (Early Stage Token); subsequent closings will likely occur in the 3rd quarter

  • Meanwhile, our new Fund VI (Mid Stage Growth Fund) is currently completing it first closing and we encourage you to learn more

If you are interested in any of these opportunities please contact ir@blockchaincoinvestors.com.

 

The Coming Wave

 

It has been an eventful year for crypto. As covered in the previous Letter from London, tumultuous markets and macro shocks begot the demise of the Terra-Luna ecosystem and it’s ‘stable’-coin. The subsequent industry-wide deleveraging, concentrated on centralized lenders like Celsius, created a cascading flow of forced selloffs and bankruptcies. At the same time, blockchain has seen massive and consistent private investment flows, which indeed have slowed in the most recent quarter, but remain substantive. Investors’ eagerness and conviction to back the companies and projects building the infrastructure for truly digital commerce remain constant.

Yet, a large elephant in the room remains, an elephant which likely will have the single greatest impact of any external shock to the blockchain sector: regulation.

 

Earlier this year, President Biden’s Executive Order on ‘Ensuring Responsible Development of Digital Assets’ highlighted the White House’s commitment to explore the creation of regulatory frameworks for cryptocurrencies. Across the pond, the UK announced a commitment to crafting meaningful regulation, or in the words of then Chancellor of the Exchequer Rishi Sunak, ‘to make the UK a global hub for crypto asset technology’.

 

Nevertheless, hitherto there has been no coordinated, international attempt to regulate the industry in a comprehensive fashion. That is, until now. Enter MiCA, or the ‘Markets in Crypto Assets’ regulation.

 

As we outline below, at Blockchain Coinvestors we believe MiCA to be the first swell in the coming wave of crypto and blockchain regulation. The battles of where the regulatory lines are drawn will not be easy or straightforward, but represent a welcomed and necessary step toward broad industry adoption.

 

Mama MiCA! Taming the ‘Wild West’

The ‘Markets in Crypto Assets’ regulation (MiCA) will implement sweeping and comprehensive crypto rules across the EU’s 27 nations. Likely going into effect in 2024, MiCA’s stated aims are to:

  1. Deliver legal certainty across the EU

  2. Protect consumers and investors

  3. Ensure financial security

Sounds simple enough, but what exactly is MiCA proposing and how will this impact the industry? Below we outline the key provisions:

 

Passport License: While a handful of EU nations have enacted their own domestic regulations, such as Germany, MiCA aims to bring parity across a unified set of rules in the economic and political bloc. A ‘passport license’ will allow companies that are licensed in one EU country to automatically be eligible to offer their services across the EU.

 

Our takeaway: this seems unambiguously positive and should reduce the regulatory burden for companies while providing clarity. Now, if a company is able to get fully licensed in one EU country, it will be able to operate across the 27 nations with legal certainty. 

 

Stablecoins: MiCA mandates stablecoin issuers to meet strict liquid reserve requirements to be able to withstand a mass withdrawal. In fact, holders will be able to redeem their stablecoins at any time under the watchful eye of the European Banking Authority.

 

Our takeaway: we are cautiously optimistic. Clearly, in the light of the failure of algorithmic stablecoin UST, regulation is needed to separate the fully-backed and safe stablecoins from their mal-marketed counterfeits. Yet, we do worry that increased regulation’s large inherent costs may solidify entrenched players’ positions while preventing small incumbents, and in turn, innovation, from flourishing.

 

Custody Liability: Currently, consumers have little to no protection and are commonly targeted by fraudulent schemes. However, under MiCA, custodian wallet providers (and exchanges holding crypto assets for clients) will have to respect strong requirements to protect consumer wallets and be held liable if they lose consumers’ crypto assets. Crypto assets will also be protected in the case of the insolvency of exchanges.

 

Our takeaway: we are positive on this development as consumers’ perception of counterparty risk in the ecosystem serves to constrain broad and popular adoption; increased consumer protection should give consumers greater confidence in the safety of their assets and catalyze growth.

