Tracer Drop Episode #03: Token Economy Fundraising

Token Economy Fundraising

Agenda

  • How can we understanding venture financing
  • What is a token anyway? (What is ‘dequity’)
  • What does it mean to fund a DAO? (Or be funded by one?)
  • The evolution of entrepreneurship in the cryptoeconomy

Australian Financial Review Article: UQ alumni raise $6m for DeFi derivatives system

PDF file: Australian Financial Review

Call Recording Link: here

Call Notes

Introduction

  • The Tracer DAO has raised US$4.5 million in finance for the creation of the Tracer ecosystem
  • This provides an interesting framework for the discussion of venture finance
  • Interestingly, the proposal put to the DAO described the process as a treasury diversification model - as in there is a large holding of Tracer tokens, why not diversify into US$
  • This episode of Tracer Drop discusses the strange boundaries of financing enterprises and innovation in the crypto space

Venture Financing

A brief history

  • Finance, debt finance and equity finance or the raising of capital is as old as history
  • The origins of fiance can be seen in the Silk Road era of trade finance - you see the arrival of trade across Eurasian continent
  • The principal issue in this era, where people undertook long voyages, either by land or sea, was who financed the cost of the voyage?
  • If the voyage is successful the operation is extremely profitable however there is a large degree of risk not only in buying the merchandise and transporting it, but undertaking the venture itself
  • Furthermore, the trader (the person transporting the goods/undertaking the act) also carries a large degree of risk
  • The person is also carrying the probability/likelihood that all the people that are paid along the way will succeed
  • Unless this risk can somehow be offloaded, there is simply going to be less trade
    • There will be less ships carrying cargo, less road built due to lower demand -the whole trade infrastructure is dependent upon the separation of finance
  • In many ways this was the beginning of the emergence of fiance - the separation of the trader (undertaking the venture) and the financier (paying for the venture), together they share the risk of the venture
  • Everyone is better off - not only those who are able to engage in trade, but also the provision of infrastructure means the optimal level/number of trade routes are built
    • It is important to note this aspect - the provisionary effect of finance to offload that risk doesn’t just affect individual buyers and sellers of the commodity, it lowers the cost of the entire economic infrastructure, creating incentives to build the capital infrastructure in the first place due to the effect of demand
  • This has flow on effects:
    • In order to keep track of promises made creating a need for commercial law, merchant law and contract law
    • Need a method to record that trade occurred, creating bills of trade or tokens of trade
  • This infrastructure/these specific institutions created to record and keep track of the separation of identifying risks that can be offloaded created the modern world
  • This is not capitalism, it predates capitalism - this is just trade
  • The point here is that the separation of finance is not a modern concept, it was there right at the very beginning and the first thing people did to enable the building of modern economies - way before capitalism
  • The separation of risk - separating those financing and undertaking the venture enabled the creation of the capital infrastructure for the venture

DAO financing

  • DAO financing is a new way of doing the same thing
  • There are now new opportunities to do things we have always done/wanted to do in new and better ways
  • Finance is about three things - money, time and risk
  • Here we are talking about new monies, new instruments and essentially new ways of looking after your money
  • One of the biggest problems in finance - when you are raising money, how do you stop the promoter’s problem?
    • The person who has raised the money - how do you stop them simply taking all the money and running away?
  • This is where governance becomes important - not only have we built these mechanisms for financing trade/opportunities, we have also built governance mechanisms
  • The latest in a long a line of mechanisms is the DAO
  • In a strict legal sense, a DAO could be considered as a partnership, however, it is much more than that
    • One of the biggest issues in a partnership is, how do you trust your partners?
  • This new social institution is built upon smart contracts and voting, creating a new governance mechanism and a new method of creating trust
  • When you have a new way of creating trust and doing something, you actually do a lot more of it
  • There is likely to be a lot more DAOs in the future managing foundations which more or less provide the public goods for an underlying dAPP or blockchain
  • Behind all the automation, people remain fundamental to DAOs - it is actually a people technology
  • It is allowing a more diverse and dispersed group of people with similar interests to come together to do things - one of which is trading
  • This links back to the question - how do we raise money; how do we diversify our foundations?
  • One of the great things about blockchain is we can bootstrap ourselves by minting new tokens that become valuable
  • You do not want to have only your own tokens - the question then becomes; how diversified should your foundations be?
  • Opinions will differ and there is currently much experimentation occurring in the space
    • Some will say diversify as much as possible - particularly from a central finance perspective
    • From a DeFi perspective however, diversify less and consider the transactions demand for money, precautionary demand for money and the speculative demand for money - as to how much of your non-native token you going to hold
    • Tracer sold 10% in their recent capital raise diversifying into USDT - this makes sense as you do not want to be selling your token every time you spend money
  • The trade off is - how much do raise now versus how much do you keep; this is integral as a foundation has to last forever

