Token sales being abused as a fundraising tool by many, will mostly go away: LuneX VC’s Kenrick Drijkoningen

With Bitcoinprice plummeting and many crypto companies and funds shuttering, 2018 was a year of reckoning for blockchain. But in 2019, it’s showing signs of a rebound; the total market capitalisation of cryptocurrencies has doubled since January.

These signs augur well for blockchain, and Singapore-headquartered LuneX Ventures looks to cash in on this vast opportunity. A US$10-million blockchain and cryptocurrency-focused arm of Golden Gate Ventures, LuneX has been investing in companies building the new open financial system and Web 3.0. It has also been appointed as co-investment partner of SG Innovate.

Last week, e27 had a chat with Kenrick Drijkoningen, Founding Partner of LuneX, who shared with us insights on the current crypto and blockchain landscape.

Edited excerpts below:

What triggered Golden Gate Ventures to launch a separate fund for blockchain investments?

We looked at the blockchain and crypto ecosystem in 2016 when one of our investees Omise was preparing for the token sale. I looked deeper into the ecosystem. This is when I realised that blockchain has the potential to become revolution — similar to how the different internet industries, including content and telecom businesses.

We looked at the underlying tech and what blockchain and crypto could do. Over the next 10-20 years, this is the next iteration of the internet that will disrupt asset businesses. Money is its first applications, but there are many more applications. It can be in smart contracts, we can digitise value now, and transfer it from peer to peer without the central third party.

Blockchain and crypto also have the potential to disrupt major industries in this world. That being said, we are early in this ecosystem; it is only ten years since Bitcoin was invented. It is a very niche and specialised field. There are are no mainstream applications just yet, so that needs a very specialised approach because the companies focused on this industry are earlier stage.

It’s just infrastructural blockchain and crypto solutions. At the same time, our LPs might not be comfortable with this kind of exposure. So we created a separate US$10-million fund. We are still in the fundraising mode until November.

US$10 million is a tiny amount. Why did you not aim for a bigger fund size? Also, does LuneX have the same LPs as Golden Gate?

A couple of things. As I mentioned, many of the companies in this ecosystem, particularly in Singapore, are still early stage. So are in the US. There are a few companies that are in the later stage, like Coinbase and Gemini. There is no such thing in Singapore yet.

The other thing is that investors who are looking to invest in this ecosystem would like to have some exposure. However, they would not allocate as much capital as they would to a traditional VC, which has a proven, tested model.

Also Read: A layman’s guide on how bitcoin is aiming to transform the global economy

As for LPs, there is some overlap, but it’s mostly new LPs.

What are Lunex’s investment thesis, mandate and outlook?

Our philosophy is that we are still in the very early stage of this ecosystem. If you think of a pyramid of how this ecosystem looks, at the base layer, there are protocols like Bitcoin, Ethereum or any other chain. These are the basis of which the rest of the ecosystem will be built.

Almost 50 per cent of our fund will be invested in tokens because the base layer of this ecosystem has no equity. These are distributed, permissionless networks that operate on a token model, and there is no company to invest in. So you need exposure to the tokens and the growth of those particular protocols.

The second layer — and that’s where we invest on the equity side — is the infrastructural level. It includes everything from new exchanges to custody providers to KYC/AML to wallets. Basically, this whole layer is to make things work. That’s why we invest in it.

And after that, it could come in five years or so — you will start seeing applications emerging from that layer. We are not investing in the application layer too much yet. Eventually, from the applications, you can get a fully-fledged new financial system, which is kind of an eventual goal of this whole ecosystem

So you invest both in blockchain and crypto companies.

Correct. If you make a comparison again with the early days of the internet — you had both internet and intranet. AOL, for example, initially launched their permission version of the internet because an open web was too scary. So they thought they could launch a better version.

But all the innovation happened on the open, permissionless internet. And the same thing here. Permission blockchains, corporate blockchains –we are not interested in those. We are interested in open, permissionless chains such as Bitcoin, Ethereum etc. and the services around those.

Which are your target geographies?

Our mandate is global. So we can invest anywhere. We’ve done two deals in the US and one in Korea. But we are very focused on Singapore because we are based here, we have contacts and access here. We can help our portfolio companies much better here. And also because we have a partnership with SGInnovate on their SG Equity co-investment scheme. It means on qualified deals, we get matching co-investment from them, on which we get to retain some of the upsides upon exit of such companies.

So we prefer to invest in Singapore. But if there is a good company abroad, we can also invest in it.

Can you throw more lights on your partnership with SGInnovate?

As I mentioned, we get added upside upon the exit of a company we co-invest in. The matching is either on a 1:1 basis or 3:7 basis, depending on the nature of the company.

