< Is the next step an ICO for infrastructure (and trips to Mars)?

I started working in fintech at Credit Suisse in 2000. I had (some) technology experience, but zero in finance. My manager at the time gave me a textbook on the principles of banking to get me up to speed1. The book was dry but comprehensive. And it was my first realization of how elastic money was2.

I've been trying to explain the current Initial Coin Offer "ICO" phenomenon to friends. And trying to understanding it myself. Language from that textbook features. Futures come up a lot. The idea you can buy a share of a future crop of Orange Juice, or Pork Bellies3. As does Crowdsourcing. As does the book Sapiens, which explores the cognitive revolution that allowed "shared myths" like money.

An anchor in the textbook is the concept of a Financial Intermediary. It's a lot of things, but some of the obvious ones are banks and their "non-bank" kin. (Layers and layers of) Intermediaries manage financial transactions from deposits and loans through to IPOs. They provide a series of benefits to each side of the transaction and take their cut in return.

Which is where ICOs come in. The current wave of ICOs are special because they (currently4) cut-out most of those intermediaries.

So, what exactly is Pontage?

One of the other key words in that old textbook was "disintermediation". It's a broad term, but in this context it means removing or bypassing the financial intermediaries. Disintermediation in simple term is the "removal of the middleman."

Skipping retail stores and selling directly to consumers is one example of disintermediation. Dell did this in the 80s and 90s with their custom-build PCs. ICOs are doing it today with these financial intermediaries.

One of the repeated textbook cases in favor of intermediaries was large capital projects. The intermediary pools the money necessary to spend on long-term pieces of infrastructure. It takes thousands of deposits to build a bridge. Take the construction of the Golden Gate Bridge by an issue of bonds. It cost $27 Million, $1.5 Billion in 2012 dollars5. A remarkable feat.

So when I thought back to ICOs, I thought of that textbook and the examples around infrastructure.

Back in medieval times, execution on these large projects was difficult. Governments were either not interested or centralized enough to maintain roads and bridges. Infrastructure needs often fell to Landowners, Lords, Monasteries and the like.

Pontage was one form of this. Pontage is a levy on bridges for their construction and maintenance. It's one of the medieval precursors of toll roads today. Take a Monastery that runs a market. They could have built a bridge enabling the market to become bigger. They can then use a toll to pay for construction and make more money from the market.

Pontage extends into the modern day. ICOs can raise money for infrastructure and create a market for demand in advance of construction. A specific example would be a Hyperloop between San Francisco and Los Angeles.

In this case, the ICO is some token used to buy tickets when the service is online. Although the token wouldn't exactly be a literal ticket, it would be a share of capacity. That's potential riders over some period. Original and newly minted tokens need to relate to this capacity.

This token supply dynamic is a fundamental property of an ICO6. It can be easily overlooked and is likely to be a major topic as more ICOs move into the build phase.

For now we can take the concept as read. You're buying some representative share of capacity between San Francisco and Los Angeles. I could buy tokens because I want to use it myself. In this way, it's a little like crowdsourcing.

Alternatively, I'm betting that high-speed rail opens up new economic opportunities along the rail corridor7. This expansion drives up demand for the token. In this way, it's little like a future. Or I am convinced of the technical merits and future growth potential. In this way, it has the "flavor" of an IPO.

However you shoehorn into traditional financial concepts, ultimately I'm buying into the idea. This is either something I would use or I can see the demand.

The great thing is that government can still get involved8. It can buy into the ICOs. Government involvement improves confidence in the token and pushes the project forward. Venture Capitalists jumping in existing ICOs has a similar effect. At it's core, it's validation. It's also good for the market to know someone with deep(ish) pockets is financially invested in success. They are somewhat underwriting the ICO. In this way, you can have a hybrid form of financing.

Why not just use Money?

It's easy to look on ICOs as the Wild West of financing at the moment. There is certainly that aspect, and it's likely to be a wild ride for some time yet. However, the quasi-unregulated nature of ICOs is just one aspect. Using money requires the use of intermediaries, and that introduces other side-effects.

