Master’s Degree Programme

Economia e Gestione delle Aziende

Curriculum “International Management” Second Cycle (D.M. 270/2004)

Final Thesis

The Evolution of Equity Crowdfunding

Through Blockchain Technology: The Bloomio case

Supervisor Ch. Prof. Giovanni Vaia

Graduand Giovanni Avogadro Matriculation Number 844580

Academic Year 2016 / 2017

II

-Thispagehasbeenintentionallyleftblank-

III

ThankstoIhadthechancetowork,butmostimportantlybecomefriends,withsomeofthemost

interestingandcapableindividualsI’veevermet;duringthecurseofthisunforgettable

universityexperience.Theyhavechangedmeprofoundly,andhelpedmetogrowintoa

new and better professional and individual. I owe a lot to them, and I am extremely

thankful.

Mygratitudegoesespeciallytomyfamily,thattaughtmetheimportanceofeducationand

themeaningoflearning.

IV

AbstractThenewconceptsbroughtupbytheintroductionofBlockchaintechnologyarechanging

many industries at once, with the promise of democratization and of the increase in

transparency of company infrastructure and of operations. The equity crowdfunding

industryisoneoftheindustriesthatcouldberadicallytransformedbytheintroduction

ofthetechnology.

Throughthisthesis,wewillpresentanintroductiontotheconceptsbehindblockchain

technology, and equity crowdfunding. We will then analyse the limitations that the

currentmethodologiesandservicesassociatedwithequitycrowdfundingmightpresent,

andhowtheintroductionofthetechnologymightmitigatetheseinefficiencies.

WewillfinallyanalysethecaseofBloomio;aSwiss-basedequitycrowdfundingcompany,

which is the first one in theworld to have implemented blockchain technology in its

operations.

V

TableofContent

Introduction………………………………………………………………………………...1

CHAPTERIBlockchainTechnology,aFocusontheEthereumNetwork…………..2

1.1.Trust……………………………………………………………………………………....31.2.DigitalSignature………………………………………………………………………....51.3.HashesandtheSequenceofTransactions……………………………………………...71.4.ConsensusandMining...………………………………………………………………....71.4.1.TheMiningProcess………………………………………………………………....81.4.2.NakamotoConsensus…………………………………………………………….....91.4.3.PermissionlessandPermissionedConsensus……………………………………....91.5.Ethereum………………………………………………………………………………..111.5.1.Accounts…………………………………………………………………………...121.5.2.TransactionsandMessages………………………………………………………131.5.3.SmartContracts…………………………………………………………………...141.5.4.SmartIdentity……………………………………………………………………..181.5.5.SmartProperty…………………………………………………………………....191.5.6.EthereumVirtualMachine(EVM)………………………………………………..191.5.7.Ether………………………………………………………………………………201.5.8.Gas………………………………………………………………………………....201.5.9.ConsensusProtocolinEthereum…………………………………………………211.5.10.Security…………………………………………………………………………..24

1.5.11.ScalingonEthereum…………………………………………………………….251.6.ThePotentialofEthereum……………………………………………………………..26

CHAPTERIICrowdfundingMechanismsanditsLimitations………………………30

2.1.CrowdfundingPlatformsandIntermediaries………………………………………...312.2.EquitybasedPlatformsanddifferentBusinessModels……………………………...322.2.1.Peer-to-PeerContributionMechanism…………………………………………..362.2.2.EquityBasedandRoyalty-BasedModels………………………………………...382.3.DifferentServiceModels………………………………………………………………412.3.1.ServiceModularization…………………………………………………………...422.3.2.ServiceModulesforCrowdfunding……………………………………………….422.3.3.PlatformInteractionandServiceProvision……………………………………...452.4TheGrowingIndustryofEquityCrowdfunding………………………………………472.4.1AdvantageswithRespecttoVentureCapital……………………………………..482.5.Inefficiencies……………………………………………………………………………522.4.1.MicroeconomicChallenges………………………………………………………..522.4.2.RisksAssociatedwithCrowdfunding…………………………………………….55

VI

CHAPTERIIICrowdfundingIntegratedinaBlockchain-BasedEcosystem:DecentralizedApplications(DApps)........................................................................58

3.1.Functionality,StructureandDesignofaCrowdfundingDApp……………………....593.1.1.FunctionsPerformedbytheDApp………………………………………………...603.1.2.EquinityCrowdfundingDAppRelationalStructureintheNetwork……………..683.1.3.ServicesandFunctions..……………………………………………………...........693.2.Blockchain-BasedEquityCrowdfundingEnvironments:BusinessandInteraction

Models…………………………………………………………………………………..703.2.1.Peer-to-PeerContributionMechanismTroughaDecentralizedApplication……713.2.2.Equity-BasedorRoyalty-BasedContributionMechanismTroughaDecentralized

Application........................………………………………………………………...723.3.ServiceModulesforCrowdfundinginaBlockchain-BasedEcosystem……………..733.3.1.ServiceModulesImplementedwithBlockchainTechnology…………………….743.3.2.PlatformInteractionsandServiceProvision…………………………………….773.4.EffectsofDecentralizedApplicationsonCrowdfundingInefficiencies……………..793.4.1.MarketInefficiencyReductionwithBlockchainTechnology……………………803.4.2.MarketInefficienciesThatCouldBeSoftenedbyDAppFunctionalities……….. 823.4.3.FinancialRisksThatCouldBeSoftenedbyDAppFunctionalities……………….88CHAPTERIVBlockchain-BasedEquityCrowdfundingPlatform:TheBloomioCase………………………………………………………………………………………………..92

4.1.The“CryptoValley”Regulation………………………………………………………..934.1.1.CryptoValleyAssociation………………………………………………………....934.1.2.FINMAinterpretationandLegislationonTokens……………………………......964.2.TheOriginofBloomio,TheVisionoftheFundersandtheLegalBattle…………......994.3.CompetitiveAdvantageandKeyFeatures…………………………………………...1014.3.1.CompetitiveAdvantages…………………………………………………………1014.3.2.BloomioKeyFeatures……………………………………………………………1044.4.FutureDevelopments……………………………………………………………......1074.4.1.TheFutureofBloomioandtheCryptoValley………………………………..…107

Conclusion………………………………………………………………………………...111

References…………………………………………………………………………….….113

ListofFigures…………………………………………………………………………....120

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Introduction

TheinventionoftheDatabasebyIBMin1970,revolutionizedtheworld;somuchthat

right now, every aspect of our societydepends on this idea of recovering and storing

information.

Blockchainisnowabouttorevolutionizedatabases,whichwillinturnrevolutionizeagain

everyaspectofoursociety.

Blockchainisaboutcreatinga“database”whichisaccessiblebyanyoneoranythingatany

time,working like a network instead of having a single point of failure. The secret is

Decentralization.

Decentralization offers the chance to individuals to interact and cooperate with each

other,withouttheneedofacentralauthorityoramiddleman.

Thisnewtechnology is influencingstepbystepmany industries,andthepromiseofa

democratizationoftheworldisincreasingitsnotorietybytheminute.

Wheneverthemiddlemaniseliminated,efficiencyrisessubstantially.Theneedtoscalein

ordertosatisfythehugesupplychainswehavecreated,makesusrelyondealsmadeon

humongousquantities.Blockchainanditsdecentralizedsystemwouldchangethat,and

wouldhelpsmallbusinesstocompetewiththeindustrygiants.

Thetechnologyisstillnewandnoteveryonehasacompletegraspofitsfunctionalities,

potentialandfuturedevelopment.Eventhoughthetechnologyisalmost10yearsold,we

arejustseeingnowthefirstattemptstotransformitinsomethingvaluableforcompanies

butmostimportantlyforpeople.

Asitfrequentlyhappens,regulatorsarebeingscepticalandslowinthedeterminationof

the legal boundaries of the technology, but this is not scaring industry giants and

innovationenthusiastsintheexplorationofit.

Many industries are changing to adapt to this innovation, but the first industry to be

affectedisofcursethefinancialone.Giventhenatureofthetechnology,thecrowdfunding

industryisalsochangingratherrapidly; it isacceptabletobelieve,thatthisecosystem

andtheworldeconomy,willundergoextremechangesinthenextfewyears.

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CHAPTERI

BlockchainTechnology,aFocusonTheEthereumNetwork

“Sayingthatblockchainisanewformofdatabase,islikesayingthat

e-mailisanewwaytosendpeopleletters”BillGates,2017

Blockchainisapublic,trustedandsharedledger(TheEconomist,2017).Sharedsinceit

isbasedonpeer-to-peernetwork,meaningthatitisnotcontrolledormanagedbyasingle

individual,butbyallitsparticipants.Itisavailabletoall,hencepublic;anddatacannotbe

manipulated without being approved by everyone in the network, which makes it a

trustedledger.Thisspecificsetofattributes,maketheBlockchaintechnologynotonly

moresecurewhenmanagingsensibledata,butalsoabletoeliminateintermediarieswhen

transferringinformationinadecentralizedmanner.

Blockchaintechnologyisusuallyassociatedwiththevirtualcryptocurrency“Bitcoin”but

thepotentialofitisnotnecessarilyassociatedwithcurrencytransactions.Blockchaincan

beadaptedtofitmanyindustriesandbusinessmodels,butmostimportantly,itcanbe

used to create organizations able to support themselves in a complete decentralized

matter.

TheBlockchainhasbeenofinterestformanypeoplesinceitcameoutin2009.Itispart

ofthe4thindustrialrevolutioncharacterizedbyafusionoftechnologiesthatisblurring

the lines between the physical, digital and biological sphere (Schwab, 2017), full of

disruptionanddisruptors, and togetherwithmanyothershas thepotential to impact

heavilyonsociety.

Blockchain can be defined as a “distributed database or ledger”, which uses a secure

protocol where a network of servers, also called “Nodes”, collectively verifies a

transactionbeforeitcanberecordedandapproved.Therefore,blockchainscanbeused

to create trust, not reliable on a thirdparty anymore, but on the technology itself; by

enablingpeoplewhodonotknoweachother(andthushavenounderlyingbasisfortrust)

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tocollaboratewithoutgoingthroughacentralauthority(Schwab,2017).It isashared

databasecontrolledbythenetworkwithnoindividualpartyexercisingcentralcontrol.

Innon-technicalterms,ablockchaincanbeseenasalargeandtransparentspreadshit,

wherealltransactionorassetsofanorganizationarechronologicallyandpermanently

stored since the creation of that entity. All the transactions are also maintained and

verifiedbyallpeersinadecentralizedway,makingitextremelytransparentandglobally

recognizedastrue.

To better understand this technology and its process, we want to go deeper in the

descriptionofallthemostimportantcharacteristicsandtermsassociatedwiththisnew

technology.

1.1.Trust

Twopreconditionoftrustareriskandinterdependence(Chen&Dhillon,2003).There

hastobeinfactinterdependencebetweenthetrusteeandtrustor.Ifthat’snotthecase,

nomatterhow intricate theiractionsare, theydonoteffectoneanother.Moreover, if

thereisnouncertainty,noactionbythetrusteecanchangetheevents,andthus,notrust

isneeded.Trust canalsobedefinedas a two-sided, asymmetric relationshipbetween

entities;thetrusteeorrecipientofthetrustcanbeanything,fromaperson,anobject,a

process or a computer algorithm. Sometimes though, the trust relationship has to be

constructed from both sides of the relationship. Trust has also a scope and can be

contingenttospecificcircumstances;thatdefinesunderwhichrulesoroccasionswemay

wanttotrustsomeoneorsomething,andwhatactionswetrustthemtoperformonour

behalf.

Intheeconomicexchangeworld,wecanfindthreedifferenttypesoftrust:institutions-

based,characteristic-based,process-based.

Institution-basedtrust:

Institution-basedTrustcomesfromanauthoritythatiscentralized.Thisistheexample

ofacommercialbank,thatwetrusttomanageourmoneyasacentralizedinstitution.

Characteristic-basedtrust:

Characteristic-basedtrustisthetrustwehaveinsomepeoplebecauseofthesimilarities

betweenoursandtheircharacteristics,taste,origin,orevenvaluesinlife.Wetendtotrust

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morepeoplewithasimilarbackground,andthatsharesimilarperceptionoftheworldto

ours.

Process-basedtrust:

Process-basedtrustisrootedintosocialmicro-rulesandnorms,accordingtowhichwhen

facing a known interaction with someone, we are able to theoretically predict the

responsebythecounterpart.Forexample,weexpectsomeonetoanswerwhenaskeda

question.

Consequently,giventhedifferencesinthetypeoftrust,therearealsodifferencesinthe

typeoftrustfaildependingonthetypeoftrustwearefacing.Trustcanbelostifacentral

organizationfails,ifthepersonyoutrustfails,orifthetheprocessyoutrustfails.

On-linetrustassumesanevenmoreimportantrole,since:

“Thedegreeofuncertainty,dependency,andriskishigherintheon-lineworld

thanintheoff-lineworld”ZainabM.Aljazzaf,2010

Uncertaintyanddependencyassumeanevenstrongerroleintheon-lineworld,where

traditionaltechniquestoholdtrustdonotholdanymoreandtrustworthyrelationships

arecreatedaroundareputationsystem.

InusingBlockchaintechnology,peoplemayfindithardtotrusttheprocessoracomputer

program,butsomeofthemaredrowntotrustthetechnologywhenfriendsorpeoplethat

share a similar vision and interact in the same sphere become early adopter of the

technology. Note that the types of trust involved in this type of relationship are

characteristic-basedandprocess-basedtrust,thatcomposethemixoftrustrelationship

thatevolvearoundblockchaintechnology.

Weneedtorememberthatisnotthetechnologyitselfthatdefineswhatisreallytrue,and

itcouldoccurthecaseinwhichnoteverythingthatisontheblockchainistrue.Whatthe

blockchaindoesinfact,isverifythatacertaindatawasinputtedinthesystemataspecific

momentintimeandstorethatinformationforever,butitcannotguaranteethatthatpiece

ofinformationisnecessarilytrue.Theonesthatdefineifthatinformationistrueornot,

aretheusersinsidethenetwork,thatvalidatethetransaction.

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Blockchainaffectstrustinseveralwaysinthebusinesscontext.Theprotocollayerand

thebusinesslayeroftheblockchain,bothaffecttrustanditsperceptioninthesystem.In

theprotocol layerwecanhave twomajorbenefits,namely transparencyandsecurity.

These two characteristics aremadepossibleby the technology, through theuseof its

system of immutable history of transactions and the use of public and private keys1.

