Austin Hill loves cryptocurrency, the new ecosystem for money that has grown up around secure and transparent technologies like blockchain. Cryptocurrency’s innovations have spawned huge investor interest and spawned currencies like Bitcoin and Ethereum.
The foundation of blockchain technology is a digital ledger, which uses a chain of distributed computers to record each transaction in a public manner. It is secure, and it enables digital transactions for virtual goods, games, and online entertainment. The secure payment system has spurred further innovations, and that people like Hill excited.
Hill has been involved in cryptocurrency for a long time. He was CEO and founder of Blockstream, which raised $77 million for its work on Bitcoin infrastructure. Now he is a venture capitalist and a partner at Brudder Ventures in Montreal.
But he is also one of a number of people who are worried about the future of cryptocurrency, since so many scam artists have moved into initial coin offerings (or ICOs). Hill is seeing so much dumb money move into the unregulated offerings, with the scammers taking the money and running. He warns that there will be a reckoning, and it could be like the dotcom crash all over again. I talked to him over the phone, and here’s an edited transcript of our conversation.
VentureBeat: How are you looking at the ICO market right now?
Austin Hill: It’s like the dotcom bubble all over again. An absolute clusterf*** of illegal, immoral, straight-out scams occurring on a grand scale. It seems to continue.
VB: It’s definitely a gold rush. It’s crazy. The SEC is stepping in, but it looks like that announcement didn’t slow it down any.
Hill: The announcement and their approach on the DAO of Ethereum sent some warning, but in a similar gold-rush mentality we have entrepreneurs and teams saying, “Listen, this is literally free money.” There are very real reasons why the SEC regulations exist. Some investors, some people would say, “The government has no reason to play a paternalistic function in protecting us against scams. The accredited investor rule is ridiculous. Why not let everyone participate?”
But the reality of the situation, unfortunately — I go back in this industry a long time. I started the largest and the oldest cypherpunk company in the world, doing pure and applied research into cypherpunk technologies. We tried to build Bitcoin before there was Bitcoin. We tried to build ecash. We did the early work on Tor before there was Tor. This was back in 1997. I raised $70 million in venture capital for cypherpunk technologies. I would never have sold or promised to consumers any part of that, because the technology due diligence that was required to separate fact from fiction was so incredibly high.
If you go back in history, there was a Canadian company back in 1998 called Jaws Technology that was rolling its own crypto, and it was listed publicly on the Vancouver stock exchange and Nasdaq small capitalization market, which was the epitome of a pump and dump. They solicited press, they promoted themselves, and the fundamental science was totally bogus. Every computer scientist in the world could tell you this was ridiculous. Yet retail investors put tons of money on it, because they could. It was the dotcom boom. They waved their hands in the air and said, “The world needs encryption and we’ve invented our own! The whole world will use ours!” Anyone who spent five minutes on it knew they were snake-oil salesmen, but they were able to access the public markets and solicit funds, and they ran a pump and dump scam.
We’re seeing the same thing recreated. We’re seeing a mix of well-intentioned but ignorant young entrepreneurs who see the allure of free money in an ICO. They parcel together a few white papers, and — generously — in some cases, they have the best intentions. Their goal is not to create a scam. But they don’t know what they don’t know yet. They’re rolling an ICO out as a way to pull in free money. In other cases I would not be so generous — there are unethical people designing these ICOs as a way to milk money from unsophisticated investors.
You also have some very well-informed investors and very well-informed advisors who are out there recruiting young entrepreneurs, and they are literally telling these young entrepreneurs, “Don’t bother with VC. Forget milestones. Forget proof. Forget anything. I’ll help you raise $20-30 million through an ICO.” These guys are taking profits out the wazoo on the back end. They’re charging these companies fees. They are taking premined or founder level tokens with the ability to resell them without vesting. Because there’s no transparency or accountability in the market, these guys are searching the marketplace and finding any idea that seems palatable or marketable. They run to these entrepreneurs and say, “I’ll help you raise $20 million with no dilution. I’ll help you do a token sale.” These guys on the back end collect fees, tokens, and upside with very little risk and oftentimes work hard to not be listed or associated with the company so that the company carries all the legal and enforcement risk while they move onto the next ICO. The entire market is very broken right now.
VB: These guys I talked to last week had a nice pitch, but there are some definite red flags with them.
Hill: I can now look back with the benefit of what I hope is wisdom, or at least history. We set up Zero Knowledge back in 1997 to develop military-grade crypto and privacy on the internet. We purposely set up in Canada, because Canada was more favorable than the U.S. for exporting crypto. At the time the U.S. government had blocked PGP and was preventing the export of crypto.
This jurisdictional arbitrage that’s going on is interesting. But at the end of the day it’s not going to matter. Even though most of these ICOs try to base themselves in Switzerland, based on the Ethereum example — Vitalik [Buterin] and Ethereum searched for a jurisdiction that would give them a free pass, and they found that in the Zug valley. Most of these crypto ICOs play jurisdictional arbitrage and try to set themselves up in the right jurisdiction.
But the U.S. government doesn’t care. The Hatch Act as interpreted by the SEC carries a very big and wide stick when they decide to use it. Frankly, the U.S. government has done this before. They did it with poker online. They started arresting executives who landed in the U.S. They grabbed them off planes. You landed in Texas? We’re arresting you for running a gambling site. I think we’ll see that in this ICO market.
There’s a huge amount of legal risk. But at the end of the day, the legal risk is a small thing compared to the actual risk, which is that building startups is hard. I’ve been a venture capitalist. I’ve been an angel investor. I’ve sat on the other side of the table and looked at what it takes to build a successful company or a successful team. It’s hard to get right.