Intermediaries bring some economies of scale, but also overheads. Technology like ICOs have the potential to route around some of these costs and barriers. ICOs connect consumers directly with a market. Along with the inherent risks, it has the potential to make things happen quicker, cheaper and with a high efficiency of demand.

Intermediaries provide a lot of value. Investopedia lists safety, liquidity, and economies of scale to name a few. Safety comes up often in the case of ICOs. Are the issuers going to fold or take off with the money? Regulation is often seen as red-tape. This is undoubtedly true in a lot of cases, but a lot of rules have been engineered to protect consumers. Some don't work, but many do.

Here is the trick about disintermediation. Where Intermediaries are less-optimal is demand. Especially when you have multiple, complex layers of them; and this is common. Every time you insert another middleman, you lose a bit of fidelity on the market. Think of it as a farmer, who sells to a distributor, who sells to a wholesaler, who sells to a retailer, who sends to an end consumer. While this aggregation can bring scale, it's very tough to be nimble to changing demand. For certain cases, ICOs bring scale and demand together.

Gauging demand is one thing crowdsourcing platforms like Kickstarter do very well. It lets producers establish demand with consumers up-front. And vice-versa.

Liquidity is another interesting angle. In many ways, ICOs are bringing reverse liquidity to the cryptocoin market. There is a large (astronomical) amount of speculative value in Bitcoin that can be realized in the real-world. ICOs provide that opportunity without jumping through fiat currencies. In many ways, ICOs are drawing down upon the Bitcoin promise. That value needs somewhere to go, and money isn't always the answer.

Can we get to Mars already?

Despite feeling like I live at LAX, I don't commute between San Francisco and Los Angeles downtown very often. So I'm unlikely to buy a ticket-capacity-token for that reason. That said, there might be an "ICO prospectus" where I'd be keen to invest. I know that there would others that would be all in.

Take a better example. Imagine SpaceX was to issue ICO tokens for Mars travel. That would be very hard for me to pass up. I'd like to get in on that, right now.

I don't want SpaceX stock to get an investment return. I want to hand SpaceX money to make the trip possible. I'm buying and signaling in advance. It fundamentally skips a whole raft of steps. It skips the stock market, it skips banks, it skips an IPO, but goes straight to the market. It's disintermediation on a new level.

There still is a lot of learning and evolution to be done in the ICO market. It will be a rollercoaster, and they will be winners and losers along the way. It's a new model that is bringing a new set of risks and opportunities.

ICOs have the unique potential to bring the market to the people. It lets people invest in the world as they want it to be9.

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Filed under Blockchain.

Footnotes

  1. Sadly, the book is in storage 8,000 miles away. It was titled "The fundamentals of Finance and Banking" or something inspirational along those lines. 

  2. Coincidentally, one of the major projects I worked on at Credit Suisse was for physical currency. 

  3. Featured prominently in the movie Trading Places

  4. The S.E.C. is watching and warning on the ICO space carefully. Despite S.E.C. Warning, Wave of Initial Coin Offerings Grows, New York Times, August 2017. 

  5. Building Golden Gate Bridge May Not be Possible Today, NBC Bay Area, May 2012. 

  6. Many ICOs have a fixed supply of tokens, or some pre-determined release schedule. This creates a market dynamic in the vein of a currency or commodity. For Distributed Applications (DApps) this may not always be the best approach. In this scenario a token representing capacity on the SF-LA Hyperloop might be the right scope. Or it could be a whole Hyperloop network. Or some other boundary. 

  7. High-speed rail to areas outside San Francisco and Los Angeles could have a bigger impact than simply the SF-LA route. 

  8. Like the Golden Gate Bridge, you could use bonds. But bonds are a de-risking measure, especially if it's a government or municipal bond. Some projects need more risk than a bond can realize. It also takes an extraordinary assembly of financial and political will to put together. There are a lot of intermediaries. 

  9. This is a personal (investment) philosphy of mine. I'll write about it again. 

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