Security canalsobe increasedbydecentralizationandencryption,making the system

moreprivateandsafer.Securityandtransparencycanbeconsideredsomeofthemost

importantcharacteristicofthistechnology,thatdirectlyinfluencetrust.

In the business layer instead, trust is affected by the creation of rules, rights and

restrictiontouser’sactions,thatcanbeimplementedinthecodeoftheprogramsthat

regulatethetransactionscalledsmartcontracts2,thatcanimprovetrustorevenmakeit

pointless.

1.2.DigitalSignature

Thedigitalsignaturescheme,inventedbyWhitfieldDiffieandMartiHellman,explained

intheirseminalpaper:“NewDirectionsinCryptography”,isthedigitalcorrespondentof

apapersignatureused in theblockchain transactionsystem.Through it,everyuser is

allowedtohaveoneormore“publickey”and“privatekey”.

Apublickey isapubliclyavailablekey, in the formofastringofbits. It is likeabank

accountnumber,anyonecanseeit,anditisassociatedwithonepersoninparticular;itis

thanatraceableandtransparentwaytoidentifyaperson.Theprivatekeyontheother

hand,isstillastringofbits,butitisonlyavailableandvisible,tothesingleuser,itcanbe

definedasadigital IDthanonlytheuserholds,andnooneelsecan. It isadigitaland

uniqueidentificationforanindividualoramachine.

Publicandprivatekeycanbeusedinthevalidationofatransaction,inwhichbothparties

involvedagreeontheexecution.Thetransactioncanbeatransferofcurrency,property,

data,orasimplecommunicationortheexpressionofaright; thisentitlestheusersto

determinewhethertheywanttobeinvolvedinthattransactionornot.

Thissystemwascreatedtoallowforahighlevelofsecurityandtransparencyandtomake

surethatbothpartiesinthetransactionareprotectedandawareofthetransaction.The

processofvalidationofatransactioncanbesummarizedassuch:

1Section:1.2DigitalSignature.2Section:1.5.3SmartContracts.

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1) Thetransactionisbroadcastedbythesendertothenodesinthenetwork.Each

transactionisprotectedbya“digitalsignature”.Transactionsaresenttothepublic

keyofthereceiverusingtheprivatekeyofthesender.Byusingapreciseprivate

key,thesenderisprovingtheownershipofthatprivatekeylinkedtohisidentity.

The receiver of the transaction verifies the digital signature on the transaction

throughtheuseofhisownprivatekeyprovinghisidentityanddemonstratingthat

heacceptedthetransactionandisawareofit.

2) Onceitisacceptedbythepartiesinvolved,thetransactionissenttoallthenodes

intheblockchain,thatcheckitandapproveitmakingsurethatalltheconditions

inside the transaction are met to be recorded permanently in the system.

Consensus3betweenthenodesinsidethenetworkisnecessaryforthevalidation

andtranscriptionofthetransactioninthepublicledger.

Wewilltakeacloserlookattheconceptof“Consensus”insection1.4,butforthesakeof

clarity,wecansaythatconsensusmeansthatbeforerecordinganytransactionsinthe

public ledger, verifyingnodes4have to agreeon the truthfulness and feasibilityof the

proposed transactions before recording it in the ledger. One of the conditions for the

transactiontobefeasibleforexample,istoensurethatthespenderowntherightamount

of currency; hence that he has sufficient funds to support the transaction. Evenmore

important condition for the system to certify a transaction, is the presence and the

validationofboththesignaturesofthepartiesinvolved.

Theuseofsignaturesisnotlimitedtocommercetransactions,butcanbeusedforevery

formofofficialtransaction,infactwiththissystem,allsortsoftransactionsandtransfer

ofownershipcanbecarriedoutdigitally.Digitalandpaperbasedsignatureshavetwo

important characteristics in common; they both guarantee that a defined piece of

informationpassed fromonesite toanotherwithoutbeingaltered;and theycanboth

allow the receiver toprove toa thirdparty thathe received thatpieceof information

directlyformthesigner.Themaindifferenceliesinthefactthatthetraditionalmethods,

relyonthecertificationofthetransactionbyatrustedthirdpartylikeabank,alayerora

notary; in the case of the blockchain on the other hand, transaction validation is

performedbythenetwork,inadecentralized,transparentandsecureway.Furthermore,

3Section:1.4ConsensusandMining.4VerifyingNodes:Nodesinthenetworkdevotedspecificallytothevalidationoftransactions.

- 7 -

information about all transactions and interactions, are secure and not guarded by a

single individualbutbythewholesysteminadecentralizedmatter. Wewouldliketo

inform the reader, that the similarities to the traditional system of certification of

transactions, ledtothecertificationbytheunitedstatesofDigitalSignaturesaslegally

binding5.

1.3.HashesandtheSequenceofTransactions

The Blockchain construction is composed by “blocks” containing all transactions; this

means that every transaction ever made on the platform is stored in groups of

transactionsthathavehappenedatthesametime.Theseblocksarelinkedtoeachother

inside the blockchain, creating a chronological order of transactions that are secure,

immutable,anduntouchable.

Havingthisconceptinmind,thechancemightbethatoneormoreuntrustworthynodes

willmakeparalleltransactions,sendingthesameamounttotwodifferentrecipients.This

actiscalleddouble-spending,andamechanismisestablishedtoavoiditfromhappening.

Themechanismthatpreventthesesituationsfromhappeningiscalledmining;basedon

theproof-of-work(PoW)schemethatwewilldiscussinthenextsection.Beforewego

intodetailwithminingandPoW,wewanttoexplainwhatdefinesthechronologicalorder

betweentheblocksintheblockchain.

Toensure thatallblocks followeachother in thedefinedorder, eachblock isgivena

“hash”thatwilldeterminetheorderoftheblockinsidethechain.

Thefirstblockiscalledthegenesisblock,andeachblockthatfollowedcontainsthehash

ofthepreviousblock.Thechainofhashes,constitutesthe“chain”inblockchain.

1.4.ConsensusandMining

Theuseofconsensusisnecessaryformanyfunctionsbotheconomicandsocial.Thereare

benefitsandempowermentforeveryonetrustingasingleledger,startingfromafaster

way to reach a settlement, or the elimination of fraudulent actions. Traditionally,

consensusisgivenbyacentralauthoritylikethegovernment,notaryagencyandsoon,

but the traditional system is expensive, labour-intensive and centralized. What the

blockchaintechnologyaimsat,iscreatingaconsensussystemthatischeaper,democratic

andlessrisky.Thisisdonebymakingconsensusdecentralized,makingitmoresecure,

5http://usinfo.state.gov/opical/global/ecom/00063001.htm

- 8 -

and creating rewards for maintaining it cost effective; improving processing power,

withoutincurringintoomuchsocialcosts.

Consensusmeans thatnodesagreeon the samestate6all the time (HenningDiedrich,

2017),andtheorderinwhichtheblocksoftheblockchainshouldbeput.Allthenodesin

chargeofconsensus,needtoagreeonthetruthoftransactionsandontheorderofthe

blocksthatcomposetheblockchain

Theonesthatneedtoachieveconsensusarethesocalled“miners”,andtheyarethenodes

thatdecidetotakeparttotheconsensusbuildingmechanism.Throughthismechanism,

valid transactionsare selectedby thenetwork to composeablockwhichminers than

validateinordertomakeitabletoattachittothenextavailablespotintheblockchain.

1.4.1.TheMiningProcess

Wewillnow try togiveamore indepthdefinitionofminingandexplainwhy it is so

importantforthecreationofthechain.

Miningistheprocessthroughwhichtransactionsareverifiedandonceverified,stored

insidethepublicledger(Sterry,D.R.,2012),andthemethodfortheextractionandrelease

ofcryptocurrency.

Theminingprocessconsistsintheaggregationoftransactionsintoablock,andusethe

computing power at the disposal of theminer, to find the solution to amathematical

problem.Theresultofsuchamathematicalproblemwillbetherighthash,meaningthe

hashthatisconsequenttothehashofthelastblockattachedtotheblockchain.

Minersneedtowintheminingprocess(theracetofindtherighthash)tobethefirstone

to attach the new block to the blockchain.Whoeverwins themining process,will be

allowedtobroadcastthenewblocktotherestofthenetworkupdatingthechain;this

way, only real and approved blocks can be put on the chain, avoiding the creation of

maliciousblockswithfalseinformation.Thewinneroftheminingrace,isalsoreworded

withcryptocurrency;thisprocessallowsforthedistributionofnewcoinsinthesystem,

andatthesametimeprovidesanincentivefornodestoparticipatetotheminingprocess.

Without this incentive, theminingprocesswouldbe tooexpensive in termsofenergy

consumption,topushnodestominetransactions.

Theminingprocessforthefindingoftherighthash,usuallytakes10minutes.Withthe

increasingof the velocitywithwhichmines are able to findhashes, themathematical

6State:isthetotalityofthedataandthetransactionsthathavebeenwrittenontheblockchainsincethegenesisblock.

- 9 -

problems to be solved become harder, in order tomaintain the hash finding process

aroundtenminutes.

1.4.2.NakamotoConsensus

TheconsensusprotocolofBitcoinisalsocalledthe“Nakamotoconsensus”,namedafter

thecreatorofBitcoinsSatoshiNakamoto(NakamotoS.,2008).Nakamotoconsensuscan

bedefinedwithasentenceas:“thelongestchainwins”.Tounderstandthisdefinition,we

firstexplaintheconceptofafork.

Asweknow,consensusreferstothesituationinwhichallminersagreeontherightspot

inwhichanewblockshouldbeput,dependingonthehashthattheblockisassociated

with.Thereistheremotepossibilitythough,inwhichtwominerswillfindthesolutionto

the mathematical problem - and hence the right hash - at the same time. In these

situations,thechainsplitsandcreatedwhatiscommonlyknownasa“fork”,whichcanbe

resolvedthroughdifferentmethodsdependingonthenatureoftheledger.Inthecaseof

theBitcoinledger,minerskeepminingonbothbranchesofthefork,butwilltrytoattach

theirnewblocksonlytothebranchoftheforkthathasthemostblocksattachedtoit.

Afteracertainnumberofblocksaremined,thebranchwiththemostnumberofblocks

attached to it wins, and the other branch is eliminated. This does not result in an

eliminationoftransactions,sincetheblocksthatareeliminated,areexactlythesameof

theonesthatarepresentonthewinningbranch.

1.4.3.PermissionlessandPermissionedConsensus

Therearedifferencesinthemodalitiesofparticipationtoconsensusbynodes,depending

on the type of ledger that is being created. Participation to the consensus can be

permissionless and permissioned; this difference affects deeply the reaching of

consensus.

Inapermissionlessledger,everyonecontributestoconsensus.Apublicblockchainsuch

as “Ethereum”7, is constructedas such. In aPublicblockchain, allparticipantshave to

reachconsensusovereverychangetothedata.Thismeansthateverytransactionhasto

beapprovedbyeverypeer,eveniftheydonotparticipatedirectlytothetransactionitself.

7Ethereum:isanopen-source,public,blockchain-baseddistributedcomputingplatformfeaturingscriptingfunctionality.ItprovidesadecentralizedTuring-completevirtualmachine,theEthereumVirtualMachine(EVM),whichcanexecutescriptsusinganinternationalnetworkofpublicnodes.

- 10 -

Allpeershaveagreeduponacommonledgerandtheyallhaveaccesstoalltransactions

everrecorded.

Thissystemraisessomeprivacyissueseventhoughinformationisencrypted,together

with the effect on performance on transaction processing. The requirement of having

everymemberagreeonthestateoftheledgertakestimetoachieve,anditalsorequires

afairamountofenergy.

In a permissioned ledger, to the contrary, consensus power is given to a previously

selectednumberofnodes,onlytheonesthataredirectlyinvolvedinthetransaction.With

thissystemthere isa strongcontrolover thecirculationof information, resulting ina

higher degree of privacy. Furthermore, with having just a limited number of peers

obligated to reach consensus, theprocess results faster andmoreefficient.Consensus

definitionhereisbroadandconsidersthewholetransactionflow.Thissystemrequires

for different roles to be given to nodes when reaching consensus, differently form a

permissionlesssystem,wherepeershaveidenticalroles.

Eachpermissionedledgerhasitsownwaytovalidatetransactions,dependingontherole

thatisbeengiventothesinglepeer.

Within“Fabric”forexample,anothertypeofledger,wehaveclients,peers,orderersand

endorsers, thatrespectively invoketransactions,maintainthe ledger,orderupdatesto

the ledger to record new transactions, and check if new transactions fulfil certain

sufficientconditionstobeputintheledger.

Anotherblockchainsystem,called“Corda”,usesadifferentsystem,whereconsensusis

determinedbyvalidityanduniqueness.Specificallydevelopedsoftwareassociatedwith

thetransactiontakecareofvalidity,whetheruniquenessmakessurethatthetransaction

inquestionistheuniqueconsumerofallitsinputstate(Sanders,P.2017).Notarynodes,

ontheotherhand,reachconsensusoveruniquenesswithapluggablealgorithm.

Blockchainisawayforinformationtoberecordedandsharedbyacommunity(Deloitte

University Press, 2016), a community in which every member has a copy of the

informationandallmembersmustvalidateanychangecollectively.Theinformationcan

be anything that can be described digitally like transactions. Information in a public

blockchainaretransparent,permanentandsearchablemeaningthateachmemberofthe

communityisabletoviewallofit.Everyupdatecreatesanew“Block”thatcomposesthe

“Chain”.Newentriestothechainaremanagedbyaprotocolthatdecideshowtheyare

initiated, validated, recorded and in the end distributed, and sets the differences that

- 11 -

characterizethedifferentledgers.

1.5.Ethereum

Theblockchaintechnologycanbeimplementedinmanydifferentways,andresearchon

thefieldhavecreateddifferentwaystoexploit it,creatingdifferenttypesofDLT8with

differentpurposesandconstruction.AtthemomentthreeofthemostdevelopedDLTs

are “HyperledgeFabric9” (Fabric), “R3Corda10” (Corda), and “Ethereum”11.TheseDLT

have different visions of the application of blockchain, especially because of the

differencesintherespectivefieldofwork.

DevelopersfromFabricandCordafocusonspecificapplicationsandconcreteusecases

(Sandner, 2017); Fabric focusses on creating a modular and extendable architecture

employable invarious industries, focusingonbankingandhealth care, over to supply

chain;whereasCordafocusesonthefinancialserviceindustry.

