Recently, a Venture Capitalist named Stefano Bernardi took a closer look at the Filecoin ICO, an impressive looking project from Juan Benet of Protocol Labs. He and his team built a decentralized protocol that is going to act as a replacement to HTTP, making file storage faster, cheaper and quicker. You can research more about the project here.
Filecoin was designed to take advantage of this protocol and create decentralized storage for the masses. Stefano was excited for the project and decided to look into the how much the team was looking to raise.
After reviewing the fundraising structure, Stefano was quite shocked at what he found. This article just came out a few days ago and the terms have neither been confirmed nor denied by the Protocol Labs, but he found that Filecoin was positioned to raise $300 million and up to, I shit you not, $1.3 Billion.
You can read the article and review the flaws or concerns with this analysis here. While Stefano focused on the actual amount being raised, I am going to focus on Protocol Lab’s justification of said amount and give my own reasoning why >$100 million is being raised (spoiler: it’s more than greed).
Funding Argument #1: Filecoin is Ambitious and Needs The Capital
In response to questions about the ICO (not the specific article above), some people had doubts about raising over $100 million. One question was:
What benefit does a potential capital raising of >$100M bring to project development, especially when tokens are already retained by the team?
This seems like a reasonable question, given that $100 million is usually given to organizations that have (A) created a product, (B) launched it to the market and (C) have shown significant market growth. This team has shown they can create a product (or at least an alpha for a project), but have yet to show significant growth.
Highlight from Protocol Lab’s response:
But let me be very clear here: it will dramatically increase our odds of success to have significant amounts of capital backing us. We need to recruit excellent teams of people; we need to fund the development of dozens of software tools, products, and services; and we need to invest deeply in forming a strong ecosystem, so that we get strong allies making Filecoin great.
On some level, this is true, as one of the cardinal sins of building a startup is underestimating the amount of capital you need an running out of runway. The flaw in this logic is that they feel that in order to be successful, they need to raise at least $100 million, or over five times what the Ethereum ICO brought in back in 2014. Remember, Protocol Labs can raise whatever amount they desire, and they chose a structure that will conservatively raise >$100 million.
This reasoning would make much more sense if they were a closed system and had to build most of this software themselves. But Filecoin is an open source project and expects to have help from the community. The better way to phrase their statement is that they need to influence the development of dozens of tools, products and services, not build it themselves.
When building an open source product, part of the work is done by community contributors and development teams building their own software on the platform. In Ethereum’s case, most ‘Ethereum’ projects were not organized by the founders, but as a result of the work the Ethereum project did to build their platform. Filecoin, if successful, will be no different.
The industry has shown that launching a successful open source project does not require over >$1 billion or even >$100 million. The $52 million raised for Filecoin so far would be more than enough. Protocol Labs has been operating since 2014 with only one round of funding in 2016 for $3.5 million. With that, they were able to create the IPFS protocol, four other open source projects and a strong development community.
But what about companies like Uber or Snapchat, that consistently raise billions of dollars? If they needed that much funding, certainly Protocol Labs might need that amount as well, right? If they were more mature, yes, but today that’s not true. Generally speaking, when firms do raise $100 million dollars, it’s not necessary for the activities to get to market. Instead, it’s for the activities necessary to scaling an organization.
Andrew Chen wrote a great article about why Startups are getting cheaper to launch but more expensive to scale. He argues that it doesn’t take much money today to build a software product and launch to market. But because of the challenges in acquiring a large customer base, later and later funcding rounds are getting more expensive. Filecoin, as ambitious of a project as it is, simply isn’t there yet.
Funding Argument #2: Filecoin Can Only Be Funded Through One Round, So It Needs To Be Big
Another argument that was made:
Normally, startup companies have many rounds, at different prices, stretched out over time. In token sales, it is usual to have a single up-front fundraising event instead, with the requirement that the team better be able to finish everything they intend to do and launch a fully functioning network. Follow-on fundraising is not solidly figured out yet. Therefore, teams raise more to be safe, and this increasing pricing function helps us make sure we’re selling it more fairly, instead of selling it all at the lowest price regardless of what people think it’s worth.
