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On the Merge of Equity in Web3 and Other Investment Trends

People typically love a story of new ideas revolutionizing the old. As romanticizing as this may sound, the reality is that new ideas and platforms usually go through a transition period, which we refer to in this article as “the merge of equity, FT and NFT”.

1. Tradfi’s changing trend

Let’s start with the current financial model AKA “TradFi”, where the first stock exchange was established in Amsterdam in 1611 and regulations were corrected, updated, and reformed many times over the last four hundred years. The following graphs display an interesting aspect that TradFi is transforming into a newer trend wanting to have faster exits than ever, such as SPACs and direct listing unlike the regular IPO process. By looking at recent data there were 5.25 times more companies IPO-ed vs SPAC, and by 2020 there will be more SPACs than IPOs.

Source: Preqin.

The following graph displays that the value of SPAC transactions in 2021 was US$158 billion, an increase of 325% compared to US$37 billion in 2020. An increase of 1045% relative to the 5-year average.

Source: SPAC research.

Conclusion: As governments print more fiat money, it inflates the quantitative value. Like a chain reaction, it adds liquidity, resulting in higher volatility. This causes investors to be less patient and wanting to exit faster to ensure the profit that was generated. These actions are signs of a failing system, and it is about time to embrace a new era of investment tools.

2. The wild investment tool “token raise, aka ICO”

Meanwhile, when traditional finance experiences signs of failure, blockchain technology offers new fundraising and existing tools with its ERC20 standard represented as “token raise”. This is faster, more global, and can reach all institutions and individuals.

One example is Ethereum, which raised money with a token sale in July 2014, raising around 31,000 BTC, equal to approximately $18.3 million at the time. This was followed by a major global boom in 2017, nicknamed the “crazy ICO era”, which collectively raised around $2.3 billion within a few months, displaying the dynamics of these new generation inventions. Unfortunately, many of these projects were fraudulent, resulting in negative attention from regulators and reputation damage for the young industry.

  • The Boom of ICOs

This figure illustrates the growth rate (in percentage) of the amount raised in ICO campaigns. High growth rates were observed in the second half of 2017 and the first half of 2018, but not since then. This is due to a combination of market factors and stricter regulatory policies.

Source: Initial coin offerings (ICOs): market cycles and relationship with bitcoin and ether
  • Compliance of ICOs

Investing in the cryptocurrency industry has progressed in few stages: the initial retail wave of ICOs in 2017, then after 2018, KYC became standard, Reg S 506c for accredited investors / Reg D for Non US investors with Token Purchase Agreements (TPA) or Sale of Future Tokens (SAFTs) becoming the standard; followed by the institution-led trend in 2020. A significant difference between the two stages is the regulatory environment. The ICOs in 2017–2019 grew in an inadequately unregulated and unclear policy framework, leading to a retail-focused market with small investments. On the other hand, institutions were hesitant to invest during this stage. As regulatory policies became clearer by 2020, institutions entered the market and the investment environment became more professional. This raised the financing threshold for entrepreneurs, but good projects can still secure higher valuations and more significant investments.

Source: DeFiLlama.
  • Conclusion

As wild as token raising may seem, it would be absurd to ignore their existence as a strong tool for fundraising or exit / liquidity for investors. Traditional finance took centuries to develop, but with our current knowledge of its regulation, we can move faster by embracing a token fundraising regulatory framework.

3. NFTs as the next hot fundraising tool

Although fundraising with tokens have suffered from many regulatory issues, innovation in fundraising with blockchain technology has not halted. Non-fungible tokens (NFTs) are more than just JPEGs that act as social status symbols or memes. The first known “NFT”, Quantum, was created by Kevin McCoy and Anil Dash in May 2014. It consists of a video clip made by McCoy’s wife, Jennifer. The term “NFT” only achieved wider usage with the ERC-721 standard, first proposed in 2017 via the Ethereum GitHub, following the launch of various NFT projects that year. The standard coincided with the launch of several NFT projects, including Curio Cards and CryptoPunks. The 2017 online game CryptoKitties became profitable by selling tradable cat NFTs, and its success brought public attention to NFTs.

The NFT market saw rapid growth in 2020, with its value tripling to US$250 million. In 2021, a significant number of brands, licenses, and celebrities have bought and promoted NFTs. Many large-scale projects and partnerships have been announced. For instance, Nike purchased the virtual wearable studio RTFKT, and Coca-Cola constructed a building in Decentraland.

Source: Dune.
Source: Dune

Since November 2021, weekly traders are expected to remain above 15k, demonstrating that NFTs already retain a significant following.

Although the NFT boom occurred a couple of years after ICOs, it is more widely accepted in global regulations and often regarded as a form of digital art. One of the key aspects regulators focus on for NFTs is anti-money laundering, and financial-related issues continue to be the main focus of current policies. Unlike ICOs, NFTs are a digital art that is recognized as an asset by regulators in many countries.Purchasing an early asset of a project to support its growth in return for future benefits, is similar to the fundraising done on Kickstarter. NFT fundraising platforms have shown positive growth, again similar to Kickstarter.

Source: icopartners.com.

Conclusion: During the NFT boom in 2021, many projects collected funds by selling JPEG file NFTs on chain. While this may sound bizarre to some, it did provide financial support for teams at the beginning of their startup journey. Therefore, the usage of this tool must not be neglected, but rather embraced with proper understanding and management of the funds.