Ethereum on the other hand presents itself more independent than Fabric of every

specificfieldofapplication.WhatstandsoutforEthereumisnotit’smodularity,butthe

goalofcreatingagenericplatformforallkindoftransactionandfunctions.

Ethereum is ahighly flexibleDLTwith itsowncurrency, thatwith itspowerful smart

contractsiscapabletomakeitapplicabletoanykindofapplication.Thepermissionless

systemandthetotaltransparencyalthough,leadstoperformancescalabilityandprivacy

issues.

Ethereumhasamoregenericapplication,andit’sveryflexibleinternalsoftware,canhave

many applications and the capability of creating a “world computer”. Ethereum and

Bitcoin are both peer-to-peer networks, and share many characteristics, but some

conceptsandimplementationsdifferfromoneanother.Thesedifferenceshowever,make

itpossible forEthereumtosupportandprogramdigital contractsdefinedbycomplex

logic.ForthesereasonswewillfocusourattentiononthisspecificDTL,thattogetherwith

the related DApp (Decentralized Applications) and DAOs (Decentralized Autonomous

Organizations)ischangingandwillchangedrasticallythewaywedobusinessandhow

wehandlesensibleinformationandtransactions.

8DLT:DistributedLedgerTechnology.9https://hyperledger-fabric.readthedocs.io/en/release/10https://www.corda.net/11https://www.ethereum.org/

- 12 -

1.5.1.Accounts

AccountsisthesystemusedbyEthereumtorepresentownershipofvalue.Anyentitythat

holdsa state inside the system in fact, is associatedwithanaccount, thathas itsown

privateandpublickey.TheprivatekeyisthedigitalIDoftheowneroftheaccount,andis

neededtosigntransactions,certifyingtheidentityofthosewhosign;thepublickeyon

theotherhandistheaddressoftheaccount,whichispublicandworksastheaddressof

theaccount.

Accountobjectsarecomposedbyfourdifferentfieldswithspecificvalues.Dependingon

the typeofaccount, thevalues for these fieldschangeresulting indifferentproperties

(Wood G., 2014). These properties are: “Nonce”, a counter of the transactions and

contracts thatwent throughtheaccount; “Balance”, thevalueretainedbytheaccount;

“storageRoot”,theroothashofthe“MarklePatrishaTree12”,constitutingthestorageofthe

account;andthe“codeHash”,ahashofthecodethatshowshowtheaccountworks.

Accountsarethandividedintoexternallyownedaccounts(EOAs),andContractAccounts.

Externallyownedaccountsarecontrolledbyaprivatekeyandarepersonal,allowingfor

interactionbetweenprivateusers likeexchangeofcurrencyandmessages.AContract

Accountontheotherhand,isacomputerprogram,whichiscomposedbycodethatholds

thelogicthatcontrolsit(Ethereumfrontierguide,2016).

AContractAccountfunctionsasadepositaccounttostorevaluewhiletransactionsare

taking place on the platform, and can have different functions depending on the

informationandthecodestoredinsideit.WecanthinkofanexampleofContractaccount

ifweconsiderUser-A,whichwantstobuygoodsfromUser-B,butbothdonottrusteach

otherduringthetransaction.User-Aisabletoputthemoneyinapreviouslyconstructed

ContractAccount andwait for the goods to arrive.Once the goodshave arrived, both

partieswillsendanothermessageto thecontract, thatwillsendthemoneytoUser-B.

Untilbothpartiesapproveofthetransaction,themoneywillbelockedinsidetheContract

Account.InordertoavoidmaliciousactionsbyUser-Athatwouldnotreleasethemoney

evenafterreceivingthegoods,theagreementcouldbeconstructedsuchthatatrusted

thirdpartywillbeinvolvedtosettlethedispute.

12MarklePatrishaTree:acryptographicdatastructureusedtostoreallkeys.

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1.5.2.TransactionsandMessages

InsideEthereumthereisadistinctionbetweenwhatcanbeconsideredatransactionand

whatcanbeconsideredaMessage.Thisdistinctionexistsbecauseof thetwodifferent

typesofaccountspresentinthenetwork.

Peersinsidetheblockchain,transfervaluethroughtransactions.Thesetransactionsare

generatedsingularlyandthendistributedtotherestofthepeer-to-peernetwork.

Inordertoavoidmaliciousactionsfromothernodesinthesystem,alltransactionsmust

be signed by generating account through the use of their own private key; this will

authorizethetransitionbythenodethatgeneratedthetransaction.

Transactionsinordertobecalledassuchmustcontainalltheinformationnecessaryin

ordertomakethattransactionuniqueandrecognizablebythenetwork;thismeansthat

they must contain: the total number of transactions sent from the senders account

(nonce), the price per computational step (gasPrice13), the maximum price for the

computationofthetransaction(gasLimit14),therecipientaddress(to),theamounttobe

transferred(value),thesignatureofbothparties(v,r,s),andspecifyifthetransactionwill

createanewaccountorwill refer toanalreadyexistingaccount (Data/Int) (WoodG.,

2014).

Messages on the other hand differ from transactions in the sense that they are

communicationsgeneratedby theexecutionof transactions.Messagesarrive fromthe

transactionthatgeneratedacontract.Massagesarenotneededtobesignedbecausethey

areneverbroadcasted to thenetwork,but theyare justpartof thesystemsexecution

environmentastheresultoftheexecutionofacode.Figure(1),showshowmessagesand

transactions interface with EOAs and contract accounts. As we can see, the external

ownedaccountistheoriginofalltransactions;messagesontheotherhandaregenerated

from contract accounts to the outside, and in between contract accounts; after been

triggeredbytransactionsinthecontractaccount.

13Section1.5.8Gas.14Section1.5.8Gas.

- 14 -

Figure(1):Messageandtransactionsinteractionsscheme.

Messages have a specific structure composed by elements that carry important

information necessary for the functioning of the process.Messages need to contain a

sender,theaddressofthecontractthatstartedthemessage;atransactionoriginator,the

addressoftheEOAthatcalledthesendercontractcodeexecution;arecipient,theaddress

of thebeneficiaryof themessage; thecodeaccounttobeexecuted, theaccountwhose

codeshouldbecarriedout,usuallyacopyoftherecipientcode;startGas,gasavailablefor

theoriginationofthemessage;value,thevaluetobetransferredthroughthemessage;

gasPrice,thepricenecessaryforthecomputationalsteps;data,optionaldataneededfor

themessage;depthofexecutionstack,theextentoftheexecutionload.(WoodG.,2014)

1.5.3.SmartContracts

SmartcontractswereinventedbyNickSzaboin1994,andrequiredacentralauthorityin

hisvisioninordertofunction.Withtheintroductionofblockchain,theyfoundanother

systemwheretheycouldbeimplemented.

WhatcharacterisesEthereuminfact,isthepresenceofthesocalled“SmartContracts”.A

smartcontractcanbedefinedasanagreementwhoseexecutionisautomated(SzaboN.,

1994),orastheyhavebeendefinedmorerecently:

- 15 -

“Acomputerized transactionprotocol that executes the termsofa contract.Thegeneralobjectives are to satisfy common contractual conditions (such as payment terms, liens,

confidentiality,andevenenforcement),minimizeexceptionsbothmaliciousandaccidental,

andminimizetheneedfortrustedintermediaries.Relatedeconomicgoalsincludelowering

fraudloss,arbitrationsandenforcementcosts,andothertransactioncosts.”(TapscottD.,TapscottA.,2016)

Such agreement is concluded between two actors as in a peer-to-peer, peer-to-

organizationorperson-to-machineinteraction.Assoonascertainconditionsaremet,the

contractwillbeexecutedandassets,ownership,orcurrencycanbeexchangedbetween

thetwoparties.Thetransactionresulting,isvalidatedbythemembersofthenetwork;

andthoughtthemethodswepreviouslyanalysed,storedinsidetheblockchain.

AccordingtoNickSzabo,smartcontractsinordertobedefinedassuch,needtohavethe

following characteristics: visibility, on-line enforceability, verifiability and privity.

Visibilitymeans thateachparticipant to thecontract shouldbeable toseeeveryone’s

compliancetothecontractandperformancewithrespecttothetermsofthecontract;this

meansthattheymustalsobeabletoprovetoathirdpartytheirfulfilmenttothetermsof

thecontract.

On-lineenforceabilityreferstotheprofofthefulfilmentofallthetermsinthecontract.

Inordertofulfilthistask,measurescanbetakenthancanbedividedinproactiveand

reactivemeasures.Proactivemeasuresmakeitimpossibletocrackterms,whilereactive

onesblockmaliciousbehaviour.

Verifiabilityreferstothepossibilitytoverifytheexistenceandthevaliditybyexternal

thirdparties.Verifiabilityofcontractsisnecessaryforconflictresolution.

Lastly,smartcontractsshouldbeprivate,meaningthatthecontentandconditionsofthe

contractshouldbeavailableonlytothepartiesinvolved.

The use of the smart contract, enables the transfer of assets and the execution of

transactionswithoutathirdpartybeingnecessarilyawareandinvolved.Thesevirtual

agreements could allow for the creation of a system in which intermediaries are

completely eliminated and transactions are carried out without the intervention of a

trustedthirdparty.

Smart contracts are simply software written in a programming language. Difference

thoughexistbetweendifferentblockchains in the role that these codeshave. In some

networks, thesecontractsarenot justmadebycode,butmayalsocontain legalprose.

- 16 -

Ethereumhaveasimplerconstructionforsmartcontractsanddonothavethisfeature.

These contracts can be seen as a binding agreement that can move information and

money,basedontheagreementsdefinedinthem.Theyareunstoppable,guaranteedto

resolvethemselves,dependingontheblockchainandnotbyalegalsystem,andeasierto

readthanalegaltextthatcouldbefalselyinterpreted.

Ethereumrunsageneralblockchain,butithasembodiedinsideit,asystemormachine

calledEthereumVirtualMachine(EVM)15,whichithasbeencreatedspecificallytorun

andmanagethesesmartcontracts.ThepresenceoftheEthereumVirtualMachineiswhat

distinguished-atfirst-Ethereumfromtherestoftheblockchain-basedplatforms.

ThesesmartcontractsarewritteninSolidity,whichisaprogramminglanguagesimilarto

JavaScript16. Solidity is now used by different systems that allow for the use of such

contracts, sincemanydevelopersunderstood thepotential of smart contracts andare

implementingthem,withcertainvariations,totheirversionoftheblockchain.Whenthe

contract is complete, it is linked to the EVM and deployed to an Ethereum address,

initiatingtherelation.

Sincesmartcontractsaredeployedtotheblockchain,werealltheinformationrelatedto

it areaccessible toallusers, therearea fewrules that these contractsmust follow to

ensureacertainlevelofsecurity;thesecharacteristicsare(BergquistJ.H.,2017):

Damagecontrol:

Thereshouldbelimitationstothevaluetobeputonasmartcontract.Ifinfact,inthecase

ofthepresenceofabuginthecontractonwhichthevalueisstored,amalfunctioninthe

contractmightcauseapermanentlockingdownofthatvalueinsidethecontracts;without

anypossibilityorreachforitbyanyone.

Modularity:

Smartcontractsshouldbeassimpleandasshortaspossible,inordertokeepreadability

andavoidmisunderstandingbyusers.Contractscanbeinterconnectedwithoneanother,

allowing for the modularization of more complicated transactions. As modularity

increases,thesystemitselfimproves.

15Section:1.5.6.EthereumVirtualMachine(EVM).16 JavaScript:Programminglanguagecommonlyusedinwebdevelopment.

- 17 -

Checks-EffectsFunctions:

Thesecontractsshouldbeabletocheckifsomepreconditionsarereachedasthefirststep

ofthealgorithm.Ifthepreconditionsaremet,thecontractcanmovetothesecondstep,

which isable toapplychanges to thestate-variable.Once thesestepsare fulfilled, the

transactioncantakeplace.

In order to be embodied in the contracts, elements like rights, responsibilities, or

allocationofpropertyshouldhavethestructuretobetranslatedintocode,andallowfor

anautomatedachievementofresults.

Traditionalsolutionstothisproblem-liketheuseofathirdtrustedparty-involveahigh

levelofhumaninteraction,hencehighermanagerialcostsandrisk.Withadecentralized

system,thereistheeliminationofthepossiblecreationofmonopolisticpowerexercised

byconsensuscentralizedauthorities.Thesefactsallowforadifferentdefinitionofsmart

contractsas:

“Smart contracts are digital contracts allowing terms contingent on decentralized

consensusandareself-enforcingandtamper-proofthroughautomatedexecution”.(CongL.W.,HeZ.,2016)

Thisdefinitioncanbeassociated,andisconsistentwith,commondefinitionsusedinthe

legalworld(Lauslahti,Mattila,Seppala,etal.,2016),andbySzabo(1998).

Aswerealizedsofar,thedecentralizedtechnologyofferedbyblockchainenablestheuse

ofsmartcontractsandallowsforagreatercontractibilityandenforcementofagreements,

facilitatingtheexchangeofcurrency,propertyandanythingofvalue,throughtheuseof

automatedalgorithmsandavoidingconflicts.

InsidetheEthereumblockchain,thesystemusescryptocurrencytomakesmart-contracts

function,thiswaythereisthealmosttotaleliminationofatrustedthirdpartynecessity.

Ethereuminfact,hasitsownbuiltincurrencycalled“Ether”.Thiscryptocurrencyisused

to rewardminers but also to pay feeswhenever a transaction or a smart contract is

executed.

Definingsmartcontractstoatisstillcomplicatedgiventhenatureofthephenomenon

andtherelativeyoungageofit.Whatweknowthough,isthatitscorenotionistocreate

contractsonpossibleeventsbasedonadecentralizedconsensus;withlowcosts,andwith

- 18 -

mathematicalandalgorithmicexecution.Inordertosupportthesecontracts,weneeda

distributedledgerwithself-executingcapabilitiesliketheblockchain.

1.5.4.SmartIdentity

Insection1.2wetalkedaboutdigitalsignaturesandtheconceptofprivateandpublickey.

Oneofthepossibleimplicationoftheintroductionoftheseapplications,isthecreationof

thesocalledSmartIdentityorDigitalIdentity.

