Recently Chain-Finance had the opportunity to interview Philipp Pieper, partner and co-founder of Swarm Fund. A method for investing in projects without some of the problems people face using traditional means, Swarm Fund makes use of blockchain technology to offer these benefits. Pieper kindly agreed to answer questions on topics such as Swarm Fund, ICOs, regulation and compliance.
C-F: Could you describe how people can use Swarm Fund to invest in and fund projects?
PP: Swarm is a decentralized capital marketplace that brings investors and fund managers together, at a fraction of the traditional cost. It lets smaller investors bundle their money and invest as a group to access high-return investments like private equity and hedge funds. This removes the need for investment minimums for smaller investors, while opening up an additional capital stack for fund managers that they’ve never had access to before in an affordable, manageable way.
In other words, Swarm democratizes access to high-return, institutional-style investments for smaller investors, while bringing the collective investment assets of the crowd – which could add up to trillions of dollars — to private equity and hedge fund managers, with much lower expenses than it would take to manage those accounts in the current financial industry.
Swarm does so by using the automation of the blockchain and smart contracts to alleviate the need for middlemen such as investment bankers, or the billable hours lawyers rack up creating largely standardized contracts.
C-F: What benefits does using Swarm Fund have over traditional fundraising and investment methods?
PP: If you think about the example of the investment minimums mentioned above, there’s a reason private equity and hedge funds have those requirements. It’s expensive to take small investments from a large number of people, and then administer all of those accounts. It’s a lot cheaper to accept $5 million from one person, than $50,000 from 100 separate people.
We alleviate that expense for fund managers by building the infrastructure they can use to connect to smaller investors. At the same time, that opens up opportunities for smaller investors they otherwise wouldn’t have.
While most retail investors can only participate in the 10 percent (on average) annual returns of the stock market, returns in alternative asset classes are upwards of 20 percent per year. With Swarm Fund, we’re providing smaller investors access to institutional asset classes that, until now, only the very wealthy have been able to take part in.
Beyond these benefits for both fund managers and investors, you add the compelling aspect of investing cryptocurrencies into real assets. That’s what Swarm does - we have built a cooperative ownership platform for investing in multiple asset classes. Our pilot funds include managers investing in art, distressed real estate, tech upstarts, software as a service companies and alternative energy.
That means that Swarm tokens won’t be some hypothetical vehicle used for value storage — their value will be determined by the worth of the actual, physical assets they’re invested in.
Our goal is to make this process of crypto investment into real assets easy to deploy and frictionless not just for Swarm Fund, but for other developers who want to use Swarm tokens to create their own projects in the future.
The first wave of crypto was transactional, with bitcoin. The second wave, via Ethereum, saw the rise of smart contracts. The third wave will come from bringing the worlds of traditional and crypto finance together, via asset-backed cryptocurrencies.
Crypto markets have hit US$100B on the underlying potential of the platform technology. But what will bring these markets to over US$1 trillion is the introduction of real assets and partners from the existing financial industry. Swarm has both the partners and team to deliver on this US$1 trillion potential.
C-F: What are the key differences between using Swarm Fund and an ICO?
PP: First and foremost, the value of Swarm Tokens isn’t determined by supply and demand alone. Instead, that worth will be determined by the value of the real-world assets behind the tokens themselves.
For example, let’s say a real estate fund running on the Swarm platform raises 1 million tokens from investors. It then invests those tokens into a portfolio of homes in foreclosure that would otherwise be valued at $1 million USD.
The assets that determine the value of the portfolio — the houses — can be denominated in USD or Swarm Tokens. The key idea here is the tokens themselves aren’t being valued in terms of another currency. They’re being assigned value from the underlying, real-world assets they’re invested in.
Secondly, the Swarm platform has a two-token architecture.
Our initial Swarm Token, which is a “utility” token, will allow buyers to gain access to and ownership in the technology platform. It will also allow them to participate in the liquid democracy governance that will ultimately decide what types of investments run in the Swarm.
At the same time, this initial utility token will give owner-members of the Swarm the ability to buy Swarm SUN tokens, which can then be used to invest in the funds and projects themselves. And incidentally, it will be owners of the Swarm utility tokens who will have “first look” access to these fund opportunities.
Beyond that, our drip-liquidity architecture, which spaces out the introduction of tokens into the ecosystem over time, ensures that Swarm isn’t subject to the pump-and-dump crypto hype cycles that have hit so many other ICOs.
C-F: How has the development of blockchain technology enabled this opportunity for businesses?
PP: Another way to ask this is whether Swarm has to reside on the blockchain, or could it be done with a centralized architecture? The answer is that the fundamental concept — crowdfunding for institutional investments — could certainly be carried out in a centralized architecture. That’s the architecture used by many of the early venture and pre-IPO crowdfunding platforms in existence today.
The difference here is that ultimately, we are trying to work ourselves out of a job by truly taking the middleman out of the equation.
While the Swarm Foundation will exist initially to help seed and develop the platform, the ultimate goal is to have 100 percent of the ownership of the platform go to members of the Swarm.
Think of it in terms of a homeowners association at a new housing development. Typically, that association is initiated by the developer who builds the project from the ground up. But once the homes are completed, ownership and governance of the association reverts to the homeowners themselves.
That’s what we want to do with Swarm, and that’s why Swarm MUST exist on the blockchain.
It is only through the use of smart contracts, which enable the binding execution of agreements without the need for a middleman to enforce them, that the Swarm can exist in this manner.