 

Anti-Money Laundering: The EU has provisionally agreed to ensure that crypto activity is subject to similar AML rules that govern traditional banking transfers. When a crypto transaction occurs, the service provider will have to maintain a log of the source and beneficiary of the transaction, and hand over any requested information to the authorities if they wish to investigate any criminal activity. Moreover, verification of identity of the beneficial owner of a self-hosted wallet, or where individuals self-custodize crypto assets, is required for transactions above €1,000.

 

Our takeaway: while we acknowledge the need for strong AML rules, we think the EU regulation here will serve to negatively impact innovation and growth in the bloc. In particular, restrictions on self-hosted wallets which allow consumers to self-custodize assets, reduce some core value propositions of cryptocurrencies, including censorship resistance and financial sovereignty. The European DeFi ecosystem in particular, which runs on user self-custody, is likely to see negative impact.

 

The Environment: MiCA will require crypto companies to disclose their energy use and environmental impact publicly. With this information, the European Commission aims to provide a report of the industry’s environmental impact and subsequently introduce sustainability standards.

 

Our takeaway: a net positive outcome as previous rumors indicated a ban on proof of work (the Bitcoin consensus mechanism) was considered. In our conversations with miners and industry insiders, a push toward sustainable energy sources is necessary (and already underway). Disclosure here should catalyze that movement.

 

What now? The View from London

 

1) Regulatory Clarity, a Positive Outcome

 

Overall, we believe regulatory clarity is a substantively positive development for the blockchain industry. The regulations in question don’t appear to be overly burdensome and provide a direction for companies to follow while giving comfort to EU consumers. Likewise, for an initial set of regulations coming out of an economic area which is traditionally skeptical of innovative technology, the rules as a whole seem fair and relatively straightforward.

 

2) Stablecoins Remain the Foremost Focus of Regulators

 

A disproportionate amount of MiCA centers around stablecoins, demonstrating the sustained focus of EU regulators and likely foreshadowing actions in both the US and UK. Regulators’ focus on stablecoins has only been accelerated by the dramatic collapse of the Terra-Luna stablecoin, UST. In Terra-Luna’s wake, Senator Toomey, the author of the Stablecoin TRUST act, called on regulators to do more to protect consumers while Treasury Secretary Janet Yellen urged lawmakers to pass legislation this year. Likewise, the UK recently unveiled proposed rules as part of its new Financial Services and Markets bill, which require stablecoin issuers to have a license from the Financial Conduct Authority. The stablecoin provisions in MiCA represent the first iteration of what is coming to the UK and US.

 

3) DeFi, NFTs Next Focus of Regulators

 

For the most part, DeFi protocols and NFTs were largely left out of MiCA. Nevertheless, the regulation includes a review clause that likely will lead to regulation at a future date. We see this as the next key area of focus for European regulators in the medium term.

 

4) The Big Question: How will the USA and the UK respond?

 

Today’s EU believes that its regulatory clout remains its largest impact on emergent technologies, and MiCA falls clearly into that narrative. As a result, the EU has initially taken a more hostile stance to blockchain technology than its British and American counterparts. As the home to more than 400 million wealthy consumers, the EU is hoping companies and projects conform to its regime, even if domiciled in another jurisdiction (e.g. think California, whose pollution regulations in affect force automobile makers to comply nation-wide).

 

Can the UK and US Seize the Initiative?

 

Nevertheless, as the first-mover in a likely multi-year regulatory effort, MiCA also opens up an opportunity for the UK, US and other countries to present an alternative. In particular, officials in the UK appear poised to draw a distinction from rules across the Channel. According to the Treasury, the UK’s Financial Services Markets law would ‘enable the creation of Financial Markets Infrastructure Sandboxes – allowing firms to test the use of new technologies and practices in financial markets’. Yet, the greatest impact may be the current race to replace Boris Johnson. Rishi Sunak – the former Exchequer noted above with a publicly open stance toward crypto – is the leading candidate to be Britain’s next Prime Minister. While we won’t know the new leader of the Conservative Party until September 5th, there is a substantive possibility the new government takes an actively pro-crypto stance.

