Some thoughts on Blockchain Capital’s token sale

In the future, all assets will be tokenized on a blockchain. I absolutely believe that can be the future, but…

The Groucho Marx problem

“I don’t want to belong to any club that will accept me as a member.” - Groucho Marx

I don’t want to put money into any private equity fund that will take my money.



Much of the excess returns that accrue to private equity come from the top funds. Those top funds don’t need to raise money from little guys. Why bother with a token sale when you can go get $100 million from CalPERS and TRS?

There’s absolutely a chicken and egg problem here. It’s likely that securities become tokens, but for now it’s unlikely that the funds likely to produce excess returns want to do a token sale.

[Financegeek note: part of the excess return in private equity is due to the lack of liquidity. If tokens improve liquidity, then we should expect the liquidity premium to go away and thus expected PE returns should be lower than historical averages. This depends on how much of the liquidity premium accrues from the illiquidity of the underlying assets vs the illiquidity of the VC fund.]

With that in mind, I had a chance to read the Blockchain Capital document today and wanted to offer some thoughts.







Bear case:

1. Didn’t crush it in the first two funds.



This is especially true when you realize that in this space they would have had magnitudes higher return from just buying Ether or Bitcoin.



Even a relatively naive spray and pray in crypto – buy a fixed amount of every project that passes basic due diligence – would’ve produced better results.

In general, I would not invest in a VC fund with such low visibility into their previous funds. I was very disappointed in the lack of transparency about performance. You have to trust their NAV. They don’t even break out the difference between realized gains and unrealized gains. For example, I’d like to know how much of their return is due to Coinbase’s valuation.

Also, they don’t mention the size of the previous funds , nor the fee structure for those funds . Those are relevant when comparing their returns to funds from the same year. [UPDATE: A Blockchain representative says that they have said that the fee structure is the same as the first two funds, and also that AuM was disclosed in the doc. That’s true ($30m under management) - but I’d like to know the size of each fund, as well as whether all investors paid 2.5% management fee plus 25% of the gains. I will update this post accordingly when I hear.]



Furthermore, the rates of return indicated are gross, not net. So investors in the previous funds actually receive a significantly smaller return than what is indicated, once Blockchain’s fees are deducted. It’s disappointing to me that they only listed the gross returns, because the only thing that matters is the net returns.







2. They aren’t believers in tokens.

I’m not excited about their thesis - they wrote their terms to allow token sales but the document makes clear that it is not a focus.



Part of the reason for their relatively low returns is that they didn’t invest in tokens or crypto. I get it - it’s very hard to raise money to do that. But at the same time, it didn’t happen, so it’s hard for me to give them credit for seeing just how much they should’ve pushed to get into tokens.

If they didn’t see the last big trend in this space, how can I feel confident they’ll see the next one?





3. High fees.



The trend on fees has probably been downward, except for the top tier. These are relatively high fees for (so far) non-top tier returns.



In general, my take on the terms was that it seemed like terms that a fund would start LP negotiations, but eventually the terms would become more investor friendly. Perhaps Blockchain will prove me wrong by raising the rest of the fund with exactly these terms. I’m skeptical, however.



Plus, at the risk of being repetitive, they gave gross returns for previous returns, but still haven’t told us what the actual returns for investors have been.







Bull case:

1. Followon rights in Coinbase, String, and Parity/Ethcore, as well as a few others.



VC is a hits business. It’s the seed rounds that produce the absurd IRR, but since you get to put more money in later rounds, so the dollar-weighted rate of return can actually be bigger.

If you think that Brian Armstrong is a great recruiter of talent and is well positioned to make Coinbase magnitudes bigger (I think he might!), then you might buy just to get some exposure to Coinbase. Likewise for String/Parity – though presumably much of those returns will come from tokens, and you could just buy those tokens yourself in the next few months.

It’s worth noting that follow on rights are only useful if Coinbase, String, Parity, etc actually raise more rounds. You don’t get a piece of Blockchain’s existing investments by investing in this fund.





2. SEC regulation/lawsuits eliminate token sales for US, thus more US based companies use VC



You can imagine a future where the SEC cracks down on token sales at the behest of the rich and politically connected. Thus, some US projects might choose VC rounds over token sales. In practice, SEC action would probably lead to even more companies fleeing the US and would just serve to further disadvantage Americans.

Even so, if this happens, this would likely boost the returns to this fund.







3. Token market never takes off.

I put this one last, because in my view it is already taking off, though that momentum could end and the future is hard to predict.

Blockchain Capital is one of the preeminent VC firms in the space. Therefore if blockchains takes off but token sales don’t, then this token should do well. In general, I tend to believe that if blockchains take off then token sales will also take off, particularly because token sales are taking off already before blockchain apps.

However, you could also imagine scenarios (such as SEC action) where token sales fizzle out, but blockchains remain strong.





Concluding thought



This is only a token sale for non-US markets. As the sale is limited to under 100 US accredited investors, I don’t think I’d have any chance to buy their tokens even if I wanted to. So I have no skin in the game here. As always, caveat emptor.







Disclaimer: None of this is financial advice, I’m not recommending that you do anything. If you want investment advice you should do more than just read a blog. I know nothing of your portfolio needs, etc.





Thanks to Alex Felix from Coinfund for some critical comments on a draft on this post.