Inthetraditionalsense,identityreferstothesetofinformationandcharacteristicsthat

distinguishoneindividualfromtheothers.Inthecyberworldontheotherhand,identity

ofanindividual,consistsofthedigitalrecordassociatedwithhim/her.Theserecordsare

formatted in a standardized way, so that they could be utilized to provide identity

informationandbeusedinastandardizedwayinthedeploymentoftransactions.The

construction and standardization of these digital documents, supported by the

blockchain, has a list of positive attributes such as: existence, control, access,

transparency, persistence, portability, interoperability, consent, minimization, and

protection,togetherwiththeimplementationandsupportofSSI17.

Users are enabled trough the blockchain to manage and control their own data

independentlyandnotbyutilizingatrustedexternalthirdparty;andatthesametime

prove their identitywhen performing any type of interactionwith other users in the

system.

The process of identity verification on a blockchain-based system, requires what is

usuallyreferredtoasthe“handshakemechanism”(KikitamaraS.,2017).Themechanism

iscomposedbyaprocessdividedinthreeseparateactionsthat,inthatsequence,allow

foraproperidentificationofusers.“Login”,“Verify-Request”,and“CreateResponse”are

thethreestepsofthismechanismandinaccordancetothese,someapplicationsbasedon

blockchaintechnologyhavebeendevelopedtomanageauthenticationsystems.

Digitalidentityisnecessaryanddecisiveinsecuringinformation;itallowsforthecreation

ofaccessmechanism,andallowsuserstohaveapersonalizedandaccountablepresence

on-line,limitingthethreatofidentitytheft.Thissystemalsoallowsforthereductionof

unauthorisedaccesstopersonalinformation,anddatainfringement.

17StandingSettlementInstruction:areinstructionstofollow,everytimeatradeismade,usuallyassociatedwiththetransferoffundsand/orsecurities.

- 19 -

1.5.5.SmartProperty

Thedefinitionofsmartpropertycanbesummarizedasthecapabilityofapropertytobe

byitself,partofastipulatedcontract.

Smartcontractscanhavemultipleapplications,oneofthoseislinkedtoproperty,andthe

possibility of creating around them, through these contracts, a digitalized security

structure.The technologywouldbeable in theory, toconstruct contractual termsand

securityobligationsaroundproperty,turningtheminactualsmartproperty.

Ifwetakeforexampleacar,asimplecontractwouldgivetotheownerpermissionforthe

usageofthevehicle,throughtheuseofcryptographickeys,basedoncontractualterms.

These applications can have many implications and benefits in terms of ownership,

transferofpropertyandpermissionstotheuseofcertainassets.

This systemcanbeapplied toanyassetwhosepropertyorusagecanbegranted toa

persontroughacontract;thisincludespropertyrightsandcopyrights.

1.5.6.EthereumVirtualMachine(EVM)

The Ethereum Virtual Machine (EVM), is the execution environment for Ethereum

(Ethereumcommunity.TheEVM,2016);itisthecomputersystemthatallowEthereum

torunsmartcontractsanddistinguishitselffromtherestoftheDLTs.Alltheactivenodes

of the system run the same items of the EVM, and whenever a new transaction is

introducedandexecutedtothevirtualmachine,thesystemchangesandmakeseveryone

in thenetworkupdate to the latest versionof the stateof the system,where thenew

transactionisincluded.Throughoutthisprocess,trustisensured,evenifalargenumber

ofcalculationsarerequired.

Externalactorsgenerateinputs,ortransactions,throughtheuseofEOAs18attheedgeof

the system, and Contract Accounts can be tackled trough transactions that can

communicatetooneanotherthroughmessages.EVMstaysabovethem,beingthesystem

that allows for the creation of these accounts and consequently, the fulfilment of

transactionsandinteractionamongusers.

EVMisaglobalmachineinthesensethatitisrunbyallthenodesinthesystem;thevirtual

machine is in fact spread out to all the nodes in a peer-to-peer fashionworkingwith

commonaccountobjects(RudlangM.2017).Interactionsbetweenobjectsisallowedand

permittedthroughmessagesandtransactions,andaccountsaremonitoredandgoverned

18EOAs:ExternallyOwnedAccounts.

- 20 -

bythekeyusedbythenodes.

1.5.7.Ether

Like many other blockchain-based environments, Ethereum requires the use of an

internal cryptocurrency in order to runmost of its operations. “Ether” is Ethereum’s

cryptocurrency, and in the Ethereum system is in fact used mostly as fuel to run

operationsontheplatform.Itismostlyusedtopayfeestospecificnodesofthenetwork

for the effort of participating in the consensus mechanism. Ether can be obtained in

differentways;bymining,orbypurchasingitfromanotheruserorthirdparty.

1.5.8.Gas

AlanTuringin1936,provedthatitisnotpossibletodeterminebeforeitisexecuted,ifa

computerprogramwillrunforeveroritwillfinishrunning,giventhedescriptionofsuch

aprogramandaninput.

Asweknow,eachtransactionthatisexecutedinsidetheblockchain,hastoberanbyevery

nodeinthesystembut,iftheprogramcodeinvokedbythetransactioncreatesaninfinite

loop,thiswillcreateseriousproblemstotheplatform,immobilizingandshuttingdown

thewholenetwork.Thepossibilityinfactexiststhatanodewillgenerateacodethatwill

runforever,eitherbyavoluntarydestructiveact,orbyaninvoluntaryhumanmistakein

thewriting of the code. In order to avoid such an eventuality, Ethereumdeveloped a

security system for smart contracts, thatmakes themconsume “gas”,having thougha

limitedamountofenergyfortheexecutionoftheoperations.

Gasisdescribedironicallyas“cryptofuel”,andtheideabehinditistoassociate-toevery

computationalsteprequiredbytheminer-acostoftransactioncalled“gasPrice”,payed

totheminerbytheuserthatoriginatesthetransaction.

A“gasLimit”isalsosetbeforethetransactiontakesplace.ThegasLimitsetsthelimitfor

the total amount of gas that the operations involving that transactionwill be able to

consume.Everyoperationthatneedstobeexecutedwillconsumesomeofthegasatthe

disposalofthetransaction.Ifsomeofthegasisnotconsumedbytheminerthroughthe

computations,theremainingfuelwillbesentbacktotheoriginatorofthetransaction.If

duringthecomputation,thegasLimitisreached;thetransactioniscancelledbutthegas

used,goestothemineranyway.

Thissystemallowsfortheinterruptionofanycomputationthatmightresultinaloopand

mightimmobilizethesystem;sinceeventually,everycomputationwillrunoutoffuel.

- 21 -

Theseprecautionswilldiscouragesomehackersfromattachingtheplatform.Thissystem

makesitimpossibletocreateinfiniteloops,butitstillallowsforverybigonesthatwill

slow down the system and give time to malicious users to take advantage of the

temporarystallofthenetwork.InthesectionabouttheSecurityofEthereum19wewillgo

furtherintodetailsonthistopic.

Withtheintroductionofthisfeeformining,minersarenotde-incentivisedtoundertake

harderandlongercalculations,sincetheeffortforsuchmathematicalcalculationswillbe

fairlyrewarded.

Gasprice isdependentontheamountofcomputationrequired,andbytheagreement

betweentheminerandtheuserofthetransaction.Itcannotbedefinedasastandardized

Etheramount,alsobecauseoftheheavyvolatilityofcryptocurrenciesinthefreemarket.

MinersarealsoentitledtoavoidcomputationsthatofferatolowgasPrice;thiscreatesa

marketforcomputationandgas.

1.5.9.ConsensusProtocolinEthereum

As we seen in the consensus section20; consensus consists in the mechanism that is

createdbetweennodes,inordertodeterminewhichblocksaretobeconsideredauthentic

andtrue,andwhicharenot.IntheBitcoinsystemweknowthattheconsensusmechanism

iscalledNakamotoconsensusanditfollowstheruleof:”Thelongestchainwins”.This

system though,may delay the broadcasting of the authentic blocks to the rest of the

system,affectingthesecurityofthewholenetwork.AccordingtoYonatanSompolinsky

andAvivZohar(SompolinkyY.,ZoharA.,2013)inthetimebetweenthecompletionofa

blockandthebroadcastingtotherestofthenetwork,thesystemisvulnerabletopossible

attacks,anddelaysinthepropagationofthebocksmayhaveserioussecurityissues.We

canidentifytwomajorfactorsthatinfluencethepossiblecreationofthisstateandthey

are“Blockcreationrate”and“Blocksize”.

Blockcreationratereferstothetimeinterposingbetweenthecreationoftwoblocks.

Let’sassumethatthetimetobroadcastanewblocktoeverynodeisalwaysthesamead

fixed;ifwereducethetimethatexistsbetweenthecreationofoneblockandtheother,

wewillputthesysteminanotsecuresituationmoreoften,increasingthetimeinwhich

thesystemisvulnerable topossibleattacks. InFigure(2)below,wecansee theblack

arrowasthetimenecessarytoreachallnodesandinwhichthesystemisinavulnerable

19Section:1.5.10Security20Section:1.4ConsensusandMining

- 22 -

state.

Figure(2):Shorterblocktime

Blocksizeontheotherhandreferstothevolumeofinformationembodiedineachblock.

Wheneveranewblockcontainsalotofinformation,itwilltakemoretimetobroadcast

allthatinformationtoallthenodesinthesystem,thiswillincreasethedeltaoftimein

whichthesystemsisvulnerable.TheblackarrowinFigure(3)showsthedifferencethat

Blocksizemakesinmakingthesystemmorevulnerable.

Figure(3):Biggerblocksize.

Theseassumptionsmakesenseinasystemwhereallnodeshavethesamecomputational

powerandareabletotransferequallywelltheinformationbetweenotherpeers.Vitalik

Buterin(ButerinV.,2014)pointoutthough,thatthereisasubstantialdifferencebetween

differentnodes,intermsofbothcomputationalpowerandcentralizationwithrespectto

othernodes;thismeansthatsomenodesaremorelikelytoproducenewblocksandbe

abletoreceivethemfasteraswellasbroadcastthemfasterinsidethenetwork.Forthese

reasons,Ethereumusesadifferentsystemtoachieveconsensuswithoutimpactingthe

securityofthesystem.Thissystemiscalled:“TheGreedyHeaviestObservedSub-Tree”

commonly referred to as GHOST. First introduced by Sompolinky and Zohar, GHOST

differsfromtheBitcoinconsensussysteminthesensethat:“theheaviestsub-treewins”,

- 23 -

ratherthat,“thelongestchainwins”(SompolinkyY.,ZoharA.,2013).With“theheaviest

sub-treewins”werefer to the treewith themostcomputationsworkrelated to it.So,

wheneverafork,orasplitfromablockoccurs,thesub-chainthatshouldbeselectedas

trueaccordingtoEthereumistheonethatisnotnecessarilythelongest,buttheonewith

thehighestnumberofblocksgeneratedbelowitandrelatedtoit.Figure(4)showsthe

differencesintheselectionofthesub-treeforthetwodifferentnetworks.

Figure(4):Subtreeselectiondifferences.

Aswe can see, a forkhas been created starting from “Block-0”, creating two sub-tree

called“Subtree-A”and“Subtree-B”withdifferentdepth,respectively4and3.According

totheBitcoinorNakamotoconsensus,Subtree-Ashouldbeselectedbecauseofthehigher

depth.InthecaseoftheEthereumconsensusmechanismontheotherhand,Subtree-B

willbeselectedbecauseofthehighernumberofblocksassociatedwithit;itisinfactthe

heaviestsubtreebetweenthetwo.BlockB2’iscalledaOmmerBlock,anditiscreatedby

smallerminersthatwouldcontinuetomineonablockevenifanothervalidblockhas

beencreated;sincethesenewvalidblocksmaytakemoretimetoreachthem.Inorderto

avoidwastingtheminingeffortgivenbythesesmallerminers,theworkcreated,isadded

up to the system to increase the tree size. The miners that create the Ommers are

rewordedfortheircomputationaleffort,evenifitisafractionofwhattheminerofthe

- 24 -

globallyrecognizeblockisbeengiven.Themaximumlevelofdepthofasubtreeallowed

is six, and themaximumnumberofOmmersallowed insidea tree is two (RudlangM.

2017).

1.5.10.Security

Thedependencyonglobalconsensusinsidetheblockchainsystem,createssomesecurity

flawinthenetwork.Oneofthemostknowntypeofattackisthe“51%”attackconsidered

tobethemostdangeroustreattothesecurityofthesystem.

Aswe have seen before, in order for a transaction to be recorded on the blockchain,

consensus by all miners has to be provided. This means that the introduction of a

maliciousblockortransactionwouldbespottedbythenetworkandrejected;unlessa

groupofminestogetherwouldbeabletocontrol51%ofthetotalcomputingpowerof

thenetwork.Thiswouldmeanthatthoseholdingthe51%oftheminingpower,wouldbe

abletocreateafakemaliciousblockthatcouldnotberejectedbytherestoftheminers

being them in numerical disadvantage. The attack could change the rules of the

blockchain,creatingprogramsthatbenefitthat51%majority.

Thecreationofsuchasituationwouldrequireanimmensecomputationalpower,thatnot

evenpoolofminers21couldgather. It is interestingtonotice though, that the freeand

opennatureofthenetworkcouldtheoreticallyallowforsuchascheme,sincenoauthority

exists thatwould prevent such an attack. It is important also to notice that if, such a

circumstancewouldcometohappen,thesystemwouldrecognizethetreatandabandon

the platform, that would be permanently compromised, leaving the attacker with a

uselessnetwork.

The“LongRangeAttack”(ButerinV.,2017)isanadaptationofthe51%attack,thatallows

fortheslowingdownoftheauthenticationprocessbyminers,allowingahackertohave

thetimetodevelopitsownblockandattachittothechain.Inordertodoso,anhacker

wouldhavetoslowdowntherestofthevalidatingnodes,creatingaverycomplicated

transaction,towhichonlyheorshehasthepossibilitytoactivatespeciallydesignedtrap

doors22andgetaheadofotherminers.Thiswouldallowhimorhertoattachtothechain

21 Poolofminers:Alargegroupofminersthatputtogethertheircomputingpowertowinminingraces. 22 Trapdoor:consistsinanunknownentrypointinsideacomputerprogramthatallowsonlythecreatoroftheprogramtohaveaccesstospecificsectionswithouttheconventionalprocessofidentification.

- 25 -

ablockinsideofwhichtherearecontractsortransactionsthatwouldvoteinhisorher

favour.Theattackercaninfactre-writetheblockchain,whiletherestoftheminersare

occupiedexecutingthelonglooptransaction.

