What is a blockchain-based bank?

​Simply by holding cryptocurrency in a wallet, one cannot expect to earn additional profits. It is difficult for cryptocurrencies without smart contracts (e.g Bitcoin) to generate additional profits. There are additional risks such as exchanges banning withdrawals, forced withdrawal limits etc. A cryptocurrency cannot serve as collateral, and there are taxation issues while liquidating the cryptocurrency assets to fiat currency. For miners, it is hard to utilize cryptocurrency for daily expenses.

​A blockchain-based bank can solve the aforementioned problems. An individual can deposit cryptocurrency and receive interest, use the cryptocurrency deposit as collateral for loans, and use such loans to increase liquidity or use leverage for other investments. The biggest advantage is that the lending process does not require the existing and rigid processes of credit assessment.

Because these blockchain-based banks are also companies, they can issue equity & bonds, or engage in financing activities such as deposits or wholesale funding. Among these methods, Initial-Coin-Offering (ICO) is a unique financing activity of blockchain-based banks.

What is an ICO?

ICO (Initial Coin Offering) is a method of raising funds through the use of cryptocurrencies. It refers to the act of passing ownership of the cryptocurrency to others in return for cash or other cryptocurrencies. ICOs are commonly compared to IPOs (Initial Public Offering) as developers can finance funds using tokens (equivalent of shares in IPO) issued in the future while investors can sell these tokens for profit. However, participating in an ICO means purchasing the tokens for use only, implying that there are no rights with regards to voting or ownership as seen in equities. In IPOs, the emphasis is on providing investors a portion of ownership in the company as securities rather than tokens which can be uncertain.

In September 2017 , ICOs were first banned in China, followed by Korea in the following month. The Korean government has stated the following as reasons for banning ICOs: increased scamming activity, increased speculation, investor protection among others. As ICOs have been categorized as illegal activities in theese markets, ICOs have no longer become a reliable financing source. Therefore, to initiate any form of ICO, a company must establish a legal entity in a foreign country, and make that entity a subsidiary or holdings of a Korean company to access its funds.

What is a venture capital?

Assuming that a blockchain-based bank can be categorized as a venture capital, we will have a look into the characteristics of a venture capital. A venture capital invests in small businesses that have the potential to succeed but cannot do so because of capital restrictions. A venture capital invests in these companies and realize profit when these companies grow in the future. Some notable Korean venture capitals are KTB Network, LB Investment, Gemini Investment, Dongyang Investment, Timewise Investment (formerly known as CJ Venture Capital).

​In many international markets, venture capitals have recognized the potential of blockchain, and related investments have been increasing. During 2018 Q4, venture capitalists have invested a total of $465 million across 10 different cases, a notable figure despite the cryptocurrency industry slump. In addition, many analysts are indicating an influx of venture capital funds to various Korean blockchain projects.

For example, blockchain projects have received series A (investments that amount from 1 billion KRW to 15 billion KRW) investment through ICOs during the period between 2017 and 2018. There were two instances in 2017, 7 instances in 2018, 13 instances until 2019 August. As you can see the numbers are growing steadily.

Terra is a Korean blockchain project that received investments from traditional venture capitals such as Kakao Ventures, Kakao Investment, Woori Capital, and Korea Investment Partners. Observing such trend, venture capitalists serve as important partners for startups in fundraising.

However, securing an investment is not an easy process. Just because a startup has a MVP (Minimum Viable Product) does not mean it can secure an investment. Even if it did, the startup would be required to submit periodic progress reports and acquire customers. These requirements can come across as a burden, leading to some startups refusing venture capital funds. Considering that blockchain-based banks need large amounts of funds to finance, venture capitals can be an important source to these banks.

Other financing methods

An alternative method for blockchain-based banks to raise capital is to receive entrepreneurship assistance from the government. The Korean government has allocated an all time high 1 trillion KRW in 2019 to assist startups, assisting more startups than ever. Here are three possible methods to receive such assistance.

​1. Institutions like Korean SMEs and Startups Agency, Korea Technology Finance Corporation, Korea Credit Guarantee Fund, and Regional Credit Guarantee Foundations provide long-term, low-interest loans to startups. 2. Entrepreneurship Assistance Funds such as KOSME and K-Startup programs provide funds to startups, in which the receiving startup is not obliged to repay the fund nor transfer ownership to the government. In fact, the institutions provide mentoring and support in securing investments. However, there is a high standard to receive the funds, implying that a well-prepared business plan must be in place. ​3. Blockchain technology is IT technology, meaning that it is eligible to receive technology development funding as part of the government’s R&D project. If the technology is deemed to be a success when completed, there is no need to repay the funds. Instead, the startup must provide a certain amount of royalty to the government. In addition, the government assists the startup by providing support & loan programs to transform the technology to a profit- generating business. However, if the technology is deemed to be a failure when completed, the startup must repay the funds that were given initially.

Financing for blockchain-based banks

So far we have talked about raising capital for blockchain-based banks that are not in place. How about those that are already operating? How did they manage to secure financing?

BlockFi is a US-based cryptocurrency ​lending platform. It has received funding from Galaxy Digital, Susquehanna, Akuna Capital, ConsenSys Ventures, and SoFi. Akuna Capital as the primary underwriter has contributed $4 million in the form of convertible debt with Galaxy Digital Ventures, Morgan Creek Digital, Susquehanna Government Products, and Devonshire Investors. In addition, Coinbase Ventures and Able Partners have contributed $4 million in the form of convertible notes. Convertible notes are commonly used in Silicon Valley in which the “conversion price” is decided in the future depending on the project’s success. Other than this flexibility, convertible notes are similar to convertible debt.

Nexo is a European cryptocurrency lending platform. It was founded by Credissimo, an online-based lending platform. Nexo is a case in which it conducted an ICO to raise $5 million, which was the pre-set hardcap amount. Another example is Celsius Network, which also raised $5 million.

Bixin is a Chinese cryptocurrency lending platform that has received series A investment from IDG Capital and series B investment from Shengyou Shidai.

One notable characteristic of these lending platforms is that they had a credible and reputable parent company to attract funding from other venture capitals.

​Yet this is only for a small number of projects, as most projects start with no parent company to back these projects. Therefore, even if these projects develop a robust business, they face many difficulties in attracting adoption. This means that such projects must secure investment from the founder’s capital, angel investors, government assistance to build the project initially, and seek venture capital investments when the business is more established. When these investments are in place, a project can utilize its unique technology and marketing initiatives to conduct reverse ICOs or IEO (Initial Exchange Offerings) to further utilize the project’s native cryptocurrency.