There are multiple benefits to this; SGInnovate is well-connected within the local ecosystem and has a massive portfolio. They are also well-connected with the regulators. So I think it’s a great combination and an excellent partnership to have.

Crypto has been going through a tough phase. How do you look at its journey from an investment point of view?

That’s why we are a long-term venture capital fund, not a short-term focus fund. Massive technologies don’t develop from one year to the next. It takes time. Just like the internet didn’t happen from one year to the next. So we see it as a much longer-term time horizon.

But I think tremendous progress has already been made. If you consider the fact that Bitcoin itself was invented only ten years ago and last week they were talking about it at IMF. It was talked about in the US congress. The President of the US tweets about it. I think it has come a long way very quickly. It’s not a short-term thing; it has a very long term outlook. And it’s normal to have the cycles that this industry goes through.

And again there is an analogy to the internet. Everybody got too excited too quickly about the internet in 2001, and there was a big crash. But it was by no means the end of the internet. It was just a start. You could have picked up Amazon shares for a few dollars back then, and you would have done very well. We are in a similar position right now.

Many people believe that token sales are a scam. What’s your opinion on that?

There are multiple lenses to look through that. Initial Coin Offerings/Initial Exchange Offerings/Security Token Offerings are a way to kickstart a permissionless network, but there are many degrees of black and white here.

In the boom, we went through many of those token sales, which were unnecessary for the product they were trying to build. Yes, there were a lot of scams involved. But there were also a few that made sense. So I would say 90 per cent of them were unnecessary or scams. Look at Ethereum. They had to bootstrap the network this way, and they also had a valid use case.

Are you bullish about the future of token sales?

No. I think they will mostly go away. A lot of people abuse them as a fundraising mechanism.

And these tokens are only needed for these layer one protocols. There are network effects that are starting to emerge. At some point, there will be a couple of winners at this protocol level –whether it’s Bitcoin or Ethereum, or some of the other ones.

Also Read: Is Cardano the best cryptocurrency to invest in?

And then, all the innovations will happen on these winners as developers will move there. And it will be too hard for any newcomers to catch up once these things mature. And there will be no less or no need for token sales.

What will be the alternatives for token sales?

I think you will see regulators catching up and regulatory frameworks coming in place, and it will move to something like security tokens. It’s a little bit outside of what we are focusing on.

Security tokens are tokenised versions of equity. They make it easier for people to contribute funds and exchange shares over the internet. They will look somewhat like equity with the corresponding right attached to those as well. But that will involve a lot of legal work, a lot of service providers, a lot of regulatory clarity. You get tokens, but they are classified as security.

Why is Asia critical to the global crypto conversation?

I think the whole industry is so new that a lot of these remains to be seen. A lot of tech talent is based in the US, so you see it emerge there.

But at the same time, the regulators are very slow in the US, but their counterparts in Singapore are open-minded and friendly. I do see Singapore emerge at the moment as a leader in this ecosystem.

Although I think it’s a little bit too early to tell where it’s going. You will see many different hubs emerging. Obviously, it’s San Francisco in the US, Switzerland and Malta in Europe, and in Asia, it’s South Korea which is very much at the forefront, and of course Singapore.

I always say that the US and Singapore are opposite. As I said, in the US the regulator is slow, but the private sector is very forward-thinking and innovation-driven. In Singapore, it’s the regulator who is forward-thinking, but the private sector is a little bit slower in terms of trying to push for innovation.

In your view, what is the future of cryptocurrencies in a very long term?

In a very long term, I think we are building a new parallel financial ecosystem. And I believe that gradually, more and more people will move to this permissionless form of finance.

The biggest use case is still Bitcoin as a non-sovereign, non-censorable permissionless currency. That’s a massive use case in itself. And there is a whole ecosystem, the entire industry that can be built on top.

So that’s just one area, and I think that’s the most significant use case for the foreseeable future. There is going to be a lot of other use cases as well if you think of Ethereum as an example in terms of smart contracts and execution. And there is a lot of things that can happen there.

In terms of industry, gaming might be one of the first to start implementing this.

Also Read: What does cryptocurrency mean for your small business?

But the basic premise is that you can now transfer any value, any asset from person to person without a third party in between and without a custodian. We can build all kinds of automatic execution solutions on top of that. And that has implications for many different things, including legal, fund management, financial services, gaming. Anything that touches assets will have to deal with this.

If you look at some Asian countries, they accept blockchain but completely banned cryptocurrencies. Do you think these countries are missing out on tremendous opportunities?

Yes, exactly! Because cryptocurrencies or tokens are the application. Blockchain itself is not that interesting. It’s a slow form of a ledger.

