Community Finance Will Dominate The Next Crypto Boom
Blockchain’s best use-cases are *actually legal* inside of communities.
DISCLAIMER: Jake Chase-Lubitz is an engineering member of LexDAO. He is not a lawyer and this is publication is not legal advice. The post is for informational purposes only.
TL;DR
The majority of meaningful use cases for blockchain technology involve the management and exchange of money. Most of those use cases are illegal, except within communities of financially competent people who have pre-existing relationships. Successful Web3 projects will maximize this opportunity by:
cultivating and documenting relationships and integrating,
focusing intensely on building trust and ensuring that community members understand financial risks, and
integrating and standardizing legal text and procedures.
NOTE 1: Some of the text below will sound very obvious to crypto-folks. The goal of this article is not to break new ground, but to illustrate how well-known properties of blockchain technology are best combined with well-known properties of communities.
NOTE 2: Some DAOs are financial communities, but not all financial communities are DAOs.
Problem: Blockchain is mostly useful for money things, but most money things are illegal.
Smarter people than me have convincingly argued that there are very few blockchain-based offerings that could not be better built using traditional architecture. That argument usually lacks one critical qualifying adjective: “legal.” There are currently very few legal blockchain-based offerings that could not be better built using traditional architecture. Remove that word, and valuable use-cases become obvious. For example:
The ability to send money to anyone in the world for any reason, without limitation
The ability for anyone to create an investment offering and sell it to anyone else without paying fees to a third party
The ability to create financial tools that, once deployed, no human can control and therefore require zero trust to use.
The problem is that the value propositions underlying these use cases — censorship resistance and the removal of third parties from transactions — are precisely what the law is designed to prevent. From the government’s perspective, it must require all parties of a transaction to be known so that it can prevent certain people from receiving funds; it must have the power to permit particular investment products so that it can protect consumers from fraudulent ones; it must have the power to license financial intermediaries so it can ensure the first two powers.
Solution: Communities create a legal space for money things.
Ensuring investors are allowed to purchase a given investment is a major component of conducting finance legally. Communities can dramatically simplify this process.
Regulations set conditions for who can legally invest in private companies.
Most private (unregistered) offerings in the United States happen under Reg D. By most, I mean $3.5 trillion-worth the first quarter of 2022. If you exclude hedge funds, venture capitalists, investment funds, private equity funds, and all pooled investments, $134 billion remains. Put more tangibly, companies sold $134 billion in equity mostly to average (rich) folks in just one quarter. It’s not a small sector.
Many of these Reg D offerings happen under Rule 506(b), which allows offerers to raise money from two types of investor. 1) an unlimited number of “accredited” investors, and 2) a maximum of 35 “non-accredited” investors. Importantly, offerers may not advertise the investment publicly.
Accredited Investors: The Securities and Exchange Commission (SEC) offers clear guidelines for who counts as “accredited” (mostly meeting minimum wealth and income requirements and/or holding certification as a financial professional or institution), and offerers must be able to show that they have checked that their investors meet these guidelines.
Non-accredited Investors: The SEC sets much less clear guidance for permitting non-accredited investors. Such investors…
“…either alone or with a purchaser representative, must meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment”
Meeting this test is more of an art than a science. I highly recommend watching Maurico Rauld’s review of this question (above), but put simply, the goal is to document (ideally many) conversations with a prospective investor in order to establish that they a) have a pre-existing relationship with the offerer, and b) really understand the implications of investing in an offering.
Well-organized communities can significantly reduce the barriers to establishing these conditions.
Communities can facilitate automatic documentation of pre-existing relationships with non-accredited investors and can centralize the legal infrastructure required to significantly reduce the cost of accrediting investors.
Say, for example, that real estate syndicators, professionals, and investors meet in an online community where they share experience and advice, find deal partners, and perhaps join educational events about specific subjects. This community, built on the right software, is in a fantastic position to document member’s experience and engagement. Its members’ profiles could reflect the events they have attended and the knowledge they have shared. It could offer a record of when two members first interacted and the substance of their subsequent interactions. It could offer subject matter quizzes to “micro-certify” members, further documenting their competency.
Imagine further that this community offered accreditation to investor members, reducing the redundancy and cost that would come with individual syndicators vetting each investors themselves. It could even certify the wealth and income of investors below the accreditation threshold, giving syndicators the ability to limit the amount each investor can purchase thereby deepening their ability to demonstrate to a court that they responsibly managed their offering.
These services add up to more than the sum of their parts. Standardization of deal terms and legal definitions, and alignment of both with education, creates an environment in which community members better understand the agreements they are signing and the risks they are accepting. Communities are in a position to go beyond compliance and advance true competency and comprehension.
Blockchain makes a lot of sense in this context.
The ability to simplify the offering process, increase transparency, and manage credentials determines the effectiveness of communities at playing the role described above. Blockchain technology is very good at all three.
On-chain offerings: Permissioned exchanges and share issuance tools like we are building at Cooperativ Labs not only dramatically reduce the overhead costs (and associated human error) of managing shareholders, but they are also fundamentally transparent. Community members could observe syndication (and syndicator) performance both historically and in real time. Investors could easily demonstrate experience.
Credentials: Community organizers could assign different categories of soulbound NFTs to members for membership status, accreditation status, event participation, and professional training. These credentials are interoperable across entire blockchain ecosystems and could build recognition outside of the issuing community. Members of multiple communities could leverage all their “badges” in each.
Safer Derivatives
An additional advantage of blockchain-based assets is their composability. Say that Alice, an investor member Community A, invests in fifty private offerings that launch within that community. Instead of using her personal wallet, she uses a smart contract with the ability to lock up the shares she has purchased and issue its own set of “index tokens.” Her index token offering is inherently transparent. A user interface could instantly present the composition of Alices tokens and link prospective investors directly to fundamental information about the underlying assets. Community managers could monitor such derivatives and either restrict them or apply disclaimers programmatically.
An Internet of financial communities
When built on public blockchain infrastructure, many of the benefits of investing within communities also apply to investing across communities. Alice could also offer her index tokens in Community B. Investors and community managers in Community B have the same ability to analyze the composition of Alice’s tokens as those of Community A. We can extend this concept further. A member in Community B could repeat Alice’s process in Community C, and so on and so forth.
In this way, syndicators in Community A could access capital from many other communities while worrying only about legal compliance for their own immediate offering. In our example, Alice, not the original offers in Community A, is responsible for the compliance of her offering.
Communities also have an interest in protecting their members, so each could set — and easily programmatically enforce — it’s own limits on the layers of derivation it permits.
Don’t let dreams be dreams.
Cooperativ Labs is collaborating with REI DAO to build such a financial community right now. If you are into real estate investment, apply to join REI DAO.
We aren’t the only people who see this future. Other projects that get it include:
KaliDAO: All-inclusive DAO launcher (full legal stack)
SyndicateDAO: Launch an investment syndicate (full legal stack)
Incred: Simple tool for creating community credentials
kycDAO: Web3-native “Know Your Customer” solution
And relevant communities already exist:
LexDAO: High-functioning community filled with smart legal engineers
TaterDAO: Real estate assets on-chain
TykesNFT: Digital real estate community
Legacy Leaders: Women-led Web3 real estate investing community.