 

Back across the Atlantic, a regulatory battle is brewing with strong interest-bargaining from both sides. Indeed, the US has a growing and formidable ‘pro-crypto’ lobby (evidenced by the growing size of the blockchain caucus, now with more than 30 members) that is finding a bi-partisan consensus. Senators Cynthia Loomis and Kirsten Gillibrand recently joined forces to propose sweeping crypto legislation, which would hand most oversight to the Commodity and Trading Futures Commission. On the other side, staunch opponents, such as Senator Elizabeth Warren, are pressing for a crackdown on the industry by regulators at the Treasury, EPA and Department of Energy.

 

Without question, the industry should embrace the coming regulatory fight head on, as the potential benefit from smart, efficient regulation focused on providing clarity and consumer protection would serve as a significant catalyst to adoption and growth.

 

No investors have a crystal ball, but at Blockchain Coinvestors we believe investors should take heed of Europe’s MiCA as the first swell in the coming wave of crypto regulation.

 

Thank you for reading,

 

Mitch Mechigian

Partner, Blockchain Coinvestors, London

ABOUT BLOCKCHAIN COINVESTORS

 

Launched in 2014, our goal is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and crypto projects. The strategy is now in its 9th year and has to date invested in more than 40 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of 400+ blockchain and crypto projects including approximately 60% of all blockchain unicorns. Our funds rank in the top decile amongst all funds in their respective categories on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in Grand Cayman, London, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.

FUND PERFORMANCE

 

Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 5.45x with an IRR of 79%. Fund II shows equally impressive early results with Net TVPI of 2.13x and an IRR of 106%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.

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. Our funds are open to investors that meet the Qualified Client definition with a minimum subscription level of $250,000 at the discretion of the Manager. 

 

  • Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 5.45x with an IRR of 79%. Fund II shows equally impressive early results with Net TVPI of 2.13x and an IRR of 106%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.

  • Blockchain Coinvestors Fund IV (Early Stage Token) provides direct access to promising private stage token projects accessing our relationships with many of the world’s leading blockchain investors. We leverage asymmetrical information from our 40+ VC Funds to pick the most attractive opportunities. This is a continuation of the direct token investing strategy of the Fund Manager that has included private stage investments in Acala, Filecoin, NEAR, Polkadot, Structure, and others.

  • Blockchain Coinvestors VI (Mid Stage Growth) provides direct exposure to the emerging category leaders in the blockchain and crypto ecosystem. The fund leverages our unique sustainable competitive advantage (USCA) in blockchain, web3, and fintech to create a concentrated portfolio of between 20 and 30 investments with attractive return profiles and visible paths to liquidity. The fund assesses the more than 400 blockchain and crypto projects in which we are direct and indirect investors and employs a robust investment framework to select investment opportunities into the leading mid stage growth rounds - typically Series B, C and D. This is a continuation of the mid stage investing strategy of the Fund Manager that has included investments in Bitwise, Brex, InfiniteWorld, Securitize, Uphold, Wyre, and others.

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@blockchaincoinvestors.com to learn more.

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 regular 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:

 

AMA with Blockchain Companies

- August 22nd, 7:00am PT
- August 22nd, 12:00pm PT

 

What is Blockchain-Based Gaming?

- September 12th, 11:00am PT

 

Options for Investing in Blockchain & Crypto
- September 19th, 7:00am PT
- September 19th, 12:00pm PT

 

Recordings of past webinars and calls can be found at www.blockchaincoinvestors.com/webinars.

RECENT PRESS

"The best way to invest in Blockchain businesses"

Matthew Le Merle