A brief history of greed and excess

How the pyramid scheme reinvents itself over and over in crypto

Apr 29, 2021

In this issue:

In the beginning there was innocence
No such thing as a fair launch
The first Initial Coin Offering (ICO)
You gotta burn money to make money
Ethereum has entered the chat
Aftermath of the Ethereum ICO

In recent weeks the number and diversity of new coins and new financial schemes has started to hit a fever pitch very reminiscent of the height of the ICO era. A number of readers reached out to ask variations of "How did we get here?"
This is the first of a series tracing the history of fund-raising in crypto from the Bitcoin whitepaper to the rise of TikTok memecoins. In this section we’ll discuss the early history of alt-coins through the Ethereum ICO and the dawn of the Smart Contract era.

In the beginning there was innocence

An interesting and perhaps not obvious thing about Satoshi is that he wasn’t interested in acquiring money. One way we know that is because he mined ~1.1M bitcoin (~$60.5B at time of writing) and never spent any of them.1 Another way we know that is through how hard he worked to ensure that he did not have any special privileged access to Bitcoin, even indirectly. Satoshi wanted Bitcoin to be equally available to everyone.

So Satoshi never gave himself an extra cut or a head start. He took no payment for his work and he raised no funds. He announced the idea of Bitcoin to the cypherpunk mailing list several months before actually starting the network and he mined all his coins as an equal peer. The reason Satoshi has more bitcoin than anyone else ever will is not because he was the founder, but because he believed in it the most. He mined the majority of his bitcoin in an era when mining wasn’t a profitable act but a charitable one.

No such thing as a fair launch

This style of distribution where the initial supply is zero and the launch is public is known colloquially as a fair launch, and for a while it was the norm. The consensus view at the time was that decentralization could be lost but it could never be added, so fair launches were viewed as necessary to preserve that ideological purity. Early altcoins like Namecoin and Litecoin launched this way, giving their founders no special privileges.

But perfectly fair launches were no longer possible - now that the market understood cryptocurrencies Bitcoin’s year long grace period before price discovery would never happen again. And it wasn’t totally clear how much the market demanded fairness over price performance - so attempts at fair launches weren’t the norm for very long.

Instead, founders of new altcoins soon began issuing tokens directly to themselves at launch - a strategy known as pre-mining. Founders who pre-mined tokens usually argued that they would use the funds to invest in the network, but the crypto community at the time was often (justifiably) skeptical. A large pre-mine was essentially a promise to eventually sell a lot of tokens and damage the price. People were often (though not always2) reluctant to invest.

The first Initial Coin Offering (ICO)

In 2013 J.R. Willet announced a fundraiser for a new protocol built on top of the Bitcoin network known as Mastercoin. Anyone could send bitcoin to the Exodus address and they would receive 100x their donation in Mastercoin. Functionally Willet had converted the pre-mine (which was unpopular) into the pre-sale (which was very popular). Here he is describing how the idea was modeled on Kickstarter:

Mastercoin raised ~4740 BTC worth ~$0.5M at the time. Willet was admirably upfront about the risks of investing. The idea was the funds would power development on the protocol and the tokens would eventually be used to access the features the protocol allowed - the very first utility coin.

Unfortunately it turns out adding extra tokens to systems makes them more complex and less accessible. Mastercoin eventually rebranded to OMNI and removed the need for users to hold tokens. The protocol is actually quite widely used - it powers USDT, for example. But OMNI tokens have no purpose at all anymore.3

You gotta burn money to make money

Raising funds to invest in a cryptocurrency project is a double edged sword. The money collected can hire developers, found conferences, pay for marketing, etc etc. But whoever controls that money inevitably becomes a source of centralization for the network. It is hard to claim a cryptocurrency is a leaderless community project with a founder running a well-funded foundation dedicated to investing in it.

That wasn’t just an aesthetic consideration - token sales were skirting around the fringes of securities law. Financial fraud has been around for a long time and is very clever about reinventing itself, so security laws are deliberately written very broadly to make them hard to evade. In American security law if someone gives you money for something believing they will profit based on your efforts, the thing you sold is considered an investment contract.4 So if anyone buying a coin in your crowdsale is hoping something you do will increase the value of that token, you are effectively selling unregistered securities. More on that later.