AsweknowtheEthereumsystemallowsusertowritetheirowncontracts,programs,and

applicationsthatareputontheblockchain;theseprogramsmayormaynothavesecurity

flawsdependingonhowwelltheyareprogrammedandwritten.Thepossiblepresenceof

bugscouldbeexploitedbymalicioususersandunderminethestabilityofthecontracts.

There has been a case inwhich an unintentional loop hole in a smart contract in an

Ethereuminstancewasexploitedbyahacker.Thehackerwasabletowithdrawfromthis

companycalled“TheDAO”,asignificantamountofmoney(ButerinV.,2017).Thecontract

of the “The DAO” worked as it was programmed to do, but unfortunately who

programmed itdidnotrealize that it couldhavebeenusedagainst them.Users in the

systemrealizedthattheTheDAOhadbeenhackedandmostofthemagreedtomakeaso

called“HardFork”,thatcreatedanewblockincontrastwiththemaliciousblockcreated

bythehacker.Thisnewblockwasrecognizedbyalmostthemajorityofthenetworkand

themoneystolewentbacktotheoriginalowners.Thishardfork,createdasplitinthe

blockchain, creating two different network, “Ethereum” and “Ethereum Classic”, that

containthesameinformationuntilthemomentoftheattack.Bothchainsnowworkand

havetheirownusers,butworkinparallel,withoutanyinteractions.

The hack of the TheDAOwas awarning sign for those thatwant to construct smart

contract.Buterin(ButerinV.,2016)intheEthereumblogreassuresusersthatevenifthe

platform is perfectly safe and allows for the creation of perfectly functioning smart

contracts,itisstillnecessarytopayparticularattentiontothepresenceofpossiblebugs

insidecontracts.Thereareon-linecompaniesrightnowthatcanhelpuserscreatesafe

andsoundsmartcontractsandpreventthesehacksformhappeninginthefuture.

1.5.11.ScalingonEthereum

Unlike the Bitcoin network, Ethereum contains not only transactions, but also the

informationonthelateststateofthecontractswrittenontheEthereumplatform.This

will create a serious issue for scalability of the platform. One of the solutions to this

problem is the fact thatEthereumnodes, canhavedifferent rolesandstore just some

sectionsofthestate,andnotthefullblockchainhistory(ButerinV.,2014);onlyactive

- 26 -

nodesinfactmuststorethecompleteblockchain,likeintheBitcoinnetwork.Theoriginal

Ethereumprotocol doesnot force all nodes to store thewholeblockchain in order to

validatetransactions.

With this arrangement, there is though still the problem of the centralization of

information.Fullnodes,as thesizeof theblockchain increase,maybecome fewerand

fewer,creatingtheopportunityofworkingtogethertousetheplatformattheirinterests.

In order to copewith this problem, Ethereum uses a verification protocol, creating a

“proofofinvalidity”thatwillavoidverificationofinvalidblocks.

1.6.ThepotentialofEthereum

Now that we have some knowledge of what a blockchain is and what are the

functionalitiesof thisnew technology,wecan try todefinewhatmightbe itspossible

applications.Thepotentialof the technology in fact,goesbeyondthemerecreationof

cryptocurrency.Applicationofthetechnologycanspaceacrossfinanceobviously,public

records, private records, physical assets keys, business, government, andmany other

industries.

TheLegalProfession:

Thelegalindustryisfacingatransformationleadedbytheuseofblockchaintechnology,

andmorespecifically,bytheintroductionoftheconceptofsmartcontracts.Throughthis

technology,someaspectsofthelawcanbedigitizedandconvertedfromlegalproseto

flawlesscode.

Currently,thelegalsystemanditsbureaucracycreatestonsofpaperworkwhichishard

tokeeptrackof.Eachaction, transactionor legalacthas toberecordedandstored in

ordertohaveanactualproofofwhathappenedandwhoweretheactorsinvolved.The

blockchaintechnologyoffersasysteminwhichanyinteractionorchangeofstateinan

asset can be recorded and remain in the ledger for ever. This will reduce drastically

administration costs and reduce time needed to gather necessary information about

single cases. The introduction of the technology in this environment could be a game

changerthatwouldhelpthecreationofabetter,moretransparentandconsequentlyfair

system.

We need to keep in mind that blockchain technology and functionalities, cannot be

applicabletoeveryaspectofthisenvironment.Thetechnologycan,andprobablywillbe

appliedtothosetasksthatcanbenefitfrombeingautomatized.

- 27 -

Whenitcomestosmartcontracts,whattheycandoisnotsubstitutethealreadyexisting

structureoflaws,buttheycanhelpinthecreationoftrustbetweenthepartiesinvolved.

Withthecreationofnewmarkets,willcomethecreationofnewneeds,inwhichsmart

contractswillcertainlyplayacentralroleinthedefinitionofrelationshipsandtrust.

Clearing&Settlement:

TheuseoftheblockchaintheClearing&Settlementservices-usuallyofferedbyfinancial

institutionsandthirdparties-isprobablythemostinterestingandusefulapplicationof

theblockchaininthefinancialsector.The“Fintech”industryisinfacttheworldinwhich

theDLTtechnologyhasbeenappliedandstudiedthemost.Theseactivitiesusuallycost

billionstofinancialinstitutionseveryyear,andfinancialgiantslikeSantander23believe

thatthistechnologywillsavetheindustrybillionsinthenextfewyears.

SomeofthemajorbenefitsoftheapplicationofDLTtechnologyinthefieldofpayments.

Clearingandsettlement,couldtackletheissuesthathavebeenpartoftheindustryfor

quitesometime;theseinclude:end-to-endsettlementspeed,dataauditability,resilience,

andcostefficiency.Thepromiseoftheresolutionoftheseproblemsledtheindustryand

itsactorstoinvestigateonthepotentialofthetechnologyanditspossiblebenefits.The

technology could changedrastically the industry and theway inwhichpayments and

otherfinancialservicesareprovided.

Thetechnologyisnotfullydevelopedyetatthispointintime,transactionsinfactcould

befaster,andscalabilityisstillanissue;butmanyfinancialcompaniesareinvestinginit

andwillsoonmaketheirdevelopedsolutionspublic(Mills,David,WangK.,MaloneB.,

Ravi A., Marquardt J., Chen C., Badev A., Brezinski T., Fahy L., Liao K., Kargenian V.,

EllithorpeM.,NgW.,BairdM.,2016).

Smart/DigitalAssets:

Thetechnologyaroundblockchain,allowsforthecreationofthesocalledSmart/Digital

Assets.Asmartassetcanbedefinedasaproperty,whoseownershipiscontrolledthrough

ablockchainandtheycanbetransferredusingcontracts;thisallowsforarathercostless

andtrust-lesstransferoftheownershipofassets.Transactionsandtransferofproperty,

through the use of smart assets,will reduce substantially transaction fees andwould

allowtradesthatwouldhaveneverbeenpossiblewithoutthetechnologybehindit.

23http://www.santanderconsumer.it/prestiti?gclid=Cj0KCQiAyZLSBRDpARIsAH66VQKkUEcGphSjM6aALj6DlbiB5iJY6jEsTjA-uV5h55uyy5vAKoNpmQUaAvtzEALw_wcB

- 28 -

Thetechnologyallowsonlythoseinpossessionofthekeytobeentitledtotheownership

oftheasset.Thisapplicationwillalsochangethewayinwhichloansandcollateralsare

distributed and collected, since the ownership of anything can be traced easily in the

publicblockchain.

Thosethatwillinvestinthissortofsystemnow,arebelievedtohaveanadvantageinthe

futureforwhatconcernspropertyrights,traceabilityofassets,andproofofownershipof

thoseassets.

DigitalIdentity:

Every individual inorder to interactdigitallywith the restof theworld,must relyon

digitalidentityinordertoberecognizedandinordertorecognizetheonesheorsheis

interactingwith.However,thestateoftheartinsecurityfordigitalidentity,makesithard

totrust thepersonweare interactingwiththoughtthe internet,since it is fallibleand

disjoint; and furthermore centralized and costly. The introduction of the blockchain

technologywillallowforthecreationofadigitalidentitythatisunique,trustworthy,not

managed by few individuals that hold our private information, and secure. This will

empowerpeopletobeentitledoftheirownidentityandshareitbetweenothertrusted

individualsinatrustednetwork.

Thiswillimprovecustomerprotection,andsecurity,whilehavingcontroloverpersonal

datatobedisclosedtothepublic;whileontheotherhandwillallowbusinessestoreduce

theriskandthecostofstoringsensibleinformationontheirservers.Ontheregulatorside

although, it will help them to standardize processes, while increasing efficiency and

qualityoftheirwork(IBM,2017)24.

Voting:

Traditionalvotingsystemscanbeconsideredriskyinthesensethatapaper-basedsystem

canbemodifiedbymaliciousauditors,anditiscostlytomanageandkeeptrackofallthe

information associated with it. It currently exists a type of digital voting, that still is

centralizedandmanagedbyasingleentityandasingleserver.Thisallowsforthecreation

ofasinglepointoffailure;asinglestorageofinformationthatcanbehackedandmodified

bymalicioususersorbythetrustedthirdpartyitself.

It is necessary to create a system that would be digitalized, secure, transparent and

24 https://www.ibm.com/blockchain/identity/

- 29 -

flawless,inwhichinformationaboutvotescanbestoredandimpossibletobemodified.

With the introduction of the blockchain technology in the voting system, these

characteristicsaremetandcancreateasecuresysteminwhichvoterscanbesuretheir

informationandtheirwillisbeingpursued.

Thesystemwouldallowforaclearandpreciserepresentationofthewillofthevoters.

Thissystemcanbeappliedinanysituationinwhichthevotingrightscanorhastobe

implemented,meaningthatitcanbeimplementedinthegovernmentsystemaswellas

insideacorporationwherethewilloftheshareholdersshouldbepursued.

Healthcare:

Oneofthemajorproblemsinthehealthcaresystemistheinabilityorthedifficultiesfor

differenthospitalsorplatformtoshareinformationaboutpatients(CollenM.F.,2011).

this limits the knowledge for medical institutions and doctors of the conditions of a

patientthathasbeentreatedintheirinstitutionforthefirsttime.Theintroductionofthe

blockchaintechnologycouldchangethistrend,byallowingnotjustforacleardefinition

ofthepatient’smedicalhistory,butwillalsoallowforthecreationofadatabasewhereall

theinformationaboutdifferentcaseswouldbestored,creatingalearningplatformfor

doctors,andpossiblyalearningartificialintelligence.

Obviously,theinformationrelatedtoeachpatientwouldbeprotectedandthroughthe

useofdigital identity, is thepatient thatwilldecidewhowillbeable toseehisorher

medicalrecordsandespeciallywhattheywillbeabletosee.

These are only some of the possible applications and the improvements that this

technologyisbringingtothetable.Butaswecansee,conceptsandthestructurebehind

it,areabletochangepositivelyandsubstantiallymanyoftheaspectsofourlives.

Inthenextchapters,wewilltakeacloserlookofoneofthepossibleapplicationofthis

technologyandwewillseehowtheimplementationoftheblockchainwillimprovethat

industryandevenbeabletocreatemanynewsideindustriesthatwillcompensatesome

ofthecurrentissueswehavewiththetraditionalmethodologies.

- 30 -

CHAPTERII

Traditional&EquityCrowdfundingMechanisms,Limitations,and

Potential

Inthecreationofanewventure,raisingcapital foranentrepreneurmaybehardwith

traditionalmethodsoffunding.Creditcanbeuncomfortabletocarryespeciallyforanew

venture.Crowdfundingtriedtosolvethisproblembycreatingspecificinternetplatforms,

onwhichapersonoranorganizationcouldraisecapitalfromthecrowdforaparticular

venture.Theobjectiveistobeabletoraisesmallamountsofcapitalfrommanymembers

ofthenetworkformingthecrowd.

The reward for contributing to the capital raising can be different depending on the

typologyofcrowdfundingused.

ApossibledefinitionofcrowdfundingcanbethefollowingbyBelleflamme(Belleflamme

P.,2013):

“Crowdfunding involves an open call, mostly through the Internet, for the provision offinancialresourceseitherintheformofdonationorinexchangeforthefutureproductor

someformofrewardtosupportinitiativesforspecificpurposes.”Belleflamme,2013

Thisdefinitionmaybecriticizedsinceitdoesnottakeintoconsiderationthegoalofthe

investorsandthecreatoroftheventure.

Thosewhoseektocollectthemoney,maybedoingittocollectsmallcapitalsforasingle

activityorinordertocreateanewventure.Theuseofcrowdfundingcanalsoprovethe

validityofanIdea,thatwouldallowfortheraisingofexternalcapitalbysomeoneoutside

the network. These platforms and structures can also be used in order to promote

business activities and raise interest for organizations in the development stage or

creation.

Collectorsmightbeseekingtoraiseasmallamountofmoneyforaone-timeprojectorto

findseedcapital forastart-upbusiness.Furthermore,crowdfundinghasbeenusedby

collectorstoshowapotentialdemandfortheirideawhichcanleadtoincreasedfunding

- 31 -

fromothertraditionalsources.Crowdfundinghasalsobeenusedformarketing,tocreate

interestfortheprojectatanearlystage.

Inthischapterwewillfocusnotsomuchonthedifferenttypologyofcrowdfunding,but

on the specific Equity-Based platforms that allow for such an innovativeway to raise

capital.Thisnewmethod is contraposed to the traditionaloneofVentureCapital and

presentsaseriesofadvantagesandcharacteristics,thatarechangingthewayfundsare

raisedbysmallandindependentventures.Inthischapterwewillanalysethedifferent

advantagesanddisadvantagesof thesystemandespeciallyhow important trust is for

bothpartiesinvolvedinthesetransactionsthatinvestorsandtheentrepreneurface.

2.1.CrowdfundingPlatformsandIntermediaries

Crowdfundingplatformscoverthethirdpartyrole,stayingbetweenthetwosideofthe

transactionsduringtheprocessofraisingcapital.Theplatform’srolecanbeconsidered

astheoneofthemiddleman,eventhough,itdoesnotparticipatedirectlyinanycapital

raisingcampaign.

Platformsofsuchsort,participateindirectlyinthecampaigns,offeringalistofservicesto

boththecollectorsofthefundsandthecontributors,inordertomaketherelationshipas

easyaspossible,ascheapaspossibleandassecureandrisklessaspossible.

