Building blockchain banks with ICOs

Polybius was a second century-BC Greek historian who brought us the theory of cyclical political change known as anacyclosis, loosely based on Plato’s philosopher king narrative. The general thrust of the argument is that political structure is perpetually revolving — moving from monarchy to oligarchy to rule by the people (over and over again) — because humans can always be relied upon to respond the same way to the same challenges. He was also an early-day tinkerer in cryptography.

Polybius, the crypto bank initiative, is a proposed blockchain-based digital institution which raised $11m last week via an Initial Coin Offering (ICO) with little more than a 22-page “prospectus” and a promise that “Polybius Bank will become a fully digital bank accessible everywhere at any time. It will have all the functions of a classical bank, but will not host any branches nor physical front-offices and will rely fully on the latest digital technologies.”

Helping Polybius, the bank initiative, raise all that money was a marketing effort which leaned heavily on associations with well-established financial and advisory institutions. Case in point, Daniel Haudenschild, partner at EY, whose name and EY connection was well publicised throughout the supporting documentation, despite a lack of clarity as to the real nature of EY’s involvement/endorsement.

Crypto podcaster Joshua Unseth spoke with Haudenschild about the ICO and the following are a few nuggets from the conversation, which we thought were worth sharing:

JU: You and I both know that tokens don’t provide any fiduciary obligation to investors, these are just tokens so there’s no equity given to investors right, or to these token holders ?

DH: Yes, I mean there’s no guarantee…there’s no recourse to the law.

JU: Right. So somebody actually does own Polybius? There is an owner of it and that is HashCoin isn’t it?

DH: So they do have a legal entity in Estonia, right, they would have to otherwise there would … it would not be very prudent. I think the founders are Anton and a couple of the other guys from… who are actually on Companies House, but to be honest I don’t know who’s the actual owner of the entity… So I think that’s going to get much more transparent when, you know, they apply for the banking license.

JU: So here’s my question, Daniel, don’t you think it’s a bit dangerous to have a lack of transparency as for example who owns the actual entity that is ICO-ing, there’s absolutely nothing in the White Paper about it and in addition to that, as we agreed, there’s no fiduciary obligation that’s out set as a result of this token distribution so really token holders have nothing more than the promise to pay dividends, in addition to that they don’t even have a banking license yet do they?

DH: They don’t have a banking license and that’s quite clearly stated. The success with the ICO would determine where they go with it. Is it dangerous? Hmm…

JU: Well the ownership isn’t out laid in their white paper so they’re doing an ICO without disclosing probably the most important element of this which is that HashCoins actually owns Polybius.

DH: Yeah, hmm. I think the way that… so so so.. that probably is not a secret.

JU: It’s kinda of a secret, it’s material isn’t it?


DH: I know they [Hashcoins] are the senior backers behind the project, but I don’t know who owns it, that wasn’t our role in advising them.

JU: I understand that, but how much money do you think HashCoins put into this project? Let’s be honest this is a project with absolutely no progress yet. They have no banking licenses, they have nothing yet, they have absolutely nothing in the way of technology yet. They just have promises of this stuff.

DH: I’m the first one to say that they have a massively ambitious intention. Look at the assets they had before the ICO went out and what you had was a white paper, a pretty good video, a good story, a government that’s willing to play ball and some bright kids, right.

JU: Then you have a token that offers no equity and which only promises dividends and in addition …

DH:.. with unlimited tokens as well.

JU: Unlimited tokens..

DH:.. without any legal company behind it …

JU: Well they have Hashcoins…


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JU: You’re a partner at EY, why is EY’s name on this?

DH: Well I mean, so.. so… I mean EY’s a company that would probably not endorse Polybius bank as a banking institution, right. The way the brand was used, there’s still discussions going on, but I think in general, you know, Hashcoins is a prominent brand in cryptocurrencies and smart contracts.


JU: It sounds to me like Ernst Young has a tacit partnership in that you’re involved kind of, but only in an advisory capacity — isn’t that a dangerous project to put your name on as a company?

DH: It is right. It is. I think it has to be seen in relation to the role we played in the project

JU: But Ernst & Young, noone knows what the role Ernst & Young plays, they’re just looking at this and Ernst & Young putting their name on the project is what looks to me an endorsement.

All of this raises an important point about actual shareholder rights within these structures. Say a legally-incorporated institution with actual shareholders dishes out an uncapped amount of tokens promising a share of revenues or dividends via the ICO process. Do shareholders’ rights to those revenue/dividends trump rights of the token holders? And if so, how does that square with the way risk is distributed through these systems? As Unseth notes, more often than not, it’s the token holders taking the bulk of the early concept risk, yet the inferiority of their ranking relative to shareholders kind of sees the latter receiving a free lunch.

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When it comes to prospective banks, that’s also a significant bastardisation of the risk/return ethos which is supposed to keep moral hazard in check. Moreover, concepts like return on equity, trust and capital tiering mean everything in banking. On that note, it’s hard to imagine how the Basel framework would apply to a challenger bank which boasts this sort of ambiguous liability.

Even Haudenschild acknowledges: “It seems like you could sneeze twice on a piece of paper and launch an ICO and get a couple of million for it the way tokens are going now.”

At the same time he suggests the easy-come, easy-go environment possibly justifies this. After all, many investors in this space acquired their wealth through rampant bitcoin speculation, not by actually going out to work for it. In that sense, perhaps there is some poetic justice in their wealth being tapped up opportunistically by even higher-risk ventures?

The only problem with that justification is that ICOs are increasingly luring investors from outside of the bitcoin ‘easy-come/easy-go’ wealth pool, prompting them to buy bitcoin or ether with hard-earned money for the sole purpose of making these investments.

It should be stressed that Haudenschild believes the group behind Polybius — while potentially inexperienced and overly ambitious — is sincere. Even so, the flawed incentives at the heart of these ICO-funded ventures cannot be ignored, not least because they make the flawed incentives at the heart of minimum viable product ventures look benign in comparison.

To wit, one of the historian Polybius’s most important observations about cyclical (political) repetition’s connection to the factors that turn ordered democracy into mob rule and anarchy. In his opinion, these were the corrupt incentives which plagued generations which had come to forget what previous generations had struggled to defend themselves from. From The Histories (our emphasis):

… when a new generation arises and the democracy falls into the hands of the grandchildren of its founders, they have become so accustomed to freedom and equality that they no longer value them, and begin to aim at pre-eminence; and it is chiefly those of ample fortune who fall into this error. So when they begin to lust for power and cannot attain it through themselves or their own good qualities, they ruin their estates, tempting and corrupting the people in every possible way.

And hence when by their foolish thirst for reputation they have created among the masses an appetite for gifts and the habit of receiving them, democracy in its turn is abolished and changes into a rule of force and violence.

For the people, having grown accustomed to feed at the expense of others and to depend for their livelihood on the property of others, as soon as they find a leader who is enterprising but is excluded from the houses of office by his penury, institute the rule of violence; and now uniting their forces massacre, banish, and plunder, until they degenerate again into perfect savages and find once more a master and monarch.

Seems appropriate for a market which is continuously regenerating middle men and autocratic leaders.

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Related links:
The ‘minimum viable product’ infection – FT Alphaville
Introducing truly outlandish ICO claims, TokenCard edition – FT Alphaville

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