To sidestep those regulations the Counterparty protocol (XCP) launched in January of 2014 with a proof-of-burn crowdsale: everyone (included the founders) created XCP by sending bitcoin to an unspendable address to destroy them. No money was raised so no investment laws were broken and the launch was "fair" in the sense that anyone could buy in at the same rate and in the same way as the founders. Counterparty burned about 2140 bitcoin in the crowdsale, worth ~$1.8M at the time.

Counterparty is still active today, although XCP is only very thinly traded.

Ethereum has entered the chat

In some ways the 2014 Ethereum ICO was the culmination of the opposite philosophy for launching a cryptocurrency: unabashed about aggressive fundraising or prominent founders. 19 year old Vitalik Buterin and a bevy of co-founders launched the Ethereum presale by describing Ethereum as a 'world computer':

Ethereum’s ICO was unprecedented in a number of ways. It was 42 days long and much more actively marketed than previous sales had been. It ultimately raised 31,000 BTC worth a staggering-at-the-time ~$18.1M. That makes Ethereum is the 28th largest crowdfunded project in history - and of the 27 projects that raised more, 18 of them raised those funds on the Ethereum platform. More on that later.

It also created and set aside two pre-mined allocations equal to 9.9% of the total ether sold: one for the founders and one for the Ethereum Foundation. That pre-mine effectively meant that insiders effectively could invest at a subsidized rate, getting some of their money back from the Foundation and some back by expanding the size of the pre-mined endowments. Coupled with the long sale window that raised concerns in the past about whether to take the numbers from the presale at face value, but at this point the market has clearly priced those concerns in and moved on.

Regardless, the precedent was set - the cryptocurrency market was full of people who had gotten rich betting on a longshot - and many of them were eager for the chance to bet again. There was serious money to be made.

Aftermath of the Ethereum ICO

Ethereum’s presale was a pivotal turning point. It made the founders wealthy overnight (which attracted a wave of new developers to crypto) and it was a wildly successful investment for anyone who bought in (which attracted a wave of new investors). Ethereum was proof that if you could convince enough people you would make them rich eventually they would make you rich right now. But it also changed the market in more subtle ways.

Prior to Ethereum new cryptocurrencies were all competing to be the next Bitcoin - but competing directly with Bitcoin meant competing on Bitcoin’s terms (scarcity, decentralization, fair launch, etc) which was inherently difficult to do. Ethereum sidestepped Bitcoin entirely and presented itself not as sound money but as a world computer, raising funds not with an imperfect imitation of Bitcoin’s fair launch but imitating Silicon Valley style VC investing. Ethereum wasn’t a better Bitcoin, but something else entirely. It turns out it is much harder to convince investors you’ve built a better Bitcoin than it is to convince them you have built something entirely different that is even more exciting.

They also didn’t go to jail! Previous projects had attempted fair launches not just to mimic the aesthetics of Bitcoin but as a shelter against scrutiny from the SEC. But Ethereum had done all their fundraising in the open, with real world identities and active marketing. It was difficult to come up with a reading of securities law that didn’t forbid exactly what Ethereum had done - and yet the SEC had taken no action. It seemed like a green light to anyone worried about running afoul of the authorities. Whatever crypto tokens were, they apparently weren’t securities!5

Things cascaded from there.

Part II: The psychedelic garden blooms

In upcoming issues we’ll talk about the year of the ICO, the rise of DeFi, the dApp Platform wars and the journey from Bitconnect to Safemoon.
Stay tuned!

If Satoshi ever claimed those coins he would be the 20th richest person in the world, just ahead of Jeff Bezos’s ex-wife MacKenzie Scott (~$59.5B).

XRP for example was 80% pre-mined by the company now known as Ripple Labs.

And yet somehow they were still able to double in price this year, to $9.8/OMNI. 🙃

That is the Howey Test, established by the US Supreme Court in SEC v. W.J. Howey Co.

Narrator: They were, actually.