6 Blockchain-based Innovations…or Loopholes?
There is no shortage of innovation in the blockchain sector. Technological innovations were the starting points, led by developers. Now, we are seeing entrepreneurial innovations, led by creative entrepreneurs and financiers who are applying the technology in ways not thought of before.
In this post, I’m highlighting 6 applied innovations in blockchain or token models, many of which border on being loopholes that are currently flying under the regulatory radars.
1) Create Your Own Currency
Traditionally, only governments created sovereign currencies. With the blockchain, anyone can design a currency by giving it a special purpose. Using Ethereum, a developer can create a new currency (now called token) in a few lines of code. The good part is that this has fueled billions of capital to fund startups and projects who created trillions of tokens, but this has also simultaneously lowered the quality bar on what gets funded.
2) Say the Smart Contract Issued the Tokens
Since typical regulatory frameworks prohibit companies from raising money from the public without substantial disclosures and due filing processes, one loophole is to structure the public ICO such that- technically, it is the smart contract that is the issuing party. This means that token buyers aren’t sending their money to an entity, but rather to a piece of software that holds it, and returns the equivalent number of tokens. Regulators are still scratching their heads around how to subpoena or arrest a blockchain smart contract.
3) Foundation Controls the Tokens
A common practice is to create a non-profit “foundation” that actually administers the receipt and use of the tokens, but then commissions another entity to develop the technology. There could be a variety of relationships between the foundation and the developer entity, and sometimes the foundation is created before, and sometimes after the ICO. Foundations offer a layer of legal protection, but the fog hasn’t completely lifted on them, and there are no standards for foundation structuring.
4) Adopt a Virtual Jurisdiction
The virtuality of the online world is now taken to the legal level. Traditionally, companies are created within the jurisdictions they are typically conceived from. Of course, we’ve had Delaware-type entities and Cayman-based funds as the precedent for choosing remote jurisdictions. With the blockchain, the leading new alternative jurisdictions are Switzerland (Zug), Gibraltar, Malta, Cayman and a handful of others. All you need is a local lawyer in that jurisdiction to get this done.
5) Air Dropping, Not ICOing
As I’ve described in an earlier post (Utility vs. Security Tokens: Why Not Both?), companies are now air dropping tokens (e.g. 20% of total distribution), while keeping a significant percentage as reserves (e.g. 60-80%). Then, they wait until the token starts trading upwards (assuming there is some speculative hype or real usage that drive it). At that point, they start selling their reserve tokens into the public markets to fill their treasury. In essence, it’s like getting the effects of an ICO without raising money from anyone, and flying under the suspicious radars of regulators.
6) Trade-Driven Mining
This practice is being popularized by new exchanges (Binance, Huobi, KuCoin), and it is well described in this article by Mohamed Fouda (How Asian Exchanges And Investors Are Making Huge Profits Through Trade-Driven Mining). As the author explains, the exchange token is distributed to users based on their trading volume, in essence subsidizing the transaction fee. By distributing their native token, the exchanges also drive the demand and price up, and they make their profits from the token appreciation in the market. In addition, to further tighten the supply/demand equation (which drives the token price even more up), some of them (e.g. Binance, KuCoin) are buying back and burning a significant number of their tokens from up to 10-20% of their profits, each quarter. This is the most machiavellian scheme I have ever seen in this space.
In my opinion, all of the above schemes equate to legal, or financial engineering prowess, and are less about product innovation. You can implement any of the above and still fail if you haven’t been able to develop a real product with substantial traction.
In the case of the trade-driven mining example, the scheme looks like a perpetual bribe for usage, almost like loyalty points that appreciate in value, so it is very attractive to users. Luckily for these exchanges, they do have a product that works.
Generically, one could extrapolate that model into any usage-driven token reward for any product, blockchain or not. Wouldn’t be nice if Apple had given you a token for every product you bought from them, and let that token appreciate in relation to their stock price? If that was the case, you would have received a x22 bump on that token price since the first iPhone was introduced, 12 years ago. Even with a less extreme case of appreciation, let’s take United Airlines whose stock appreciated x3 in the past 5 years. Anyone would have loved a 3x bump on their MileagePlus points, no? If a new credible and safe airline appeared on the scene tomorrow, with a fly-based mining reward scheme that is linked to their token appreciation, I’m sure it will instantly get filled with travellers.
That said, the jury is still out on the longevity of these practices. Entrepreneurs are always 3 to 4 steps ahead of regulators.