We can boil this argument down to one statement: Protocols Labs only have one opportunity to raise funds for Filecoin, so they should raise all the money they will ever need now. Token sales (to date) only happen only once and once the tokens are gone, that’s it.
There’s two big gap in this logic: The first is that token raisers have already built in a safety measure to be able to raise more funds later. ICOs disperse most of their tokens to early investors during the fund raising event. However, it is standard practice to leave part of the tokens to the organizing team. Filecoin is no different. From FileCoin’s token sale page:
20% of the tokens generated from the FileCoin ICO are being retained by Protocol Labs (for profit company) and the Filecoin Foundation (non-profit organization). The reason for this is for the exact reason listed above: if the company needs to raise more funds in the future, they can sell their tokens. It’s not hard to imagine a way that they could sell 1-2% of their tokens at a separate event to raise funds for their next project or set of milestones.
However, this ignores the biggest flaw in FileCoin’s argument: Token Sales are not the only way to raise fund, but just one new way to do so. Raising VC through an equity sale is a 100% a viable option for this organization in the future. Protocol Labs has already raised $3 million using this method, so they are fully aware of how the process works.
An Alternative Theory to Why Filecoin is Raising >$100 Million
I want to focus more on that last point, because I think it’s the crux to why FileCoin and other decentralized application developers are opting to create >$100 million ICO events. I don’t think greed is a sufficient answer, as this team has clearly been dedicated to the industry for many years, built a solid community and wants to build even more. But >$100 million is overkill, especially since traditional funding for such a product would be available if they can show traction. So why do it if not greed?
I believe the answer lies in the risk in raising venture capital, risks that disappear entirely during a token sale.
Protocol Labs knows that raising Venture Capital is difficult and risky. Coming from Y Combinator, they would have seen their friends and colleagues go through grueling process of raising funds when their product is struggling. They’ve heard the stories of how founders have lost control of their organization and got ejected during hostile takeovers.
Raising investment capital is a very nasty business that requires kissing a hundred asses and getting a few yesses if you’re really lucky. Most founders are out of control of their destiny, largely because they need the money to survive and have to bend to the whim of those that fund them. For every 1 Facebook, there’s a 100 failed startups that struggled for every cent. This is a risk that every founder takes when giving up equity and raising VC funding.
And then the ICO appeared. Protocol Labs was fortunate to be specifically positioned to raise money in a time when ICO funding was hitting it’s zenith. Your company gets to create a new asset that is specifically not tied to the equity of your organization and raise hundreds of millions of dollars. You give up no control, are not accountable to your investors and can still sell your equity if you do find you need the money. It is as forgiving as Venture Capital is ruthless. And for decentralized protocol founders, it’s a godsend.
The New Fuck You Money
Fuck You Money is general discussed from the perspective of the individual. If someone writes me a check for $20 million, I have the right to say fuck you to whomever I want and do whatever projects I desire. ICO funding is Fuck You Money for a whole organization. If you raise >$100 million, you can say ‘fuck you’ to any and all investors, saving your equity and not giving up control.
This ICO is about giving Protocol Labs the funding and the ability to do whatever project they feel is in the best interest of their community and organization. From everything I’ve read, this is a good team with a strong vision. This money will give them the ability to control their company and lead a vision as they see fit, without interference.
There’s one major drawback here: extreme levels of funding in undelivered products create weak organizations and even weaker industries. Venture Capital is designed to get teams to work towards a goal and either produce a result or get out of a market. We want companies exposed to the harsh reality of the market because this method creates better products. Over funding creates companies similar to what existed during the dot com bubble, where products do not have to deliver and, as a result, do not get get delivered. This creates great crashes that take a long time to recover from.
Understand that raising Venture Capital is a shitty experience that often ends in entrepreneurs losing everything they’ve worked towards. But also understand that flipping power in the opposite direction, to giving ultimate power to the company and none to the investors, is just as perverse. It creates no incentive for the organization to create a real product, putting the investors and the industry in serious risk.
Filecoin will raise a lot of money today and maybe, hopefully, create something good. But it’s only a matter of time before some more egregious comes out of this madness. I would love to see Protocol Labs reconsider, take the $52 million they’ve raised so far and produce a great product.
But the allure of ‘Fuck You’ money is too tempting to pass up.