What gives these things value and application is that nobody is in control of it, nobody can stop it and reverse. And the future application of that is the actual token. So Bitcoin is the money, Ether is a transaction mechanism, some consider it also money. These assets will be in the form of tokens. Blockchain itself is an excellent term, but it’s just the means to get into the censorless, permissionless world of transferring assets.

Do you think cryptocurrencies are over-regulated in some countries and it’s not ideal for their development?

Well, it depends on how you look at overregulation. I think it’s vital that regulators clarify and make things clear without being too prohibitive of the technology. Singapore is doing an excellent job with that.

Obviously, some places are trying to ban it altogether. If you look at India, for example, it is completely illegal to have crypto. And I think it speaks about the power of cryptocurrencies. If they weren’t powerful, then they wouldn’t bother to ban it. But there is something compelling in them that they see as a threat to the financial system, to the sovereign control of central banks and governments. This new system becomes a threat to it.

I think as long as the regulators are measured and reasonable and open for innovation, that’s the most crucial part. There is a lot of game theory involved here as well. If you, as a country, ban this ecosystem altogether, you are going to lose out on a lot of talent.

Tech businesses are the main source of economic growth as we’ve seen in the build-up of the internet, the largest companies in the world today (FAANG stocks) are all tech businesses that emerged from the growth of the internet as the US embraced the technology in the ’90s. At that time this was not obvious and it could have gone the other way if rules on exports of encryption had not been relaxed. As a result, capital and talent assembled in Silicon Valley.

Similarly, today if governments are too prohibitive in allowing innovation in the crypto space to naturally occur, entrepreneurs will choose other jurisdictions to build their businesses. Arguably talent is even more mobile these days and will pick countries that provide regulatory clarity, capital and a deep talent pool to start their businesses.

Do you think its valuation of Bitcoin will, as John McAfee predicted two years ago, hit US$1 million in future?

Bitcoin is by all measurements is the best currency humans have ever invented. It’s more limited in supply, and it is easier to store, carry and transfer.

Bitcoin is digitally native, and it can’t be censored. It’s more restricted in supply than even gold.

Of course, it’s very volatile at the moment because it’s an early-stage technology. It exists for only ten years, while gold has existed for thousands of years.

So if you assume those things to be correct — and those are entirely factual things — then you can come up with some kinds of valuation methods.

An interesting model is being discussed on social media these days by a guy called Plan B. It’s basically looking at the stock-to-flow model of monetary assets.

So if you think if gold is a monetary asset and it has been there for thousands of years, why is gold a financial asset? It’s not just because it’s a rare asset; rare is not sufficient for something to gain monetary value. The stock-to-flow needs to be low, meaning the new supply that comes above ground every year needs to be very small compared to the existing stock.

So if people store value in it, they know that even if the value raises, you can’t just print or extract 10-20 per cent more every year. That is restricted by physics and economics. Gold has value based on that, and you can also apply the same model to Bitcoin. The halving that occurs every four years in Bitcoin with the next one coming up in May 2020, when the supply growth gets cut in half, eventually to zero.

Also Read: What’s in store for blockchain and cryptocurrency?

And if you extrapolate that model next year, it will get to between 50-100 thousand per Bitcoin and four years it 10Xs from there again. So I see it as a real possibility. It will not be smooth and exact. And you will have these huge runs and massive falls. But that’s just the process of monetising the new asset.

What does Quantum Supremacy mean for the future of cryptocurrencies? Do you think it will kill blockchain?

I’m by no means a computer scientist or engineer, so in terms of actual cryptography and technical details of that, I have to give it a miss.

But I’ve looked into this and listened to the experts and people who know much more about this. I think it’s overblown. Quantum resistant algorithms can and will be developed before quantum computing is even here to crack them.

By all means, we are many years away from having commercially available quantum computing. Researchers are already well on the way in terms of developing these quantum-resistant algorithms.

And if you look at history, it’s always a race between the cryptography and people trying to break it.

Some people believe blockchain will make banks obsolete. What do you think?

I don’t think it’s going to happen shortly. But what you will see is an infrastructure inversion where banks will run on top of these open, permissionless chains as service providers. Right now, you need the banking system to gain access to crypto.

At some point, this infrastructure will invert, and all banks will be service providers on top of the blockchain. A lot of people don’t understand blockchain and think it’s too risky for them. They want a third trusted party to be the custodian and to manage their money for them. And that could be some form of banks. Whether it’s a native crypto bank or some of the existing banks that will adapt to new business models, that remains to be seen. But the infrastructure will invert.

In the beginning of the internet, you needed phone companies to dial into the internet. And right now, all phone calls are routed over the internet. Us being a primary example right now. So this infrastructure completely inverted. And I think you will see something similar for the transfer of value and money.

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Image Credit: LuneX Ventures

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