Paul Gordon talks about regulation, crowdfunding and ICOs with Banafsheh Fathieh, Head of Investments for the Americas at Prosus Investments; and Kendrick Nguyen, Founder and CEO at Republic.
Banafsheh worked in investment banking and private equity, then joined a crypto startup. She joined Prosus four years ago heading early stage investments in the Americas, with a focus on frontier investment areas like blockchain and synthetic biology.
Ken had a prior career in traditional finance as a securities lawyer. He was also involved as co-founder for CoinList, part of the AngelList ecosystem. He heads Republic as a one-stop shop investment platform making private investing accessible to everyone on the net worth spectrum.
(6:36) There are two attributes that blockchain will fundamentally change in the world of investing: fractionalization and automation, said Ken, adding:
“When you combine those two things to make it far easier and cheaper for people to transact, you’re going to enable a lot more people to come into the ecosystem. If you can unlock and enable that lower-middle class to invest, I think it’s going to usher in a new world of prosperity and connectedness. And that’s one of the reasons why Prosus and Republic’s vision as global investment firms are different to much of the venture ecosystem.”
Retail and Regulation
Regulators’ role in a bull market is a tough balancing act.
(9:55) “Historically we’ve seen regulators err on the side of exclusion and as a result created a market dynamic where as more and more of the value of technology is accrued to equity investors. You’re starting to see wealth disparity that I think is increasingly problematic. For us, we look at that and say ok, maybe we need to look at the laws and think about platforms that are compliantly looking to widen that base…and give retail some more access than what we’ve historically seen,” said Banafsheh.
(11:25) Retail needs educating on the volatility and the financial products that they’re investing in, but the adage that somehow retail can’t ‘get it’ is not the right assessment, said Banafsheh. Tech and education can bring them up the learning curve and give them the opportunity to participate in some of the gains generated on the equity side.
(12:26) On the institutional side, the administrative costs on both the public and private side of trading securities are exorbitant and not in line with the simplicity of the transactions. The automation that you see through blockchain, the ability to leverage AML and KYC are obvious, said Banafsheh.
(15:05) The main role of the SEC or its equivalents is making sure that investors are adequately protected whilst having a strong interest in promoting capital markets, said Ken.
(15:24) “When you look at something like equity crowdfunding outside the blockchain space, in the UK, it’s been ten years and not a single instance of fraud. And so when you look at the earlier phase of ICOs in the US, non-compliance, non-regulated in any way, there’s no doubt there have been more than just a few cases whereby investors felt like they were defrauded. When you apply this regulatory framework and ensure that people have to disclose things and make some baseline level of SEC disclosure and requirement, naturally you’re going to have a more credible pool of entrepreneurs,” said Ken.
The cap on equity crowdfunding in the US went from USD 1 million to USD 5 million recently — a sizable increase. Regulators take time to change their positions, but they have a very clear role in society. And the securities law in the US came about because of the Great Depression and because of non-compliance leading to massive fraud, said Ken.
Patience and Progression
(18:49) Regulation tends to change incrementally. The premise that regulation is broken and needs to be reformed from scratch doesn’t tend to be a fruitful dialogue.
“The role of the SEC is to protect the consumer, so I think they’re trying to as best they can keep with an industry that is moving at lightning speed. And whether intentionally or unintentionally, there are a lot of projects that get fairly cutesy with their legal stipulations if you will, so they’ll find out that maybe something is squarely compliant and they’ll tweak things to circumvent regulation in a meaningful way… I truly believe that the intention of the regulators is to strike this balance between consumer protection and inclusion,” said Banafsheh.
People forget that back in the 1990s, the way that securities used to be traded, it got announced in ads. It’s not that the regulators are trying to slow things down — innovation is moving very quickly.
(21:03) “I don’t think the SEC is not here to play ball. I do wish — and I say this from firsthand experience — that the SEC were providing more speedy guidance. Because I think one of the challenges of being a company in this space is even if you intend to be compliant, sometimes it’s difficult to know,” said Banafsheh.
(21:56) Emerging countries don’t have an established securities or banking infrastructure and therefore should be able to put in place frameworks that are more in tune with tech development. For example, Vietnam’s regulatory framework is very nascent, said Ken. In places like the UK, US and Australia, naturally things will take longer for the laws to catch up to tech change.
