Guide to Startups on Blockchain: Funding, Team and Ideation

Peter Borovykh is a blockchain expert and solution architect at BlockchainDriven.com and is currently working on his book Blockchain Applications In Finance. It will be out this Summer.

I had the opportunity to attend the Ethereal Summit 2017 where the lid was opened on a swarm of ideas, concepts, and directions for startups (and larger enterprises) on building out and integrating on blockchain. Key speakers included Joe Lubin the founder of Consensys, Zach Lebeau CEO at SingularSTV, Rachel Haot Chief Digital Officer of New York City, Vinay Gupta Blockchain Thought Leader, and more.

Articles such as The Blockchain Will Do to the Financial System What the Internet Did to Media by Harvard Business Review and After Internet, It’s Blockchain Internet 2.0 by Entrepreneur.com both pinpoint that blockchain can revolutionize the world. Whether you do blockchain or not, it is certainly part of the startup environment, so here I’ll paint some parallels to help future companies navigate this rising landscape.

Bill Gross, the founder of a tech startup incubator Idealab, conducted a profound study on more than 200 companies to analyze the key elements that matter the most for startup success. He went on to examine the following five factors: idea, team, business model, funding, and timing. His research revealed that timing was the most important predictor for success of a startup, while funding was the least significant.

The Ethereal Summit 2017 that took place on May 19 in Brooklyn, New York featured many interesting views and discussions regarding the future of blockchain technology as well as its various applications. What’s even more staggering is that speakers and panelists at the summit pinpointed all of the five factors analyzed by Bill Gross. Blockchain technology has all the necessary elements to truly dominate, especially in the startup landscape.

1.  BLOCKCHAIN CONCEPT & IDEA

The most basic definition of blockhcain is this: blockchain is a distributed ledger. To make it even easier we can say that blockchain is a shared database; nothing else, nothing more. What can be so special about a shared database?

Of course this technology has a lot of merits useful to both individuals and enterprises explaining its vast and growing popularity. In his closing speech at the Ethereal Summit 2017, Joe Lubin, the CEO of ConsenSys and co-founder of Ethereum, mentioned some of the fundamental functions of blockchain including “secure and trustworthy infrastructure”, “peer-to-peer context”, and virtually automatic and guaranteed trust amongst the counterparties.

For example, he described the Ethereum blockchain as “fully publicly and permissionlessly accessible from anywhere in the world”, “fully programmable”, “configureably private”, veridical, and  “confidential or transparent when appropriate” with non-repudiable entries.

The real vision behind blockchain technology could be summarized by Lubin’s inspirational closing “Welcome to the decentralized future”.

It takes some time to realize how great the idea of decentralization really is. Lubin goes on listing “financial, economic, education, governance, energy and so many other systems” that could all take advantage of blockchain.

But can decentralization ever become a reality given a highly centralized mentality of today’s world? Let’s look at successful examples of decentralized decision-making that has already taken place.

According to the research conducted by Gollman, Hagmann, and Miller published under the title Polya’s bees: A model of decentralized decision-making, a variety of natural systems such as colonies of ants and bees “make decentralized decisions using common processes involving information search with positive feedback and consensus choice through quorum sensing”.

This work also concludes that neurons in the human brain utilize decentralized decision mechanisms that “engineers of social and artificial systems could imitate”. In the first volume of his series The Source of Social Power, Michael Mann emphasizes that decentralized trading structure of Phoenicians and Greeks contributed to breakthroughs in literacy and coinage (as ironic as it sounds).

The idea of decentralization is more real than we think. Many retail and institutional investors truly believe in this concept and back up their beliefs by investing significant amounts of capital, but we will talk more about this later in the article.

2.   TEAM IS YOUR CORE

According to Bill Gross’ study, the team was the second most important factor predicting whether a startup will succeed or fail. Once the idea is conceptualized, it needs to be implemented. Strong teams of research & development, operations, and marketing are key elements that help in bringing the project from idea stage to market.

The beautiful thing about blockchain is the great amount of teamwork across the board. At the Ethereal Summit Joe Lubin fairly emphasized that Ethereum blockchain “supports collaboration as a first-class principal”. And it is really true.

Blockchain is an open-source, meaning it can be shared or edited by anyone. It also means that blockchain may be developed further in a collaborative public manner by anybody interested to move the humanity closer to the state of decentralization. Thus, the research and development can be conducted by a mutual effort of an extensive community of a given blockchain system. Such communities usually consist of scientists, programmers, and engineers from all over the world, representing the smarter layer of our society.

The operations team is also set up in a very interesting fashion. One of the most important characteristics of blockchain is its ability to verify transactions. It is possible to identify three parties to every transaction recorded in the shared database: the sender, the receiver, and the validator or miner. To be more specific, every transaction is validated by the entire distributed network of miners whose job is to confirm these transactions and write them into a shared database. These miners are the ones that technically represent the operations team, which is totally decentralized and collaborative.

Finally, what about the marketing team? How the blockchain system can market itself? Brad Burnham, the managing partner at Union Square Ventures, said it best at the Open Source Entrepreneurship panel. Blockchain completely evolved the profile of an entrepreneur who is looking to receive funding or promote the product or service. With blockchain entrepreneurs have a key “ability to build community around ([the]) asset and to communicate broadly to a very large audience of developers who are adding value to ([the]) asset.” Communities become a closed circle of early innovators and early adopters who will market the product or service to a larger audience in a decentralized manner.

What’s so special about blockchain is that it encourages its community to conduct all kinds of responsibilities in order to build something everybody in the community would love to have. And this is where the true magic of team-work really shines.

