My thoughts on the Overstock/tZero ICO

This is a follow-up on my original post on Overstock and blockchain.  There are likely be more to come as I learn more (and come up with more questions).

Up until I got interested in Overstock.com I had not given a lot of thought to initial coin offerings (ICOs).  I knew they were a way of raising money, I knew a few fellow investors were making a killing on them, I knew that the details were often murky and that the holders rights were not all that clear.  But I didn’t really delve into the concept too much.

As I explained in my last post, I have yet to make a serious investment in crypto-currencies.  I was running into stumbling blocks being Canadian, and it appeared that there were going to be more stumbling blocks with ICOs.  So I didn’t look too closely.

But when I started looking at Overstock, I started thinking about ICOs.   Overstock’s subsidiary tZero is going to start the pre-sale of their ICO on November 15^th (there is a countdown on their website).  tZero is 83% owned by Overstock.  This is, in essence, the first ICO for a publicly traded company.

After spending some time on it, what I’m kinda thinking now is that an ICO is a pretty neat way for a public company to raise money.  Particularly if it’s a company trying to fund a new venture that needs scale from the customer to succeed.

What are the details?

From what I can tell, we don’t know all the details.

Overstock announced some details about the upcoming t0 ICO on October 24^th, so about a week ago.  As I pointed out in my last post, of these details I thought the key ones were the following:

• The tZERO token will be tradable on tZERO’s U.S.-regulated ATS.
• The tZERO token will incorporate profit-sharing features of a security as well as utility features of an app token, including:
  • Token holders will be able to use the tZERO token to pay for fees on the ATS and payment of such fees using tZERO tokens will grant up to a 25% discount as compared to payments made using U.S. dollars. The tZERO token is expected to have additional functionality and token holder benefits to be announced at a later to date and will be included in the offering memorandum; and
  • tZERO believes its token will be the first to offer a percentage of tZERO’s profits, distributed as a quarterly distribution paid into tZERO token holders’ digital wallets.

The benefits of token holding are: A. discounts when using the platform, B. quarterly distributions and C. additional functionality to be announced at a later date.

The one thing that I’m not clear on is whether the discount is referring to the token exchange, the share lending exchange or both?  I am assuming its referring to both, but that might be wrong.

The most important distinction is that this ICO does not convey ownership, at least not in any traditional liquidation/acquisition sort of sense.  While the strict definition of Simple Agreement for Future Token (SAFT) considers this offering a “security token”, and that is how Overstock refers to it in their press release, it is not a security in the way we usually think of it.  Byrnes himself has referred to the token as a “utility token” on other occasions.

When the ICO is complete Overstock expects tZero will get somewhere between $200 – $500 million of capital (based on comments made by Byrnes a couple of weeks ago).  This will be used to further develop their various platforms: their security lending platform, their token exchange, potentially other exchanges that have yet to be revealed.

What I think is pretty cool

The way the token is set up has some pretty interesting consequences.  Unlike a share offering or debt offering, the capital provider doesn’t just give his money and sit passively. The token holder has an active interest in seeing the platform succeed.

This is because one of the two key features of the token is a discount on usage.  This means the value of the token is best realized by a consumer of the platform.  Maybe a speculator can make some money buying a token and watching it appreciate but the token holder who is also lending stock or buying tokens on the exchanges (so using the platform) is going to be benefiting more from holding the token then the speculator.  Moreover, once a consumer of the platform is a token holder, they have an interest in making that platform succeed because the value of their token will increase based on its success.

In this scenario the consumer of the platform is the natural lender.  I think that’s the key point here.

The lynch pin to the whole process is having a platform that is valuable.  If you have that, then the token offering becomes a virtuous circle of on-boarding consumers and giving them a stake in its success, which in turn will help lead to its success.

In the case of tZero, if a pension fund decides they like the idea of the alternative security lending exchange, they can buy tokens.  This will give them a discount on transactions when using that exchange.  Furthermore, once they have tokens they can benefit from the dividend and benefit from the rise in value of their token.  So it becomes in their best interests to drive business to the exchange and get others involved.

The same reasoning can be used for the other tZero platform, with a consumer of the ICO trading platform.

As for the benefits to Overstock, I’ve already pointed out that tZero gets a capital injection they can use to facilitate the growth of the business.  If allocated properly, this presumably will lead to more value creation for the token. And I imagine, though I don’t know this for sure, haven’t seen it detailed, that Overstock will keep a significant percentage of the tokens so they participate in the increase in value of the token as the platform grows.  The less obvious benefit, but the one that I think is the most interesting and should be underestimated: in many ways Overstock acquires partners in the business with an interest in seeing it succeed but without giving away ownership.

What they are really giving up is a portion of future revenues determined by the discount on usage. But again, this benefit only accrues to consumers of the platform.  And Overstock/tZero needs those consumers to buy into the platform anyways for it to be successful.  Giving away a portion of that future value to prospective consumers in return for improving the chances that this future value is realized seems like a pretty reasonable trade-off to me.

The other way to think I was thinking about these benefits was to try to frame it as a very unique debt offering with unusual attributes.  First, the principle will never have to be repaid.  Instead of payment of principle you give payment of discount.  Second, the “interest” that is paid (I’m framing the dividend as being an interest of a sort) is a function of the platform success (in terms of lost revenue from the discounts and from dividends paid).  And third, you give some sort of stake in future developments yet to come.

I’ll be honest. I have thought about this in maybe half a dozen different ways in the last few days.  Its kinda like debt, kinda like equity, kinda like a membership, kinda like a co-operative, but not really exactly like any of those things.  None of the analogies fit perfectly.  This is different.  And It’s a pretty cool way to raise money.

One other thing…

The last thing I wanted to mention is that @teamonfuego found a great bit of due diligence.  A little over a week ago Byrnes made three announcements at the Money 20/20 conference.  One of these announcements was with respect to the digital locate receipt technology they are using in the tZero stock lending platform.

Brynes said that the platform is now live in an alpha stage and has about $8 billion of inventory.  If you remember from my last post, there was about $100 million of inventory as of the second quarter earnings call.

But even more impressive, Byrnes said that by November 1^st the platform will go live with more than $120 billion of inventory.

He also said they were integrating with a couple platforms (so far unnamed), have about 8,000 users, active traders involved, and he reiterated that he thinks they can disrupt the prime broker desk which is 75% of revenue of prime brokerage industry.

When I wrote my original post on Overstock, my thought was I would add once we have confirmation of buy-in on the security lending platform.   I doubled and then tripled up on my position on hearing this news.