Our London Correspondent Nick Ayton, the Sage of Shoreditch, explores the infighting at Tezos that reveals the ICOs structural challenges.

Some suggest the SEC might demand Tezos’ founders refund investors’ money...all $232 mln of it.

Apparently there are some deep seated personal and structural issues with how the token sale was structured, marketed and executed that will be a lesson for us all.

Why are being raised the suspicions that some investors allowed to exit with profits? How was the $150m valuation arrived at? What was Tim Draper’s role? Might investors have simply been misled and was there a role here for the hype and dumb people? And the big one, is the Tezos token really a security? And why was the token not registered with the SEC?

Tezos, a kick in the teeth for investors…

Tezos was intended to deliver a self-amending crypto ledger technology and improve on the Ethereum and Bitcoin networks, boosting security and trust. This is a bit rich given what appears to have been going on behind the scenes.

A quote from Tezos sale website will come as little comfort and a kick in the teeth for investors.

“Tezos was built on the belief that a deep commitment to security, formal verification and governance that gives stakeholders the power to make protocol decisions is the formula for earning trust and generating widespread adoption on the blockchain”

Earning trust, deep commitment, governance are very strong statements but clearly don’t apply to how investors may have been treated or the behaviour of the founders and their VC partners.

Red flags

Tezos is owned by DLS (Dynamic Ledger Solutions), which is in turn owned by husband and wife Arthur and Kathleen Breitman and venture capital partners.

It was later disclosed the VC was given a pre discount months before the ICO and then after the sale with 8.5% going the Mr and Mrs Breitman and billionaire Tim Draper.

The main sale happened in the summer of 2017 but pre deals were done as far back as September 2016 valuing the company at $6m without actually having an code ready to be released, barely in alpha.

And then as the ICO approached, Tezos was being valued at $150m - whereby Draper might have been exited his $6 mln investment in DLS and doubled his money.

Was Tim Draper cheating?

Isn’t it always the case that when a VC gets involved we should become suspicious as they are sure to tip the balance in their favour as the industry once again demonstrates that greed dictates their behaviours?

It is clear the strategy to use the Draper’s name helped launch the ICO, but what retail investors didn’t know was that he would not be investing for the long term and had a preferential deal.

Many questions remain unanswered and I am sure the SEC will be concerned primarily because investors may have thought they were investing alongside Mr Draper that will have influenced their decision to invest, when this was not the case...

Bad governance

Since the end of the ICO there has been a diversion of funds to various corporate structures and foundations. But the biggest issue is clearly the early profit taking for DLS and others ahead of retail investors, way before the venture has delivered anything substantial.

The most significant structural change is that Tezos’ IP is transferring to a Foundation structure but the founders will hold 10% of all tokens generated at ICO, with no doubt the bulk being BTC that has enjoyed a huge capital gain and essentially doubled their money.

One has to ask where was the lock-in for the founders and the commitment to deliver what was promised in the White Paper to retail investors? Is this a clear warning for future ICO token buyers (of app tokens) and investors (securities tokens)?

Why should Mr and Mrs Breitman and the VCs be rewarded before the Tezos proposition deliver on promises made - keeping in mind it has NO customers yet!

It is also worth remembering that Tezos would need to become a multi billion dollar corporation to be able to return the $232 mln plus a decent premium to investors. And there is an expectation the founders should reveal their full business plans to show investors how they intend to build the business and secure its value.

A long shot when Tezos is competing for airtime and there are several others Blockchains emerging that claims to do what Tezos promises…

Tezos token value engineered for the founders?

As it turns out, Tezos tokens most likely will not deliver for investors not only because it allowed profit taking via a deep discount pre sale but worst of all, because the token sale was uncapped.

Of course the biggest problem with uncapped token sales is you immediately limit the after or secondary market and that can hurt liquidity. If the Tezos sale was capped at $100 mln then technically the investors that comprise the $130 mln that missed out would seek to buy the tokens in the market which would help the Tezos tokens market value and therefore reward early retail investors.

It is also clear the tokenomics were designed to deliver for early investors and the founders but not for the crowd of investors that placed faith in the management team to build out a new technology and lock in the value.

Not investors, but people with money to spare

There was a vesting period for the husband and wife team but not as part of any formal Employment Contract, where there are expectations for delivery. Instead, the vesting period is merely programmed into a smart contract that releases 1/48th of their holding monthly over four years without regard for how well they do their job. Please keep in mind they still have no customers or working production systems!

The Brietmans clearly think very little of their investors. Should any refund include the full repayment of ETH plus any capital gains made from the recent rise in BTC and ETH? As it was clear investors handed over their BTC and ETH in good faith (thinking Tim Draper was alongside them) and they missed out on the recent rise in cryptocurrency values.

Hint of Ponzi

The Brietmans have made their money so why would they stick around to make good on the White Paper?

Now we find income from the ICO is being diverted into projects that are intended to prop up the original investment and generate returns for investors (and it seems more for the founders) - making it look like Tezos is also active and attractive.

Is it Ponzi Scheme or not? You decide..

Kathleen Brietman is also a former member of Bridgewater Associates, the world’s largest hedge fund and she is involved in the mechanics of DLS. And yet despite the funds raised there is little to show how the Tezos team have scaled their operations or the development efforts to get the tech to market to be used by real customers.

Book of ICO revelations, chapter 2

As an advocate of ICOs and Libertarian, I find the Tezos position very disappointing. We are all reminded that the greed of the few could ruin it for everyone. Even worse, VCs were involved, and they should know the rules and know better! In the case of Tezos, once again greed seems to have gotten the better of everyone, and retail investors were hung out to dry.

It is worth reminding everyone there are some founders who engineer an ICO to make money for themselves and not for investors, as the Tezos situation indicates.

What is surprising is that with lawyers, VC’s, hedge funds and a board of advisors in tow, the Tezos founders were nonetheless allowed to create a money making structure that would bleed retail investors, allowing early investors the opportunity to ‘flip’ and get out, taking profits from retail ICO money.

With several ICO projects raising $100 mln, $200 mln and more questions will be asked.

With so much money at stake, the warning signs for future investors are there. In short, beware chasing quick returns, trying to buy into the next big technology thing on the Blockchain.

Structural changes needed

The problems with Tezos highlights the need for structural changes to the ICO process, beyond merely declaring the token a security and making sure the jurisdictional laws are applied and existing banking and payment laws are not breached.

For many ICOs the single biggest problem is governance, or a lack of it, closely followed by clarity of how the founders’ feet will be held to the fire to ensure they deliver what was promised for investors.

There should be control of funds, and then we have the vesting period, both for founders and investors. When are they allowed to get out, and should all terms be ‘pari passu’ where all investors are treated the same?

Then there are the pre sales, pre ICO discounts that many now see as either a Ponzi structure that works against retail investors, creating an uneven playing field that will suit the bigger and institutional investors.

Now look, offering discounts, founders taking tokens and institutional investors getting involved or the odd big name is all fine, provided everything is disclosed upfront and the necessary controls and checks are put in place to protect retail investors and the value of the token.

Don’t make the same mistakes.