Theyoffer a platformof communicationbetween investors and entrepreneurs,where

communicationbetweenthetwopartiesisalloweddirectly;secondly,theyallowforthe

creationofapoolofpossibleinvestorsfromwhichentrepreneurscanhaveaccessto.Itis

a group of people that declare to the platform their willingness to participate in

interestingandprofitableopportunities.Furthermore,theseplatformsallowtransactions

tooccurbetweeninvestorsandnewventuresinordertoraisecapital;andfinally,they

areabletoclosedownpossiblydishonestprojects,butatthesametime,candecideto

sponsorotherones thatparticularly interest them.Theseplatformsare in factable to

create good conditions for entrepreneurs to raise capital and be able to create new

ventures(AgrawalA.K.,CataliniC.,GoldfarbA.,2011).

Theyalsoprovidethe investorwitha listofpossiblecampaigns fromwhichtochoose

from,andmostimportantly,theyareentitledoflegitimizingthecrowdfundingmarket;

meaningthattheyplaytheroleofthetrustedthirdparty,necessarytoallowtheflowof

transactionsbetweenthetwopartiesinvolved.Oneofthemostimportantrolesinfact,is

theserviceofduediligencetheyperformontheproposalsoffundraisers.Thisisthemost

interesting characteristic, that distinguishes them from the traditional form of

- 32 -

crowdfunding,inwhichanyideacanbepresentedtotheinvestingpublic,regardlessof

itsvalidity.

2.2.EquitybasedPlatformsandDifferentBusinessModels

Thepresenceofmorethanoneagentthatinteractsthroughanintermediary,characterize

thecreationofwhatcanbedefinedasamulti-sidedmarket(RysmanM.,2009).Inthe

caseofthecrowdfundingmarket,theseagentscanbecalledcapital-seekingandcapital-

giving. In thisenvironment, the roleof the intermediary thatallow for the interaction

between these two agents is played by the crowdfunding platform. Through a

crowdfunding platform, the two agents are able to connect and avoid possible

asymmetriesininformationandreducelargelycostsoftransaction(MahadevanB.,2000).

Platformsarefinancialintermediaries,thatplaytheroleoftwo-sidedfinancialallocators

inamarketcomposedbycapital-givingandcapital-seekingactors.

Financialintermediariesareabletoofferfinancialservicesthatcanbedescribedfroma

functionalperspective,anddividedinthreesubcategoriesofservices,thatare:LotSize

Transformation,RiskTransformationandInformationTransformation(HassP.,BlohmI.,

2014).

LotSizeTransformation:

These intermediariesprovideservices inordertoaccumulatecapitalandtheymake it

easierfortheactorsinvolvedtohaveaccesstoit.Theyallowtheexchangeofgoodsby

creatingadhockpaymentsystemsandmechanisms for theaccumulationof resources

betweenbusinesses;regardlessofthegeographiclocations,andtime(MertonR.C.,1995).

RiskTransformation:

Financial transactions are associatedwith risk, created also by the possibility of free

ridingbycapita-givingagents.Financial intermediariesareabletomanageandreduce

significantlycostsofmonitoring,throughdiversificationandincreasingofsuchactivities.

Thismeansthatinthefieldoffinancialtransactions,theyperformandactinsuchaway

that reduce the risks associated with financial intermediation (Gorton G., Winton A.,

2003).

- 33 -

InformationTransformation:

Intermediariescanreduceinformationasymmetriesinthesensethattheycreateabridge

betweentheonethatholdtheinformationabouttheprojects,meaningcapital-seeking

agents; and their counterpart, meaning capital-giving agents. Intermediaries hold the

trustwiththeformerandare,bydoingso,creatinginformation(GortonG.,WintonA.,

2003).

OnaCrowdfundingwebsite,thetwoagentsinteractonaninternetbasedplatformthatis

able to reduce transaction costs, monitoring costs, and enhance the interaction and

pairing of agents. Intermediaries though, through these platforms face different

challengeswithrespecttotheonesfacedbytraditionalfinancialintermediaries.Infact,

internetplatformdoesnotperformtheactofborrowingandlendingcapitalperse;infact,

their core activity is to reduce information asymmetry and reducing transaction cost

betweenthetwoparties(MahadevanB.,2000).Crowdfundingplatformsareabletotake

advantageofthedissimilarities in informationbulks,andtheglobaldistributionofthe

agentscomposingthemarket.Whatplatformsarealsocapableofdoing, isgivingboth

sidessomedegreeofguaranteeandtrustintheplatform,whichhelpsreducingtherisk

associatedwithmoneytransfersandcapitalaccumulation(MahadevanB.,2000).

Wecanalso say that crowdfundingplatformshavechanged the roleof the traditional

financialintermediatorinwhatwedefinedearlierasatwo-sidedmarket.

Table(1)(HassP.,BlohmI.,2014)showspreciselyandinagraphicalwaythedifferences

betweenthetwomodelsoffinancialintermediation.

- 34 -

FunctionalCharacteristicsofEquityCrowdfundingasaFinancialIntermediary

FunctionFinancialIntermediaries

Implementation

EquityCrowdfundingas

FinancialIntermediaries

Implementation

Lotsizetransformation

Paymentsystemsforexchangeofgoodsandservices(MertonR.C.,1995).Mechanisms for pooling funds(MertonR.C.,1995).Transfer economic resourcesthrough locations time andbusinesses(MertonR.C.,1995).Provide liquidity (Gorton G.,WintonA.,2003).

Allowing for the interactionandmatching between agents andenable funding (Belleflamme P.,2013).Provide the service of aneconomic market for theexchange and return of capital(BakosY.,2000).Allowingforcapital-givingand–seekingagentstoovercometime,space, communication, andbusiness limitations (Bakos Y.,2000).Demandandfundingmechanismregulation(BakosY.,2000).

Risktransformation Managing risk and uncertainty(GortonG.,WintonA.,2003).

Assessing credit of the capital-seekingagents.Pre-selectionofprojects.Acting as a trusted andincorruptible third party,objectivelydisassociated (BakosY.,2000).

Informationtransformation

Handling asymmetry ininformation(MertonR.C.,1995).Provide price information andinformationproduction(MertonR.C.,1995).

Accumulatinginformation.Providing information aboutprojectsforcapital-givingagents(MitraT.,GilbertE.,2014).Functioning as an electronicmarket place creating arelationship between the twoparties involved and allow forthe exchange of information(MahadevanB.,2000).

Table(1):DifferencesintermsoffunctionsbetweenTraditionalFinancialIntermediaries

andCrowdfundingasFinancialIntermediaries.

Different crowdfunding platforms can have distinctive businessmodels depending on

howtheywanttotacklethemarketandcreaterevenues;andonwhattypeofregulation

theyneedtoapplyto.Whatallplatformshaveincommonontheotherhand,isthefact

that theywant tomanage relationships between the actors in the two-sidedmarket;

meaning that they want to offer “project-regulation” and “fundraisers-screening”

services.

The typologyof fundraisersand fundersmaydetermine theapproachand thepricing

policyoftheserviceprovider.Eachplatformneedsinfacttoattractpossiblecustomersto

- 35 -

enlarge its customer base and the scope of the platform, and not just being more

competitive,butalsoofferdifferentusefulservicestofinalusers.Theperceptionofthe

validityoftheplatforminfact,isrelatedalsotothewithin-typeandacross-typeexternal

effects;thisiswhymostintermediariesusethefollowingrevenuestream(Bellaflamme

P.,OmraniN.,PeitzM.,2015),(BellaflammeP.,OmraniN.,PeitzM.,2016):

1. Theplatformcanholdinterestsonthefundsraisedwhilethecampaignisbeing

processed.Infact,thefundsraisedarenotdeliveredtothefundraisers,untilthe

completionofthecampaign.

2. Fundraisersmayberequiredtopaytransactionfeestotheplatform;inmostcases

thepaymentofthisfeeisrequiredonlyifthedesignatedamountisreached.

3. Chargescanbemadeonsupportservicesofferedbytheplatform.

Inthecaseofcrowdfundingplatforms,thissystemiswhatmostplatformsuse;theywill

holdapercentageontheraisedcapitalbynewventuresasfeesfortheservicesprovided.

Inthefigurebelow(Figure(5))weillustratethegeneralmodelusedbytheseplatforms

(BellaflammeP.,OmraniN.,PeitzM.,2016).

Figure(5):Crowdfundingplatformbusinessmodelillustration.

The next subsection is dedicated to the presentation of three different peer-to-peer

contribution mechanisms that are used to create crowdfunding models. The three

represent the most diffused models in the market. The IOSCO Research25 gives a

25 https://www.iosco.org/

- 36 -

description of themodels that led to the creation of these synergymodels (Kirby E.,

WornerS.,2014).

The interaction between the two parties and the degree of involvement of the

intermediary as a trusted external partner are the two variables that define the

differencesbetweenthethreestructuresthatwillbedescribed.Thelevelofinvolvement

oftheplatformisextremelyimportantindifferentiatingcrowdfundingwebsitesfromone

another.Thedifferencesintheinteractionmodels,movementofmoney,andthedifferent

interactionsbetweenpartiesinvolvedwillbeexplainedthroughthissectionalsowiththe

useofgraphsforabetterunderstanding.

2.2.1.Peer-to-PeerContributionMechanism

Peer-to-peer lending procedures come into play when a bank or another financial

institutiondeniescredittoapossibleentrepreneur.

Thecasemightoccurwheninsteadofacentralandsingularinstitutionwillingtoabsorb

theriskofthecreationofanewventure,agroupofpeopleiswillingtosharetheliability

formingwhatiscommonlyreferredtointhemilieuasthe“crowd”.Weshouldalsokeep

inmindthateveryloanisassociatedwithalevelofinterestratesorpaymentsatmaturity,

whichistackleddifferentlybycrowdfundingplatformsandbybanks.

SeparateAccountModel:

Thefirstpeer-to-peemodelweanalyseiscalledthe“SeparateAccountModel”.

Thetwoactors in themarkethavedistinctaccountsonwhichtheymanagerespective

funds.Whattheplatformdoesistoconnectthemthroughthecreationofacontractsthat

holdathird legallyseparatedandprotectedaccount,storingtheamountraisedbythe

campaign.Inthiscasetheplatformconstitutesatrusteeoftheaccountandwecansee

fromtheFigure(6)(KirbyE.,WornerS.,2014)thegraphicaldescriptionofsuchamodel:

- 37 -

Figure(6):Peer-to-peer“SeparateAccountModel”interactionillustration.

NotaryModel:

The second peer-to-peermodelwe analyse is called the “NotaryModel”. This system

leveragesontheuseofwhatarecommonlyknownaspublicbonds.Wheneverthelender

isputincontactwiththeborrowerthroughtheplatform,heorsheisabletoinvestinthe

newventureandisaccreditedwiththerighttotherepaymentoftheloanedamount;this

conceptissimilartotheconceptoftheinvestmentsecurity.Abankmaybeauthorizedto

managethecredit,whilethefunderstillholdstheriskoftheinvestment.Thefigurebelow

(KirbyE.,WornerS.,2014)(Figure(7))representsthenotarymodeljustexplained.

Figure(7):Peer-to-peer“NotaryModel”interactionillustration.

- 38 -

GuaranteeModel:

The third peer-to-peer model we analyse is called the “Guarantee Model”. What

characterizesthislendingmodelisthefactthattheinvestmentsarenotmadedirectlyby

thefunder,butbytheplatformitself.Theintermediaryinfact,canguaranteeapreviously

determinedrateofreturnonapreviouslysetamount,thatthelendercandecidetoputat

risk.Themoneyusedtofinancenewventuresisextractedfromafund,inwhichagroup

of investorsaccumulatedacertainamount.Byputtingmoney in thataccount, funders

agreeforthatamounttobeinvestedindifferentventures,regardlessoftheventurein

whichthosefundswillbeputinto.Thedecisiononwhichventurestofund,isinthehands

of the platform trusted by the funders. The figure below (Kirby E.,Worner S., 2014)

(Figure(8))representssuchamodel.

Figure(8):Peer-to-peer“GuaranteeModel”interactionillustration.

Aswecansee,thesepeer-to-peermodelsarethefirststepintotheinteractionbetween

equals;inasysteminwhichpeoplethatneedtointeract,donottrusteachother.Thereis

willingnesstointeractwithoneanother,buttheleveloftrustistoolowforthisinteraction

tohappenespeciallyonaninternetplatform.Thisisoneofthereasonswhytheequity

crowdfundingplatformisutilized,inordertoguaranteeacertainlevelofeligibilityofthe

marketandhelpsreducethelevelofriskassociatedwiththelowtrust.

2.2.2.Equity-BasedandRoyalty-BasedModels

Oneof themost interesting formsof crowdfunding, is also the less utilized. Equity or

Royaltybasedcrowdfundingmodelsinfactaremostlytheoretical,sinceveryfewactors

havedecided touse theirplatform insuchaway.Thismethodallows for investors in

- 39 -

crowdfunding campaigns to receive not just a reword, like in the most common

crowdfundingplatforms,butactualsharesofthecompanytheydecidetofund.Different

modelsarecharacterizedbydissimilarregulationsonequityrightforfunders,depending

onthetypologyofthesystemimplemented.

Revenueandprofitsharing,directequityandconvertiblebondsarecommonmechanisms

usedbytheseplatforms,andtheutilizationofthesetoolsvarydependingontheapproach

each platform decides to undertake. The next few paragraphs will describe a few

interactionmodelstochoosefromwhencreatinganequitybasedplatform,dependingon

thelevelofinvolvementasathirdpartythattheplatformdecidestoundertake.

LowResponsibilityModel:

Themodelwepresent first, is characterize by “low responsibility” undertaken by the

equitycrowdfundingplatform,intheroleofthethirdtrustedparty.Theintermediary’s

roleistocreatearelationshipbetweenthepartiesinvolved,grantingtheinvestorlegal

claimsonapercentageoffutureprofits,revenues,aswellasroyaltiesdependingonthe

termsofthecontract.Theplatformcanalsoadministerequity,makinginvestorseligible

forvotingrights,orownershipofshares(KirbyE.,WornerS.,2014).Thefigurebelow

(Figure(9))showsgraphicallysuchamodel.

Figure(9):“LowResponsibility”modelforanequity-basedcrowdfundingplatform.

- 40 -

MediumResponsibilityModel:

In the secondmodel, the intermediary is able to offer the service of detention of the

investmentlegaltitleinfavouroftheinvestor,thatcontinuestobetherightfulpossessor

of the shares. This model is characterized, for these reasons, by a higher degree of

responsibilitiestobeundertakenbytheplatform.Thefigurebelow(Figure(10))givesa

graphicalrepresentationofsuchamodel.