4. The Merge — Web3 raising tools

As mentioned above, equity, token or NFT sales are ways for a community or a project to gather funds to start a business.

The fundamental question becomes: which format is best for your start-up? Or what are the best sequences to raise funds among these various tools?

The following shows examples of project type for each format:

  • Equity Only: The business model is rather traditional, possibly from the Web1 or Web2 era, or even older, with very little or almost no digitalization and barely any consumer-facing services. Or it may operate in heavily regulated financial sectors that require licenses. In these cases, unfortunately, firms will have to be patient with regulators to fully understand the new financing world and adapt changes to allow other forms of capital injection beyond just equity raises.
  • Token Only: Typically, tokens are classified by a few categories: security, utility, payment or DAO tokens, each of them may have a different raising structure:
  • Security token/ STO: This is similar to equity, and requires the firm to be fully compliant with local regulations and work with platforms that are licensed to provide these services.
  • Payment token / Stablecoins: This token format is highly regulated and must be compliant with regulators, just like security tokens. However, it is unusual to see this mechanism used as a fundraising tool, as all tokens must be backed by an asset.
  • Utility token: The most popular format since the 2017 ICO boom is still very early in its regulation. Therefore, it is necessary to consult with a lawyer to understand legal requirements.
  • DAO / Gov token: A membership voting token became mainstream during the DeFi Summer of 2020. This token is similar to a utility token and should also be met with legal consultation from law firms.
  • NFT only: This is for teams that want to raise funds by selling NFTs that have further value besides just being a JPEG on the chain. The following are some scenarios for teams to implement into their product map:
  • NFTs as membership passes into chats, products, or social recognition as community building tools.
  • NFTs as out-of-product assets, such as for gaming, metaverses, future data ownership, or others.
  • NFTs as utility pre-sales. Dynamic NFT tools can provide a countdown of usage.

All three options mentioned above are possible and already exist in the market. However, we propose that the new future of web 3 fundraising is not merely a choice between these three options, but rather a combination of them, as shown below.

  • Equity + Token: This model is suitable for projects that utilize blockchain tokens within their product roadmap and can use tokens as a go-to-market strategy to quickly bootstrap the user base and strengthen the community network. Such projects are also seeking long-term VC supporters with a fixed token warrant ratio within the token matrix. This model may also provide other upsides in the future, such as an IPO whenever the traditional market is ready for the new adaptation. However, for firms that have revenue, it is important to be clear with equity investors about where the cash benefits will go, whether dividends or a token repurchase plan.
  • Equity + NFT: This model is ideal for projects that require many NFTs in product roadmaps, but do not necessarily need tokens. For example, it is useful for many tooling middleware projects or analytical sites that have a hard time proving the necessity of utility or DAO tokens. Managing this model with NFT’s is also easier than managing tokens, as tokens are more liquid and require listings, complex market making, and so on. This model is especially useful for gaming and metaverse pre-sales, where the team can build a community and supporters without being diluted with a proper NFT-matrix set with different vesting schedules. Furthermore, as long as the NFTs are considered to be digital art or product pre-sales, there are very few legal restrictions, making this the preferred strategy.
  • Token + NFT: Suitable for gaming or projects that can spearhead internal tokenomics, and use NFT as assets within game or project scenarios. To do this successfully, teams must be highly knowledgeable about Web3 and ensure that there are enough scenarios within the project to support both funding tools.
  • Equity + Token + NFT: This is by far the most complex fundraising format among all options. The clear upside of this mechanism is that it allows projects to raise funds from traditional VCs, crypto funds, and NFT funds. More funding provides longer lifespans and less dilution allows projects to have more control. While this fundraising model is interesting, it faces many challenges within its product design to allow for reasonable token usage and NFT-needed product tooling. We believe that a savvy Web3 investor can add value by co-designing the space.

Some projects allow participants to tokenize NFTs or NFT-lize tokens (like shareholder certificates in TradFi). This way, startups can play around with different combinations of the methods above. Besides understanding the mentioned concepts of fund-raising tools, it is also very important to design its priorities dependent on the product design or market scenario, such as bull market or bear market approach:

1)Bull market strategy:

In a bull market, where general liquidity is high and it is worthwhile to capture market premium, it is recommended to start with a token raise. This can be followed by NFT sales, and if additional capital is needed, another equity round can be pursued.

2)Bear market strategy:

The bear market has the opposite effect on market capital liquidity. Therefore, projects should seek long-term support via equity raises first. After that, they can consider NFT pre-sales before product launches. If the market is heading into a bull run and tokens are needed, the project can then do another token raise.

5. Conclusion

As a TradFi person, I have been lucky enough to experience both the ICO and NFT booms in the past years. As a team, we are excited to see how the industry is constantly moving forward with new ideas and innovations throughout each bear and bull cycle. It has become our responsibility to share our thoughts and observations with the community so that we can all be prepared for new trends after the “merger” of traditional finance and innovations in the Web3 space. As always, we encourage founders, projects, and communities to continue building. We are all motivated to see that innovation never sleeps, so let’s embrace it moving forward.

About the author: Czhang Lin is a member of the board of directors LBanks Labs. Labs is the venture capitalist and blockchain accelerator arm of global cryptocurrency exchange LBank.

Read more: https://lbank-exchange.medium.com/on-the-merge-of-equity-in-web3-and-other-investment-trends-a59fb2e27549

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