For many crypto startups in 2017, the ICO bubble meant raising millions of dollars in token sales, over promising on product potential, and, in a classic case of The Idea Execution Paradox, under-delivering on those promises.
It also apparently meant mismanaging treasuries with zero accountability to token investors.
Funds with a focus on liquid token investments used to either 1) write off these mismanaged startups or 2) quietly resolve the situation and have their investment returned. To cover their bases, larger funds with more leverage would often structure terms in a way that allowed them to have more influence over the project’s development. These terms were typically managed by dedicated term sheets or side letters that were neatly tucked away from the public eye.
That isn’t, however, the case with a very recent and very public conflict between investment firm Arca and Gnosis.
Gleaning from recent reports we learn that:
In April 2017, Gnosis raised $12.5M in a dutch auction that lasted less than 15 mins during the ICO frenzy. The team collected 250,000 ETH at a price of about $50 per ETH. The project promised to deliver prediction market platforms along with other products that natively use the GNO token. The team kept the collected investments in ETH, betting heavily on ETH’s price.
Since the ICO, the team has allegedly focused more on contributing to the Ethereum ecosystem than executing on the deliverables they pitched during the ICO. In this sense, the team has been more focused on growing their ICO proceeds, which are denominated in ETH, than making Gnosis’ token GNO more valuable. Moreover, the Gnosis team still controls an overwhelming majority of the GNO tokens, estimated to exceed 85% of the token supply.
GNO’s price has suffered largely due to a lack of momentum and apparent centralization of token distribution: GNO traded well below the ICO price during 2019 and through the majority of 2020. As one might reasonably assume, this has angered GNO token investors, such as Arca, who have to bear the losses while the Gnosis team enjoys an 8x appreciation of ETH holdings and burns an estimated $7.5M in annual expenses.
Arca’s proposal to the Gnosis team, distributed by The Block, pinpoints Gnosis' failure to build useful products. DEX development efforts such as DutchX and, more recently, Gnosis Protocol failed to attract much volume. Similarly, the prediction protocol is experiencing low utilization.
Arca also attacked Gnosis team’s undisclosed investment activities which goes beyond the scope of the project: the Gnosis team is allegedly using their ETH holdings to participate in yield farming activities. From Arca’s perspective, the team is more focused on making money for themselves than creating value for GNO token investors.
Consequently, Arca is proposing a buyback program where the Gnosis company uses its inflated treasury (largely appreciation from ETH) to buy back the GNO tokens offered in the ICO. The proposal calculates the fair GNO token price to be about $89, approximately 3x the ICO price.
Tokens or Stocks?
The interesting bit about Arca’s proposal is that it proposes the use of funds currently owned by a company, i.e. company founders and equity holders, to compensate token holders who invested in the ICO three years ago. In Arca’s words, token investors have provided a $12.5M zero-interest loan to the Gnosis company on the promise of developing a product.
Instead, the company used the money to invest in ETH and grow the Ethereum ecosystem, creating value for the founders and equity holders while the token investors were left empty-handed. Arca’s proposal challenges the zero-rights understanding that was tethered to token investments from the 2017 ICO era. The proposal pushes for token holders to have equal rights as company shareholders - especially when these companies have inflated treasuries repurposed as investment vehicles.
New risks for ICO founders
The current dispute can easily develop into a legal battle that could set the precedent for many startups that ICO’d in 2017. In many scenarios, token investors are in the red while companies are sitting on millions. In some cases, these companies used ICO proceeds to launch venture investment arms that only benefit equity holders of the company.
Arca’s proposal should be viewed as an opportunity to resolve ongoing issues from the ICO boom and to apply those lessons to the next wave of DeFi projects and tokens.
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Disclosure: Volt Capital and/or its partners may have exposure to some of the cryptocurrencies mentioned in this newsletter.