If you look at the recent reports out of the Kauffman Foundation, something like four percent of venture capital funds account for 95 percent of returns. Picking a winning team is really hard. Picking a team that can produce software is just as hard. The average consumer — if you’re marketing or promoting a retail investment in a startup, they have no ability to assess that risk. What ends up happening is, your primary goal is speculation versus innovation. That’s bad for the industry.
In addition there are tons of risks associated with giving companies too much capital without strong governance. There are exit risks and future financing risks. I think many of these companies raising funds through ICOs are closing the door to traditional M&A exit paths, and should they need capital in the future will be shut out of most major forms of traditional financing. Once you do an ICO, it may very well be the last financing a company will ever be able to do. If everything goes well and the tokens still have value in two years, then maybe it works out for a few, but a majority of these will probably run out of funds and be left without options.
VB: If you look at the cryptocurrency capitalization, you don’t look at that and say, “Maybe the top five are trustworthy.” You’re looking at it and thinking that the whole thing is crazy.
Hill: For the most part, it’s a house of cards. There are maybe four or five projects that have actually innovated in the area of computer science, or are doing something groundbreaking. Beyond that, not a single one of them has ever been able to answer the question, “Why create your own currency?” Unless it’s just to do a get-rich-quick scheme or take advantage of dumb money that doesn’t require traditional milestones or validation.
Zcash? They innovated with Znarks. Ethereum? I don’t agree with everything Vitalik has done, but there’s been legitimate innovation. Bitcoin? Groundbreaking innovation. You can count on one hand, probably, the projects that have done something new and unique. The rest of them have all forked from or are copying something else, or are peddling white papers with unproven science that is flawed. The reason for creating their own currency is a shortcut being paid for by speculators who have little clue of the risks — which ultimately like the dotcom collapse could negatively affect the entire ecosystem for years once it collapses — even if they’re well-intentioned. Like I said, a lot of these people don’t understand what they don’t understand. They have the best intentions, and they’re being recruited.
VB: How does this unravel, then? We saw market forces happen in the dotcom crash.
Hill: There’s a number of factors playing into this. One, we have an incredible appreciation of wealth in the crypto bubble itself, in the sense that you have people — I’m affiliated with a venture capital fund. I recently interviewed someone to work on investments in the crypto space — the person is in his early 20s and has made millions by speculating in crypto currencies — the technical skills, the market experience to assess risks or conduct due diligence wasn’t developed; it was more of a “I’ve been a lucky gambler in this industry,” which I think carries risk.
What’s funny is, I’ve seen this before. In early 2000, there was a wave of online poker players who made a fortune. These guys were making millions of dollars in online poker, because everyone else sucked at online poker. They would make tons of money a year, but it was just free money. They had no appreciation of it. Almost to an individual, these players have lost most of their money in the long run. For them it was like game credits. Some of these experts were people who literally moved their skill sets from playing video games to online poker. It was just another game currency. They had no appreciation of what it takes to earn or make money.
We’re seeing the same thing happen in cryptocurrency. A lot of these wins, a lot of these investment cycles, are coming from people who’ve made 80,000 percent returns on Ethereum. They go in and say, “OK, I don’t mind dumping a quarter million dollars into a new ICO and trying to replicate that.” That artificial, false market has to hit a wall at some point.
I don’t know what the catalyst is. Is it enough of these projects getting reported as fraud? Is it when enough of them don’t deliver? Look at Tezos. Tezos raised $240 million for a ridiculous, crazy — I’ve shown computer scientists the Tezos white paper and others like it and they just laugh. They joke that kindergarten kids must have written this. Most of these startups copied and pasted a bunch of ideas from someone’s Ph.D. thesis and tried to present it as a credible idea, when there’s no hard science underlying this. Yet they and others are raising hundreds of millions of dollars. At some point this has to break down.
VB: I did a story on Nvidia’s earnings today and talked to their CEO. He said they did about $200 million in hardware sales related to cryptocurrency mining. That’s still going strong.
Hill: That’s not going to change, though. The underlying fundamentals of cryptocurrencies, or the credible ones — Bitcoin, Ethereum, real cryptocurrencies that have some utility function — that’s not going to change. The challenge is that the market anticipation and hype and people trying to cash in on it all, that far outweighs where the industry really is.
VB: We’d get into trouble if he started giving free GPUs to his customers and they paid him back in the proceeds of what they mined.
Hill: Exactly. And he doesn’t need to. There was an article a week or two ago about how one group of crypto miners has actually chartered a 747 to fly around Europe and buy up graphics cards. The time to delivery was too long trying to order it the normal way, so they chartered their own plane.
VB: It’s always funny for a while, but eventually someone’s going to get hurt by this.
Hill: How do you separate the wheat from the chaff? How do you distinguish between good behavior and bad behavior? There’s a lot of us in the Bitcoin industry that warned Vitalik they were violating U.S. law, regardless of how they structured their company in Switzerland. We were worried he was going to get arrested. Now that Ethereum has found such widespread adoption amongst banks and other people, the likelihood of him being arrested or the project being attacked is quite low. Who’s the next case study, though? Clearly, the SEC has said that they want to regulate this.
VB: How would you describe yourself and what you do, relating to cryptocurrency?
Hill: I’m an entrepreneur and venture capitalist.
VB: Do you just closely watch the cryptocurrency space? Are you actively investing in it?
Hill: A combination of both. I was the cofounder and CEO of Blockstream, which was the most funded startup in the Bitcoin industry. We raised $77 million to improve the infrastructure of Bitcoin.