Secondarily, the maintenance of the platform itself will need to be carried out by miners over the decentralized network, because there won’t be anyone in a centralized position to do so.
Of course, the hows and details of all of this will ultimately be decided by the members of the Swarm as the platform evolves.
C-F: Was there an issue with the level of crowdfunding through ICOs or was it simply enabling the growth of promising businesses?
PP: Yes, it became far too easy for projects with certain characteristics to pitch what they claimed were crypto-related enterprises, and then have investors blindly send them money. There were a good percentage of ICOs that couldn’t prove they had a reason to exist, or even how they would develop overtime.
Either they were fraudulent Ponzi schemes, or they were brought to market entirely prematurely.
But that doesn’t mean all ICOs are a sham. Some of them have been so huge, it will take a while to determine what their actual value is, or can be, or even what they will develop into two or three years from now. The problem is akin to the early dot-com days, when no one knew how to value Internet companies. Back then, it was done in terms of eyeballs, but no one really knew what that meant.
In crypto today, it’s done with the amount of “community” behind a project or idea.
Think about Ethereum. It had broad-based support and a deep developer community that helped build its success. But even today, that still it’s just an approximation, because nobody really knows what the real revenue and value creation behind Ethereum is.
I think we’ll see a similar evolution among some of the real ICOs that have come to market recently.
C-F: Is consumer protection the biggest concern for fundraising and how can it be guaranteed?
PP: When consumers and investors are taken advantage of, it’s the duty of regulators to step in and protect them.
C-F: With ICOs and blockchain technology, is regulation as necessary; if so, how much regulation is required?
PP: See my (previous answer). That said, regulation isn’t the end all, be all for crypto at this moment.
I personally think that the cryptocurrency ecosystem can only grow if you find a compatibility with the existing financial ecosystem, as the Swarm Fund aims to do.
But I don’t think it requires a lot of regulation beyond just weeding out the obviously fraudulent stuff, which, you would assume, is already covered by criminal law.
The difficulty comes from the fact that this new ecosystem doesn’t necessarily have one jurisdiction or legal system that it resides within.
C-F: How can Swarm Fund ensure compliance?
PP: It starts with the two-token system, with one being the utility/governance token, and the second being a framework for asset-backed tokens. That gives us a lot of freedom to be compliant in different jurisdictions, since the asset-backed tokens can (and will) be customized to the rules and regulations of the market and territory and the difference between the two token tiers is the quintessential bright line test in terms of not being classified as a security.
But it’s also the willingness we’ve shown throughout our history to work with regulators in different jurisdictions. Joel Dietz, one of our co-founders, helped organize and contribute to one of the first academic gatherings on the intersection of crypto and the law with a summit on the topic at Harvard in 2014.
Ultimately, as I said above, I believe crypto can only grow if you find a compatibility within the existing system, be it regulatory, finance or otherwise.
C-F: What difficulties will regulators face in making and enforcing regulation?
PP: Simply knowing enough about the current state of affairs, and then being fast enough to react and adapt in an effective, productive way that gives guidance without having a chilling effect on innovation. But that’s always been the challenge regulators face.
C-F: Was China’s move to ban ICOs warranted and will other countries follow suit?
PP: A big part of the blanket ban in China was due to the prevalence of Ponzi schemes and scams in the ICO space. This sullied the reputation of companies that were legitimate businesses and genuinely looking to leverage opportunities in blockchain technology and smart contracts. On Friday morning, Korean regulators decided to ban raising money through all forms of virtual currencies citing consumer protection reasons and the growing risk of scams.
We agree with the motivations for hitting the pause button on ICOs, especially when such scams are lingering. Adding concerns around Anti-Money Laundering/Know Your Customer regulations being ignored and terrorist financing being facilitated by the lack of oversight around cryptocurrency, regulation is definitely in order, and we fully concur with the authorities on the need for it.
Who knows, we might see the markets in China return in a more regulated way.
It remains to be seen if other countries will follow China’s lead. In Asia, there is such diverse opinion on cryptocurrency. Japan has been welcoming, legalizing bitcoin and other digital currencies as legal tender earlier this year. Japan’s Financial Services Agency (FSA) will step up scrutiny and regulation of digital currency exchanges from October, amid plans by Japanese banks to launch their own digital currency, the J coin, with support from the government on this. 11 bitcoin exchanges have just been licensed under Japan’s new regulations. Singapore operates on a regulatory sandbox model, allowing space for innovation while clearly drawing the line between a securities offering and digital tokens while Malaysia has announced that regulation guidelines will be put in place by the end of the year. Countries worldwide are looking to regulate this space and the general outlook does not appear to be unfavourable to the continued existence of cryptocurrency, albeit in a more regulated manner.
C-F: Which countries have the most forward thinking approach to using cryptocurrencies and blockchain technology to facilitate investment?
PP: Japan, Luxembourg, Estonia, Liechtenstein and Panama are all looking for ways to play a role here. Even Germany and Hong Kong may be looking at crypto in a favorable light. It also seems that Russia is developing a friendly position.
C-F: What are Swarm Fund’s plans for the future?
PP: Launch our technology components and platform, including the liquid democracy governance structure.
Prove out the legal and technological framework by introducing the first pilot funds to the Swarm.
Open the platform to other, third parties to come on board and create their own projects, in their own way.
Get a true community ownership of the platform and market established.