Figure(10):“MediumResponsibility”modelforanequity-basedcrowdfundingplatform.

HighResponsibilityModel:

Themodelthatfeaturesthehighestleveloninteractionbythethirdpartyplatformisthe

following; in which the platform, based on contractual agreements with investors, is

entitledtomakeinvestmentdecisionsandholdshares.Thefigurebelow(Figure(11))

showsthegraphicalrepresentationofthemodel.

- 41 -

Figure(11):“HighResponsibility”modelfora,equity-basedcrowdfundingplatform.

Thiswasageneraldescriptionofthedifferentmodelsassociatedwiththedifferentlevels

ofinvolvementoftheequitycrowdfundingplatforminthefinancingindustryinwhichit

operates.

Wewouldliketonotethelevelofinvolvementofthebankinsuchasystem.Afinancial

intermediarysuchasthebank,isalwayspresentandhasacentralroleintheinteraction

betweentheparties involved.Thefinancial intermediaryisoneoftheholdersoftrust,

andthereferenceforissuesthatregardtheborrowingandlendingofvalue.Itisimportant

to remember theroleofbanks in thenetwork,especiallywhenwewill talkabout the

differences with the system that the introduction of the blockchain technology will

introduce26.

2.3.DifferentServiceModels

Crowdfunding platforms have developed through the years, differentiating from one

another especially in the typeof services theyoffer toboth investors anddevelopers.

Whatneedstobetakenintoconsiderationwhendesigninganewplatforminfact,isthe

typeofservicesitwantstoprovide.Inordertounderstandbettertheeconomybehind

crowdfundingthan,inthissectionweanalysethedecompositionoftheservicesoffered

by crowdfunding ecosystem, into single components (Haas P., Blohm I., Peters C.,

LeimeisterJ.M.,2017).

26 CH III

- 42 -

2.3.1.ServiceModularization

“Modularizationisthedecompositionofoneobjectintodecoupledsinglecomponentswith

specifiedinterfacesthatcanbecombinedtocreatenewsingleobjectconfigurations”(HaasP.,BlohmI.,PetersC.,LeimeisterJ.M.,2017).

Bydecomposing servicesprovidedby crowdfunding institutions,we can create single

modules that canbestudied.Theseservicescanbeseparated, recombined,andhence

form new and different services. Modularization has twomajor principles to keep in

considerationinthedefinitionofthesingleservices;theseprinciplesare“Cohesion”and

“LooseCoupling”(HaasP.,BlohmI.,PetersC.,LeimeisterJ.M.,2017).Cohesionrefersto

the necessity of themodules to have defined levels of complementarity between one

another;LooseCouplingontheotherhandreferstothefactthatsingleservicesmustnot

dependoneachother.

2.3.2.ServiceModulesforCrowdfunding

Throughthestudyonthemodularizationofservicesprovidedbycrowdfundingplatforms

andecosystemsaroundtheweb,weareabletoidentifyalistofmodularservices(Haas

P.,BlohmI.,PetersC.,LeimeisterJ.M.,2017)that,inthenextchapters,willhelpussupport

a comparison between web-based crowdfunding platforms, and blockchain-based

platforms.

Herebelowwepresent a brief explanationof themajor services that a crowdfunding

ecosystemcanoffertousers,usefulforbothsidesofthemarket.

Matchmaking:

Themainobviousroleofawebplatform is tobeable toconnect the twosidesof the

market, meaning capital-seekers and capital-givers. This is done in order to spread

information,andregistercapitaltransfersandfundingactivities.

Theplatformisabletocreateabridgeandalinkbetweenthosethatarewillingtoinvest

innew,evenifriskynewventures,andthosethatareinneedtoaccumulatecapitalforto

startanewbusiness.

- 43 -

Contracting&Compliance:

Once the target funds are reached, the platform can legally validate obligations and

conformitythroughtheissuingofastandardizeddigitallegalcontract.Eachplatformcan

have their own standardized type of contract to be presented to the company or the

investors.Theconditionsstipulatedinthecontractbetweenthethreepartymaydepend

on many factors including the type of industry in which the company is or will be

operating,andtheamountofcapitaltoberaised.

CustomerSupport:

Throughtheplatform, thetwoactors in themarketcan interactwitheachothermore

easily.Certainservicesareprovidedinfact,toimproverelationsbetweenthepartiesby

loweringorclearingupobstaclesbetweenthemandresolvingconcerns.

Wheninvestingsmallorconspicuousamountsofmoney,investorsmustfeelateasein

theinteractionwiththefundraiserandtheplatform.Itisintheinterestoftheplatformto

make the transactionsand thecommunicationsbetween thepartiesas smoothandas

transparentaspossible

RiskScoring:

In an equity crowdfunding platform, risk associated to capital seekers is tracked and

ranked.This informationreferstothetrustworthiness,projecthistory,credit,andalso

projectdescriptionsandvalidityassociatedtothecapitalseeker.

Theattributionof a score to the capital seeker is ofmost importance for the funders,

especiallyforthosethatarenotabletodoitbythemselvesawell-definedduediligence

oftheprojecttheyarebeingpresented.

Somecompaniesperforminternalduediligenceandpresenttothefundraisersascorefor

theprojectsbasedon theirexperience in the field.Othercompanies, inorder toavoid

conflictsofinterests,prefertoletotherthirdpartiesperformtheduediligenceforthem.

Theseimpartialpartiesaresometimesthebestchoiceinsituationsinwhichtheexpertise

oftheplatformmaynotbeenoughtodeterminethefeasibilityofsomeprojects.

Authentication:

Identificationandauthenticationisnecessaryandthoroughlyappliedontheseplatforms.

Theuseofauthenticationisusefultoallusersinordertocomplywithregulations,and

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create a safer environment for clients, in which they know exactly who they are

interactingwith.

Informationabout investorsandfundersareanalyseddeeplyandsecurelystored;this

createsamoretrustworthyandtransparentenvironment.

CrowdActivation:

Propagative and educational activities are performed by these platforms in order to

createontheirnetworkavalidpoolofclients.Alargernumberofclientswillingtoinvest

in new ventures,will ensure a higher rate of success for proposed projects;with the

consequenceoftheactivationofanetworkeffects.

Theuseofcrowdfundingandequitycrowdfundinginparticular,ischangingthetargetfor

thefinancingindustry.Inthepast,onlytheonesthathadaccesstosufficientamountof

moneytofinancesignificantlynewventures,wereabletoparticipatetothemarket.The

useofcrowdfundingismovingtheattentiontotheconsumermarket,wherethereare

nonethelessindividualswithlowercapitalavailability,butstillwithahighwillingnessto

undertakefinancialrisksandinvestinnewventures.

InvestorRelations:

Constant interaction and communication on the performance of active projects is

disposedbetweenthepartiesinvolved.Theseprecautionsareimplementedinorderto

maintain a transparent and democratic platform; and it is done through the use of

speciallydesignedon-linetools.

Thelevelofcommunicationisdeterminedbothbytheplatformitselfandbythefirm.The

communicationinteractioncanbelimitedtotheperiodinwhichthecampaignisbeen

developedorevenafterthecampaignisover,dependingontheagreementbetweenthe

parties.

ITOperations:

Itisfundamental,inthecaseofanon-lineserviceplatform,aproper,welldesignedand

user friendly, accessible platform. The platform will have to provide the point of

interactionbetweenthetwouserstype.

Afriendlyandeasytonavigateplatformcanbeofextremeimportancetotheinvestors,

thatwouldbemorewillingtotrustitandinvestintheventuresassociatedwithit.

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Payment:

Onlinesecureandefficientpaymentactivitiesareprovidedontheplatformstoallowfor

avalidmovementofcapitalbetweentheparties.

Paymentactivitiescanbeintegratedinsidetheplatformorcanbeprovidedbyanexternal

partnerifnecessary.

Banking:

Banking services are provided that include: access to credit information, account

managementcounselling,andex-antefinancing.

Dunning&DebtCollection:

In order toprotect users fromany investment lossesdue todebtdefault, invoice and

liabilitycollectionservicesneedtobeimplemented.

These services are implemented in order to create a safer and more transparent

environmentforbothcapital-seekersandcapital-givers.

2.3.3.PlatformInteractionsandServiceProvisions

In the crowdfunding ecosystem, we can define different actors with different duties,

necessarytosupportthenetworkofservicesthatispresentedtothepartiesinthistwo-

sidedmarket. These services can be selected and divided according to their possible

disruptivenature(HaasP.,BlohmI.,PetersC.,LeimeisterJ.M.,2017).Fromtheprevious

identificationandmodularizationof services,weareable to select sevenof them that

accordingtoHassandal.canbeprovidedbyageneralcrowdfundingplatform.Sixofthese

sevencanfurthermorebeconsidereddisruptiveinthemarketofcapitalfinancing.The

different characteristics of the six services selected, allows us to divide them in two

distinctcategories;specifically,“crowd-related”and“funding-related”.Thedistinctionof

these two categories will be helpful in explaining crowdfunding decentralized

application’spossibilitytodisruptthecurrentcrowdfundingmarketinthenearfuture.

Thecrowd-relatedcategoryreferstothegroupofservicestobeimplementedtosatisfy

theneedsof theactors involved inthecrowdfundingnetwork.Theseservicesarealso

necessary inorder to incentivize the interactionbetween the twomajoractors.These

servicesarenecessaryfortheexistenceofcrowdfundingplatforms.

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Funding-relatedservicesontheotherhandrefertotheservicesprovidedbytheexternal

serviceprovidersinthemarket,thatallowfortheexecutionoffundingactions,necessary

forthecreationoffundingactivitiesandtherelativetransferofvalueandcurrency.The

twocategoriescanbethoughtas thecreationof two levelsof interactionbetweenthe

parties aroundwhich the crowdfunding ecosystem is built, namely capital-givers and

capital-seekers.

In order for the ecosystem to function, there is the need for three intermediaries to

interactdirectlyorindirectlywiththeparties.These“networkpartners”andtheircrucial

roleinsidethesystemarerepresentedinthefigurebelow(Figure(12))(HaasP.,Blohm

I.,PetersC.,LeimeisterJ.M.,2017).

Figure(12):NetworkPartnerInteractioninthecrowdfundingsystem.

Thesearesomeofthemostinterestingservicesthatcanbeprovidedbycrowdfunding

platforms.TheSixserviceswehaveselectedanddividedincrowd-relatedandfunding-

related,aredisruptiveinthefundingservicesenvironment.Theseservicesprovidefora

better communication and interaction between capital-seekers and capital-givers,

reducingriskanduncertaintyinthefundingsystem.

Theinnovationbroughtbycrowdfundingplatformshaschangedtheworldoffundingand

madeitpossibleformanyentrepreneurstogetaccesstofundsandbeabletoconstruct

strongandindependentventures.

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2.4TheGrowingIndustryofEquityCrowdfunding

Despitethepossiblerisksandthelimitationsofvariousplatforms,theindustryofVenture

CapitalthatincludesEquityCrowdfunding,havebeengrowingsubstantiallyinpastfew

years,becomingoneofthemajorplayersinthefinancingindustry.

Inordertogatherfundstoenlargeandimprovetheirbusinesses,smallcompanieshave

veryfewoptionsthatwouldguaranteeanaccesstofundsandtheconsequentpossibility

tocreateanewventure.

Thehesitationofbanksinthelastfewyearstolendmoneytoentrepreneurs,hasleftthe

spaceforsomeotheractorstoimposethemselvesasmajorplayersinthefieldoffinancing

newcompanies.VentureCapitalwasthefirstonetotakecontrolofthemarket;butEquity

Crowdfunding is making its move fast inside the market, becoming one of the most

popularmethods(GreenhalghH.,2016).

EquityCrowdfundingisoneoftheindustriesthatisgrowingthefastestinthefinancing

industry.Forecastsaythattheindustrywillraiseabout11$billionsby2020(Kocianski

S.,2016).

The graph below (Graph (1)) shows the increasing volume of capital that equity

crowdfundingplatformsareraisingandwillcontinuetoraisegiventheforecast.

Graph(1):Increasingvolumesofcapitalraisedbyequitycrowdfundingplatforms.

Both investorsandbusinessesareswitching to thismethodof funding,becauseof the

multiplebenefitsofthemethodology.Thesebenefitsincludetheavailabilitytoanyoneto

participateevenwithsmallamounttothefundingofcompaniesthattheybelievehave

0

2

4

6

8

10

12

2015 2016E 2017E 2018E 2019E 2020E

USA UKBillions($)

Source:Nesta, KPMG,BIINTELLIGENCE

- 48 -

thepotentialtobesuccessfulintheirrespectivefield.

The introduction of Equity Crowdfunding is leading to the consolidation of a trend in

whichthe fundingofnewandestablishedbusiness,couldbebroughttotheconsumer

market(StengelG.,2014).

Thetraditionalmethodsofventurecapital,allowtheparticipationtothemarketofonly

those that are willing to invest conspicuous sums of money. Venture Capital creates

enormous entrybarriers to everyonewilling to facehigh risks, butwith low liquidity

availability.

EquityCrowdfundingontheotherhandmakesiteasierformanywillingtoinvestand

undertake high financial risks, even if they do not dispose of substantial amounts of

money.

Ontheothersideofthemarket,start-upsandsmallcompaniesthatneedfinancing,are

abletohaveabiggerpoolofpossibleinvestorsfromwhichtheyareabletogetfundsfrom.

Theimportanceofcrowdfundinginallowingthegrowthofsmallcompanies,isincreasing

fast and it is establishing strongerbases tobecome thenextmostusedmean to raise

capital.

2.4.1AdvantageswithRespecttoVentureCapital

Before crowdfunding came along, Venture Capital was about the only way in which

companieswereabletogatherfundstostartabusiness.

TheuseoftheVentureCapitalmechanismscanbeinmanycasesofhugehelpfornew

ventures,andtheexpertiseoftherightVentureCapitalcompanycanreallyhelpstart-ups

toexploittheirwholepotential.Formanycompanies,ontheotherhand,theuseofthis

traditionalmethodjustdoesnotfitwiththeownerideas,expectations,andvisionofthe

market.Wehavemanyexamplesofcompaniesandfunderswhoseideaandtalentwas

not recognize by Venture Capitalists formany different reasons, including the fear of

investing a conspicuous amount of money, in something that may appear too risky,

unnecessaryornotprofitableenoughforthem.