3.   BUSINESS MODEL ON BLOCKCHAIN

The genius of the blockchain structure is the realization that people must be compensated for their work. Yes, blockchain heavily depends on the network. However, the network is compensated for its participation. Of course, business models of two different blockchain systems might be completely different. But the original model was based on compensation of miners by tokens that later could be used in certain types of transactions. Higher acceptance of a given blockchain system led to organic growth of outside services that would be accepting tokens.

Such radical approach makes blockchain very unique. Traditional businesses are rather centralized with revenues flowing back to the local headquarters. The management team decides how and where the resulting profits will be allocated. The goodness of a company is often judged by its financial health, which could be easily seen from a number of financial statements. In case of blockchain, the centralized authority does not exist. Revenues can flow to miner A or to miner B, both of whom offer their computational powers in return of tokens. But what stands behind the value of a token?

Blockchain solves many problems that could be very beneficial to the outside counterparties. Outside counterparties flow in their real financial capital to acquire tokens in order to take advantage of the blockchain’s architecture. System receives more outside capital, which naturally drives up the price of tokens. As the price keeps surging more miners join the blockchain, making the entire system even more reliable and trustworthy. This level of self-sustainability is one of the most elegant combinations of technological and socio-economic factors that make blockchain systems so ingenious.

Bill Gross mentions that many startups lack a business model at first and develop it only after they saw a clear demand from customers. Blockchain is still in its early phase, and the community is yet to develop innovative and unorthodox business models the world has never seen.

4.   FUNDING: TO ICO OR NOT TO ICO?

While the human kind is still at the fork in the road regarding the future course of decentralization, both retail and institutional investors heavily invest in the blockchain space backing their dreams, vision, or curiosity with tons of cash. According to Laura Shin’s article in Forbes magazine, the total value of initial coin offerings (ICOs) has reached $380 million. Keep in mind that this number is likely to be much higher due to significant gains in the price of cryptocurrencies with Bitcoin, Litecoin, and Ethereum surging by around 30%, 10%, and 100% respectively since Shin’s publication on May 16, 2017.

ICO is the initial coin offering that allows many blockchain startups to raise capital from both retail and institutional investors. Brad Burnham further explains that “crypto assets or crypto tokens are inherently public [on] day one.” This great feature of almost instant monetization given the product or service is highly valued by the customer could induce startups to solve more complex, intricate and customizable problems, not obvious to VCs and other institutional investors.

Aside from ICOs available even to retail investors, the total amount of institutional capital invested exceeded $500 million based on the data provided by CBInsights. Institutional investors see great potential in the blockchain technology, investing in the idea of a decentralized future.

One of the main issues of financially backing the blockchain startups and projects lies in high volatility of tokens. While the general trend in cryptocurrencies has been bullish for quite some time, the entire blockchain space is still at its infancy stage. Large price swings accompanied by high levels of intra-day volatility drive the inflow of retail investors simultaneously discouraging some of the largest institutional players to even consider the possibility of implementing or investing in token-based blockchains.

In his talk Early Adopter: How I Became a Blockchain Investor at the Ethereal Summit, the billionaire Mike Novogratz pointed out that “price move [of Ethereum] has grown faster than the community has grown up”, and it will take some time to fill the gap. A more massive and flexible crowdfunding technique suggested by the blockchain technology can work both ways. Temporary times of enormous volatility and mind blowing crashes, similar to the 2001 dotcom crash, are not to be overlooked.

5.   TIMING IS EVERYTHING

We finally got to the most important aspect predicting whether a startup conquers the world or fails miserably – the timing. The reason why I really enjoyed Ethereal Summit is because many speakers were cognizant about the aspect of timing and made very good cases explaining why the right timing for blockchain is now.

Andrew Parker, a General Partner at Spark, made a great analogy related to “why did YouTube work when there were dozens of properties before that looked a lot like YouTube.” The secret sauce behind YouTube’s success lies in the fact that “a group of enabling technologies, secondary technologies, (…) all converged” around the time YouTube was launched. In case of YouTube, the four factors included flash popularization in the browser, MySpace distribution, cameras getting video load just at the right time, and high-speed bandwidth penetration.

Panelists of another very interesting panel A Global Marketplace: The Next Frontier in Financial Inclusion spoke about how blockchain has all the potential to be integrated in lives of 2.5 billion of unbanked individuals all over the world. These 2.5 billion people represent a huge cluster of new internet users and new world consumers.

A member of a panel, Sam Cassatt from ConsenSys, mentioned that there are two major trends responsible for such high level of excitement behind blockchain and Ethereum, in particular. First of all, the maintenance and the advancement of blockchain are conducted by a global community. If an emerging economy “could not afford to have an infrastructure, the world will provide it for them.” Secondly, more people are coming online, “there is higher smartphone penetration” and “within a few years the cheapest smartphone ([cost]) $10.” Cassatt goes further to say that it is the confluence of these trends that is really making people excited about the space.

On top of aforementioned trends, higher computational powers, thirst for faster payment verification and transfer, rise of social entrepreneurship, and tight regulations forcing financial institutions to optimize costs are the drivers behind popularization of blockchain and distributed ledger technologies (DLT). Federal Reserve Bank, FINRA, and SEC already started discussions on DLT integration and regulatory implications. The world is evolving towards decentralization. Join the move! If you have any questions visit me at Blockchain Driven.

For more on blockchain see Silicon.nyc’s Exclusive Interview with Joe Lubin, CEO of Consensys and Co-founder of Ethereum.

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Peter Borovykh

Blockchain Solution Architect

Peter has made his name in the traditional financial background and later became fascinated with digital applications of blockchain in finance. He is a quant who has created his own groundbreaking algorithmic trading strategy based on quantifying the market sentiment and leveraging the emotion of market participants. He set out to illuminate that part of the finance industry. He is currently finishing his book “Blockchain Applications in Finance”.