Dequity

  • The Tracer token is a DAO token/governance token - it does not have cash flow rights and is not a security
  • Investors gave USDT in order to receive Tracer tokens
  • These tokens can be considered as ‘dequity’ - a hybrid between debt and equity
  • This builds off the work of 2010 Nobel Prize winner, Oliver Williamson who did a lot of work around transaction costs; the way in which they inhibit trade and how they can be controlled
  • Williamson makes the argument that the natural financing tool of the economy is debt
  • Debt put simply - a person borrows money from you now, to be repaid at a later date plus interest’
  • Debt holders generally have no economic interest in your operations beyond the fact that they have lent you money - they have no voting rights and no control; there is no governance in this particular system
  • The polar opposite is equity - not only does a person now owe you money, but they have also sold off a portion of their future cash flows
  • You now have an economic interest in the business beyond the fact that you are owed money - in fact when you buy equity you are not owed money, if the business loses your money that is a risk you undertook
  • The risk profiles of debt and equity are very different
  • Importantly however, equity comes with a vote - permission is necessary for the running of the company
  • For a long time people thought that votes, and governance did not matter - however, if governance did not matter than the value of the share and that value of the debt would be the same; but shares are a lot more valuable than debt
  • Governance in and of itself is important
  • In Williamson’s 1988 paper he proposed a financial instrument called dequity which combined the best features of both debt and equity - when the state of nature indicated that the preferred option was equity, operated as equity, and vice versa when debt was the preferred option
  • Williamson said that whilst this is a nice argument it would never work as nobody would ever trust another person to determine when it should be debt or equity
  • Blockchain, as a technology industrialises trust - we can write smart contracts, we can indicate when debt or equity is preferable
  • Tokens shouldn’t be seen as either debt or equity - they should instead be thought of as this new financial instrument, dequity
  • Tokens are sometimes just a voting right; or a just cash flow right; or just a medium of exchange - these tokens perform a whole multitude of functions in the blockchain ecosystem that can be combined and redesigned
  • There are a whole array of things that can be done in the space because trust has been industrialised - counterparty risk and opportunism has been greatly reduced due to smart contracts
  • This means the scope for financial innovation has exploded

For more information about dequity you can read, Introduction to the Blockchain Economy by RMIT

Innovative Funding

  • These new innovative funding methods are essentially being used to fund innovative products - or innovative funding funding innovation
  • This raises questions - do these two things have to occur together; does this supercharge innovation; does this open up a new space?
  • Finance and innovation have been there from the beginning, among other things, built the modern world
  • In the 21st century, we tend to have a strange hang up in regards to industrial innovation and particularly regulation - we tend to see industrial innovation (chemical, car, mining, manufacturing industry etc.) as having particular shape/process
    • Venture finance and various forms of finance to raise capital is used for research and innovation which is then rolled out by the company into a marketplace - this is what we consider to be innovation
  • In terms of finance, no one wants innovation - this is the last place where anyone wants to see innovation which is inconsistent with history
  • Finance is a technology, of course there can be innovation in terms of financial technology - it is one of the oldest forms of innovation
  • Innovation in finance does not resemble the process of industrial innovation - instead as finance is so old, almost no idea is a new idea; all of the underlying mechanisms are already out there
  • Often, there is instead the combination of different financial mechanisms or applying a mechanism in a new area
  • The main barrier to financial innovation is permission - the ability to craft a mechanism that is within the set of permission granted
  • Great periods of financial innovation are often accompanied by periods of deregulation combined with new technologies that lower transaction costs, verification costs etc.
  • Right now blockchain is the perfect space where there is an incredible leap in institutional technology combined with an interesting space of regulatory opportunity
  • Dequity is neither debt nor equity, and it is not money - currently there is ambiguity which creates a huge opportunity because there are no constraints
  • The key point to take away from the dequity argument is that we are dealing with a new phenomena
  • This combination of an open space for experimentation of mechanisms and new technologies has implications for a golden age of financial innovation
  • This is Satoshi’s vision - he designed Bitcoin and blockchain technology as he saw traditional money as being overly repressed by governments
  • Excessive repression of finance and money leads to an explosion of creativity - you take an existing thing and you alter it to avoid excessive regulation and control, called regulatory arbitrage
  • Given Satoshi’s vision, the technology he created and the people currently working in this field, it is not surprising that we are going to see a massive explosion in innovation - interestingly this time, there may be simultaneously an explosion in new goods and services and new ways of financing
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