ICOs and Incentives
Back in 2017, ICOs were the ultimate outcome of the potential of equity crowdfunding — projects around the world raising tens of millions of dollars without VCs involvement, done in a non-compliant way.
(27:26) “I think there’s a narrative that somehow if ICOs, if the token economy were to succeed, that will undo the value of VC. And nothing is further from the truth. Even though we are financially robust, the value of having someone like Prosus and Banafsheh on the board, the connection and advisory expertise, the consultancy and global network is something that is a very different value than the value of a million customers backing and supporting you,” said Ken.
(29:01) To incentivize people to invest in Republic, inviting friends will contribute to the value of the tokens a user holds.
The Republic token is still the only one available to non-accredited investors. Getting the support of Prosus is a tremendous validation because by and large institutions are watching intently but not formally backing projects. So it could be a weatherbell for the blockchain and securities sector, said Ken.
Prosus was one of the first public companies to invest in the blockchain space. The firm is heavily focused on emerging markets, remittance markets and places where the potential for what blockchain offers is very large.
(34:32) “In terms of our outlook for blockchain going forward, I’ll tell you some of my personal challenges in terms of looking for opportunities. One is given that this is a public company, we care about compliance. And so I think finding teams at the forefront of compliance and working with the regulators to make sure they’re functioning within a framework is something that is very important to us, probably even more so than the smaller blockchain funds,” said Banafsheh.
(35:24) There is this incredible innovation around tokens and the ability to fundraise using them, but it’s also created this perverse incentive for teams to manage to the price of the token, i.e. projects are heavy on PR, thin on substance, said Banafsheh. Retail and institutional investors run into the difficulty of sifting through that noise and to remain a long term investor as opposed to a liquid, short term strategy. Prosus is a very long-term investor and has been in some investments for over 20 years. It’s challenging knowing that short-term goals are a theme in this space, and it is a challenge to find opportunities and teams focused on creating fundamental value, said Banafsheh.
(37:27) A lot of tokens have lock-ups and a minimum hold expectation. The challenge is stepping back and looking for pockets of value 5-10 years from now. That’s one of the most difficult things to do in this space, Banafsheh said.
Compliance and Identity
In terms of DEX and DeFi, there’s a substantial component of non-compliance that is ignoring the need to consider compliance and raising risks for investors, said Ken.
(42:04) “I think when it comes to DEX and DeFi… know your customer (KYC) and anti-money laundering (AML) is an area that is still slowly catching up to technology. The existing framework around banking standards for KYC/AML is literally knowing you through your ID, your passport, loading an image. That’s not the only way of doing it. At the end of the day, they just want to know that this is not a fraudulent/illegal transaction for improper purposes, so there are different ways of verifying that. With tech you can enable KYC/AML onchain in sharing a validated identity without actually having to prove a passport photo, so there are newer, more efficient ways currently in development.”
(44:21) “These things you just can’t ignore forever. You can wait for five years and wait until you’re a multi-billion dollar project and come with a hammer and are you ready and are your investors ready and expected to deal with that? I think that’s a question that all founders and all investors should have in mind,” said Ken.
Republic and Prosus in the Short Term
(45:24) Republic are working on secondary solutions for traditional as well as digital equities. That’s a difficult component but it’s needed for mainstream adoption of private investing and specifically for digital securities. Republic hopes to be able to introduce a framework for that over the next couple of quarters, Ken said.
(46:22) At the forefront in the DeFi and NFT space is liquidity. Banafsheh said: “Each NFT is a market in and of itself so you have to think about what you’re buying and ultimately how you will come into liquidity eventually, so I think about that a lot and research that quite a bit. It applies obviously to the secondary trading on the security token or equity side. It’s again how do you bring liquidity to retail? So creating a robust market around that is really interesting.”
(47:50) Insurance products are also definitely lacking both on the retail and institutional side. There are certain aspects it would be great to able to insure against, with the consideration that this market tends to be volatile and prone to hacks. When you talk about real sums of money, insurance products are very welcome, said Banafsheh.