Imagine that you are a Soviet weight lifter. It’s the height of the Cold War. You’ve trained for years to crush the bourgeoisie on the battlefield of the Olympic podium, to bring back gold and glory to the motherland. One day your trainer pulls you aside and tells you that not only does he have access to performance-enhancing drugs developed for the Russian military, but also that all other Russian athletes are taking them, and that the USSR will help you hide the doping from international regulators.
This is the situation of most crypto startups today. On the fundraising and execution side, it is very, very easy to get ahead by playing fast and loose with compliance. It isn’t sustainable, but neither is prolonged drug abuse. When the lines aren’t clear, it’s very easy to slip across them.
In the early days of Carbon, we spent months assessing the viability of a token sale. It was at the height of the bull market for alts and our primary competitor, Basis, was knee deep in theirs. We ended up not moving forward as there wasn’t a clearly compliant option. Basis went on to raise 133M at a nearly billion dollar valuation. Their CEO made the Forbes 30 under 30 list and the startup was hailed as the golden child of crypto. A month later, Basis shut down and refunded what was left of the investors’ funds, due to concerns around compliance.
Basis did the right thing by shutting down. It took guts, especially after all the press, to admit that they were wrong. Many lesser men would have pivoted, redomiciled, or hired more attorneys tasked with the impossible task of forcing the square peg of Basis into the round hole of compliance. Many high-throughput chains seem to be taking the latter option. But Basis was willing to let go of the money which is a huge testament to the competence of their leadership team. (Basically, every competitor of theirs from that era has “pivoted” drastically and most still don’t have a clear path forward on compliance).
Unfortunately, crypto will likely be defined for the next few years by projects that will burn compliance to get ahead. Compliance is expensive and slow and, worst of all, ambiguous. Everyone will claim to be compliant but it will be essentially impossible to ascertain the validity of these claims. Investors generally won’t have the time or expertise to assess compliance so survival will likely end up being the proxy used there. We’ve found this to already be the case in crypto payments as the primary criticism of our feeless on off ramp being that “it’s new”). To top matters off, many crypto founders came out of less regulated sectors (crowdfunding, adtech, and gaming) where forgiveness was always cheaper than permission.
We have seen and will continue to see projects do “impossible” things only to learn later that they were about as far away from compliance as Uber is from profitability. Two companies will be in a rat race. One will break away by having no KYC, lowering fees (licenses are expensive), outraising through dubious token sales, launching products more quickly (legal opinions take time), and blatantly disregarding securities laws (as is in vogue in the stablecoin space). These groups aren’t burning the furniture: they’re burning the foundation and sloshing gasoline onto whatever’s left in the form of aggressive marketing.
Starting a crypto company, even if you have the best idea, is putting yourself in the position of the Russian weightlifter. Will you take steroids or watch a black and white television in Siberia while Boris from Chechnya crushes the capitalists?
The Path Forward
My advice to investors is to invest in both responsible founders and in compliance. For compliant (onshore) crypto companies, legal is often 30 to 50% of burn. Offering free legal resources to portfolio companies will lower the net burn rate, reduce the risk of companies engaging incompetent law firms, give the investor insight into the black box of compliance, and increase the rate of learning across the portfolio (what works for X should work for Y). As the sector matures investor’s legal teams will be well positioned to flag for regulators non-compliant competitors of their portfolio companies.
Most importantly, it diminishes pressure on portfolio companies to cheat. If lawyers are recommending delaying a launch, the founders are much more likely to acquiesce if the lawyers work for the investor rather than the company.
As both a payments company and capital markets actor, Carbon has found a niche that we’re comfortable with, on the sidelines of all the major races, where we can we try to help compliant companies get ahead. In fact, we generally try to notify our partners when products they may be interacting with are flagged by regulators.
As more companies collapse or get shut down compliance issues will be viewed as less of an act of god and more as a failure on the part of the founder and thereby a failure on the investor’s part. If a company seems like it’s doing something impossible on the regulatory front, it probably is. Eventually, the rest of the world caught Russia and banned the majority of their athletes from competing.