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From the Archives: "Dorm Room Fund's Investment in the Blockstack Token Offering"
A pragmatic pre-bubble articulation of the potential for blockchain technologies
The challenge of quickly understanding a broad array of new markets and technologies is one of the things I love most about being an early-stage investor. From time to time, I like to go back and read memos I’ve written on companies or markets to evaluate my ability to underwrite the future of markets as a means of calibrating instincts on investments today. One of my favorites is a 2017 piece I co-authored during business school as an investor at Dorm Room Fund about our participation in Blockstack’s (seeded by Union Square Ventures) Stacks Token offering. That Token returned (on paper) over 250,000x for a $100 investment. Though the market for crypto has cooled dramatically from the peak of 2021, the ability to quickly articulate a long-term view on a core technology and market is something the best early-stage investors are great at. I was fortunate to learn this from working with the amazing team at First Round Capital and my amazing colleagues and partners at Dorm Room Fund, who I still learn from to this day!
Enjoy this blast from the past :)
Dorm Room Fund’s Investment in Blockstack’s Token Offering1
University ecosystems hold one of the most powerful forces in the entrepreneurial community — a culture where students are encouraged to pursue their moonshot dreams and ideas, unafraid of the challenges and risks that may come about throughout their journeys.
Back in 2014, we discovered a duo of Princeton students who embodied this culture. Muneeb Ali (Princeton PhD ’17) and Ryan Shea (Princeton ’12) envisioned a future that they wanted to build, as they ventured off to create a decentralized internet called Blockstack.
Since our initial check of $20,000 in what was originally called “OneName”, the team has gone on to raise additional capital from investors like Y Combinator, Union Square Ventures, and AngelList CEO Naval Ravikant. They’ve garnered strong interest from blockchain developers around the world, and even launched a $25M Signature Fund to invest and support these same developers.
Today, we’re proud to continue supporting the same students we took a chance on 3 years ago through our participation in the Blockstack Token Offering.
As part of their next phase of development, the company issued its first Token — Stack — and afforded each existing investor (including DRF!) the ability to invest their pro-rata in the offering. Below is a redacted version of the internal DRF memo discussing our considerations for participation.
In the past 10+ years, we have seen network effects become the primary driver of tech companies’ sustainable competitive advantage, with the resultant economic rents accruing to a handful of large players in the space. A network or platform where increased usage results in users deriving a greater value from that network or platform creates a feedback loop where gains continue to accrue to players with the strongest network effects. This dynamic has created large tech companies that have virtual monopolies on the “oil” or “gold” of the modern market, e.g. ownership of “data” or “eyeballs.”
Blockchain technology represents a credible but nascent threat to the current paradigm in tech.
Using blockchain technology, companies can offer users monetary incentives in the form of “Tokens” to participate in various networks or ecosystems, potentially muting or diminishing the feedback loop that exists in the companies that rely on those network effects for competitive strength. These new blockchain-based networks are not controlled by a central authority and there is no single owner of any data or assets. Instead, ownership is distributed amongst network members, with proof of ownership evidenced by control of tokens or coins.
A great way to view the impact that blockchain networks seek to have on today’s network effects is to view how Facebook and Google play roles in our society. Emerging blockchain networks seek to disrupt Facebook’s social network by creating an infrastructure where more user posts and content make the platform more valuable for that user. With Google, imagine a system where users’ usage of Google search makes their PageRank algorithm stronger and thus drives more traffic to the site.
With blockchain technology and token incentives, companies have the ability to compensate users with tokens — exchangeable into fiat currency — for each post or contribution to a given network.
Evaluation of Blockstack Token Utility
The primary benefit of a decentralized protocol is its ability to democratize or offset the immense competitive power of network effects.
An infrastructure-layer player creating a new decentralized internet where users own their own data, and decentralized apps on the network run locally without remote servers.
An open source project with core developers and contributors located around the world.
A platform for developers to create consumer-facing apps through its decentralized browser add-on, where developers are allowed to use Blockstack’s tools (decentralized identity, storage, and payments) in creating these apps.
One of the fundamental tenets of the creation of this infrastructure layer is the need for unique “domain names” that will need to be owned on the Blockstack Network (the “Network”). As such, the primary utility of Blockstack Tokens, as contemplated in the Offering Documents, is the ability to exchange them for ownership of domain names on the Network.
Domain names on any network represent the real estate on that platform and have the potential to be very valuable as the Network grows. This value will accrue in the form of increased Blockstack Token value. In effect, distribution and ownership of domain names are a prerequisite to the construction of any internet-like asset, which is what Blockstack seeks to become.
Based on the stated use-case, we believe the Tokens have utility and that their issuance is warranted and non-speculative. As purchases of domain names become more active, we expect the value of the Investment to increase, representative of an increase in the value of the Network.
Tokens will not be transferable for a period of three years while the Blockstack team builds out the relevant utility and functionality for them to have utility in the Network. It is expected that the Network could take six months to two years to be fully functional, and the documents have qualifications that suggest the Network may never actually become active, rendering the Tokens worthless. Investing in a pre-product token sale has considerable risks as the tokens will not be immediately usable. The proceeds generated from this sale will be used to fund development of the Network, and any interim fluctuations in value of the Blockstack Tokens can be viewed as pure speculation given that their intended use-case is not yet active.
In addition to contractual risk, there remains considerable regulatory risk. Great uncertainty exists with regard to how the SEC and other similar regulatory bodies will ultimately choose to view ICOs (“Initial Coin Offerings”) and Token Sales, and whether they will qualify as securities ultimately subject to Securities Act registration. This represents a risk that cannot easily be underwritten for the purposes of this Investment. This Investment offering is restricted to only Accredited Investors as a Regulation D exempt offering, which mitigates this risk. However, it is contemplated that future Tokens could be issued to non-accredited investors and as such it is a risk we must highlight. It is unlikely that Blockstack would pursue that avenue if it were to trigger registration under the securities laws.
Given the nature of crypto assets, they are particularly vulnerable to cyber attacks. This could result in one of two outcomes: (i) a complete loss of value for the Tokens of an individual, or (ii) a hard fork that could significantly impair the value of the Investment or any assets acquired using the Blockstack Tokens. With respect to (ii) there is also risk in that the Tokens are convertible into Bitcoin, which compounds the risk of hard forks by adding a second blockchain into the equation prior to the ultimate conversion to USD.
The Blockstack Token will be convertible into Bitcoin. Since there is not a direct conversion into USD, we remain exposed to the price fluctuation risks of the Blockstack Token as well as price risks of Bitcoin. It is possible a decrease in the value of Bitcoin could offset otherwise meaningful returns to the Blockstack Token, in what we can define more commonly as “currency translation risk.”
This recommendation does not include a general overview of the blockchain and token ecosystems, but incorporates a review and evaluation of certain private individual opinions and publicly-available viewpoints and background, including but not limited to this, this, and this.