Therearemany featuresofequitycrowdfundingthatmightcreateadvantages for this

methodologywithrespecttothetraditionalVentureCapitalways.Inthissectionwewill

analysethemandexplainwhyEquityCrowdfundingmightbetherightchoiceformany

newventuresandnewentrepreneurs.

- 49 -

EasyAccess:

ThroughtheuseofEquityCrowdfunding,thedecisionofgivingcapitaltofunders,does

notcomefromonesingleindividual,butfrommanyinsidethecrowd.Theaccesstocapital

isthaneasierandpossiblepersonalconnectionstoinvestorsarelessrelevant.

Equity Crowdfunding allowsmore investorswilling to take the risk, to invest in new

companiesthattheybelievehavethepotentialtocreateasustainableentity.Theamount

ofcapitalinvestedcomesfromadistributednetworkratherthatgivenbyasingleVenture

Capitalfirm,thatwouldotherwisehavetobeartheentireriskbyitself.

VentureCapitalfirmsareusuallycomposedbyprofessionalsintheevaluationofpossible

ventures.Itisimportanttothemtolimitasmuchaspossibletheriskofthecompanywhen

lendingcapital;sotheideapresentedtothemmustbeinterestingenoughtoallowforbig

financialinvestments,limitingtheriskoffailurefortheproject.TheEquityCrowdfunding

environmentdistributes the risk amongmanyusers, and tackles a larger shareof the

market,willingtoinvestinnewandevenmoreriskybusinesses.

BetterOutcomesforMarketEstimation:

According to Ethan R. Mollick (Mollick E. R., 2013), only 75% of companies funded

through crowdfunding actually deliver the product they promised, letting down the

investorsthatbelievedinthem.Evenso,CrowdfundingVenturesdogetabetteroutcome

formarketestimationandthereasonisnotbecauseofthetypeofprojectsorideasthat

areproposedtothemarket.

Venture Capitalist have a great experience when it comes to starting a business and

evaluation how said business will perform. When entrepreneur pitch their ideas,

sometimestheydonothaveaclearviewoftheindustryorthemarketinwhichtheywill

have to compete. VentureCapitalist thanks to their expertise, are able to give amore

precise evaluation of the idea,which is usually lower than the one that a less expert

evaluatorwouldgive(WilsonK.E.,TestoniM.,2014).

EquityCrowdfundingswitchesthepowerdynamicmoreinfavourofthecompanythatis

been funded. The new venturewill have to convince very fewhundred people out of

millions thatparticipate to thecrowdfundingactivities, that theircompany isvaluable

andhasthepotentialtoreachallthegoalsthathavebeenset.

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Wemayhaveheardhowsomecrowdfundingcampaignsareunrealisticallyovervaluated,

butitisimportanttodetermineifthesecomplaintsarevalidorhavebeenpointedoutby

someonewhoisinneedtoprotecttheirownbusinessfromdisruption.

BetterFinancingConditions:

Thought the traditional Venture Capital investment deals and contracts; Venture

Capitalistsareabletogetmostoftheirrevenues.Usingfavourableinvestmentconditions

in the subscriptionof investmentdeals in fact, allows investors toprofit substantially

fromtheirinvestmentinnewventures,usuallyattheexpensesoftheentrepreneursand

theirideas.

Withtheuseofcrowdfunding,thepowerincontractingisgivenawayfromtheVenture

Capitalists and given to the entrepreneurs and to the crowdfunding platform. Equity

Crowdfundingplatformsareabletostipulateverydifferentsortsofcontractsthatmake

it able for both the funders and the fundraisers to profit from the investment in new

possiblyprofitableventures.Conditionsofthecontractsarethannotdeterminedonlyby

the venture Capitalists, but are determined by a combination of the different actors

involvedinthefinancingstructure.

Visibility:

The levelofawarenessthatcanbereachedwiththeuseofEquitycrowdfunding,goes

beyondthetraditionallevelofpublicitythatcanbegivenbyVentureCapitalist.Theuse

of an internet platforms to publicize their product, gives entrepreneurs the chance to

interactnotonlywithabroadcustomerbase;butalsowithanetworkofnewsuppliers,

distributors,andotherpossiblecollaboratingcompanies,thatmightaddsubstantialvalue

totheirventure.

Whenacompanyisputonsuchaplatform,theexposurecanbeusedbythefundraiserto

publicizeitsproductsaswellasitsvisionandmission;beingabletoimproveandenlarge

itsmarketanditsnetwork.Thepossibleexposuregivenbythesetypeofplatformscanbe

ofextremeimportancefornewventures,whetherthetypicalconversationwithaVenture

Capitalistisusuallydonethroughaprotectedandprivateconversation.

Itisimportanttonoteontheotherhand,thatthepublicpositionanewventuretakes,can

beveryriskyinthecaseoffailure.FailureonanEquityCrowdfundingplatformwould

mean a public exposure of the failure, while on the other hand through a Venture

Capitalist,thefailedattempttogetfundswouldnotleavetheroom.

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WiderInvestmentBase:

ManyofthecompaniesthatdecidetouploadtheirprojectsonanEquityCrowdfunding

platform,havea“BtoC”structure,andwouldbenefitfromanincreaseinthenumberof

shareholdersthatmightbecomesuccessively,possibleambassadors.

Having a large number of advocateswith the same interest and respond to the right

incentivesastheonesoftheentrepreneurcanbeveryvaluableforacompanythatisstill

workingonconstructingavalidcustomerbase.

Aswewillseeinthenextsection27theuseofEquityCrowdfundinghasitslimitationsin

givingtherightamountofrightstoshareholdersandinprotectingtheirinterestsonce

thecrowdfundingcampaignisover.

DoesNotEliminatetheIdeaofHavingCollaboratingInvestors:

Crowdfunding is usually associated with the idea that the investors will not bring

anythingtothetablebesidestheirmoney.Ontheotherhand,VentureCapitalisusually

associatedwith the fact that the experts associatedwith it,will be able to participate

directlyinthemanagerialactivitiesofthecompaniesusingtheirexperiencetoaddnot

onlycapital,buttheirknowledgetothepotentialofthecompanyitself.Whenfacedwith

thedecisionwhethertogetthecapitalfromoneortheothersystems,manyfundraisers

believethatthechoiceofusingequitycrowdfundingcouldresultinthepossiblelossof

possiblynecessaryknowledge.Onthecontrary,it isveryplausible,andencouragedby

EquityCrowdfundingplatforms,thatinthecrowdfundingnetworktherewouldbemajor

fundinginvestorsthatdecidetocontributesubstantiallytosomeprojects,expectingtobe

involvedintheboardofsaidcompany.

MarketResearchPossibilities:

Thecreationofanewproducttobepresentedtocustomersistheresultofacontinuous

trial anderrormechanism for theevaluationofwhat ismostlyneededby consumers.

There are different ways tomake research in order to have the right information to

develop a new product. Some companies are today turning to crowdfunding for the

gatheringofdatafortheirmarketresearch.

27 Section:2.5.Inefficiencies.

- 52 -

Thegoalistoreachearlyadopters,willingtotestonthemselvestheproductsandtogive

thecompany feedbacksonhowtomake toproductbetter formoredemanding future

customers.

This method is mostly used by already established companies that are investing in

innovation,buthavenotclearyetwhatcustomerrequirementsforsuchproductsare.The

informationthataregathered,becomeanimportantmarketingandbusinesstoolinthe

developmentofthenewproductandtherelativecampaign.

2.5.Inefficiencies

Aswehaveshownintheprevioussections,theuseofcrowdfundingplatformsischanging

substantially the fundingmarket,enabling funders tohaveaccess tosmallamounts to

fund their organizations without going through banks or other traditional financial

intermediaries. The crowdfunding system although, presents some inefficiencies and

challengesthataffectbothsidesofthemarket.

Inthissection,wewillanalysethepotentialdrawbacksandrisksofusinganequity-based

crowdfundingplatformfromthepointofviewofthecapital-givers.

Wheneverweinteractwithanonlineplatformorrelyonanintermediaryforthehandling

ofcapitalor information,weneedtokeep inmindthepossibleconsequencesofusing

suchthirdparties.Riskscanariseinmultipleforms,fromtheeconomicormicroeconomic

pointofview,todirectplatformrelatedrisks.Wewillfurtherdiscussthesemattersinthe

followingparagraphs.

2.5.1.MicroeconomicChallenges

Whentwopartiesareinthestageofdevelopmentofacontractbeforeatransaction,one

ofthetwomighthaveaccesstoalistofinformationthatmightbemorerelevantthanthe

informationavailabletotheother.Theinformationnotpublictobothparties,mightbe

crucialforbothinthedeterminationoftheconditionstoberecordedinthecontract.This

asymmetryintheamountandvalidityofinformationavailabletotheactorsinvolvedis

referredtoas“InformationAsymmetry”.Informationasymmetrymaybeconsideredone

ofthemostchallengingproblemswhendealingwithequity-basedplatforms.

In the current stateof the art of the crowdfunding system,mostlybasedona reward

system, the information asymmetry relies on the capabilities of the creator of the

enterprisetodevelopornottheproductthatheorshepromisedtodeliver.Inthecaseof

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equity crowdfunding, the information asymmetry involves not only the capabilities in

producingamaterialproductoraservice,butalsotothemanagerialandorganizational

skillsoftheentrepreneur.Thecreatorofthepossibleventureinfact,mustbeablealsoto

createasustainableentity,withequityvalueabletoworkefficientlyinthemarket.

Thelevelofriskwhichfundersface,ismuchhigherconsideringthatthecreatorwillbe

requiredtocreateastructuremadebyagovernance,reportingandaccountingstructure;

allaspectsofacompanythatarerequiredtobemaintainedinapubliclytradedmarket

(LernerJ.,SternS.,2014).

We are able to divide the concept of information asymmetry in two independent but

correlatedissueswhenitcomestocrowdfunding.Theseissuesare“HiddenInformation”

and “Hidden Action”. These complications affect the interaction that exists between

agentsthroughdifferentstagesoftheprocessofraisingcapital.Theyhavethepotential

to create market failure, limiting the possibility of the rising of value-creating

transactions. Here below we present some of the consequences associated with

information asymmetry and hidden information and actions, that can cause market

failure(LernerJ.,SternS.,2014).

AdverseSelection:

Thenatureofthesemoderatelyregulatedplatforms,allowsfortheinteractionbetween

parties that could be even geographically far from one another. Low regulation and

control, togetherwithgeographicdistanceontheotherhand,couldcauseproblemsto

ariseintermsofinformationasymmetry.Fundersinfacts,duetosuchcircumstances,may

notbeabletoperformpersonallyorefficientlyaduediligenceanalysisbeforeinitiatinga

financialcontributiontotheprojectsinquestion.Itcouldbehardforfunderstoaccess

theaccountabilityofthecreatorsincreatingasustainablebusinessinwhichtheywould

bewillingtoinvest.

Onaweb-basedcrowdfundingplatformsthisassessmentisparticularlydifficult,andasa

result,anyprojectpresented,maybediscountedandunderfunded,regardlessofthevalue

itmighthaveonthelongrun.Consequently,high-qualityproposalswouldnotbeputon

theplatformbycreators,fearingalowervaluationoftheirventureandnotachievewhat

couldbeconsideredasafairpricefortheirequity.

Thebottomlineresultforthishiddeninformationproblem,istheparticipationofonly

low-qualityventurestothenetworkoftheplatform.This“AdverseSelection”,createsa

- 54 -

suboptimal equilibriumwhere high quality ventures funders and creators are left out

fromtheopportunityofcreatinghighstandardtransactions(LewisG.,2009).

MoralHazard:

Theinequalityinthedistributionofpowerandknowledge,isnotlimitedtotheperiodof

timeprecedingtheinvestmentactions.Theissuesrelatedtoimbalanceofinformationand

powerinfact,arisealsoafterthetransactionwentthroughandthefundsareraised.The

natureofthecrowdfundingcontractdoesnotgiveanyrighttothefunderovertheactions

ofthecreatorafterthefundsaretransferred.

Thecreatormightchangeitsapproachtothemarketandtorisk;actinginaselfishmatter,

andhemightactnotincompliancewithwhathasbeenagreeduponbeforetheinvestment

wentthrough(LernerJ.,SternS.,2014).

Thestructureofthesystemespeciallyinanequitycrowdfundingenvironment,doesnot

alsoallowforthecreationofasecondarymarket for theexchangeof the investments.

Meaningthatoncethecampaign isover, the investorscannotsell their“shares”of the

companytheyinvestedin,butitisallriskcapital.

Thesehiddenactionsaretheconsequenceofthe“MoralHazard”involvedinthesetypes

oftransactions(BellaflammeP.,LambertT.,2016).Asaconsequence,fundersmayavoid

using such platforms for investing, fearing possible mismanagement of the capital

invested;thiswouldresultinamarketfailureandtheshuttingdownoftheplatform.

Principal-AgentProblem:

OneofthemostcommonexamplesofanegativeconsequencearisingfromtheHidden

InformationandHiddenActionsissues,isthe“Principal-AgentProblem”.Thisproblem

ariseswhentheactionsofthecreatorsarenotinlinewiththeinterestofthefunder.These

actions may be the result of business information related to the insider position the

funderhas inthemarket;ormoresimply, thenotalignmentof the interestof thetwo

partiesinvolved.

Theabsenceofasecondarymarketforinvestments,limitstheactionsoftheinvestorsin

thecaseinwhichtheactionsofthefundraiserarenotinlineanymorewiththeirinterests.

Thesystemdoesnotallowforabackoutoptionafterthecampaignisover.

ThePrincipal-AgentProblemisacommonconsequenceof themiscommunicationthat

usuallyoccursbetweenfundersandfundraisers.Thecommunicationsysteminsidethe

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platformshouldbeconstructedsuchthatobjectivesofbothactorsareclearbeforeand

aftertheinitializationofthefirsttransaction.

CollectiveActions:

Duetotheinformationasymmetrypresentinsuchplatforms,oneoftheissuesthatmight

ariseisthe“FreeRiding”problem.Investmentinformationinsidetheplatformarepublic,

meaning that some fundersmay rely on others work in the definition of a solid due

diligence.Fundersinsidetheplatforminfact, inordertoavoidtheissueslistedabove,

mightrelyonthedecisionsmadebyotherpeers,slowingdownthefundraisingprocess.

Ifthiswouldbethecaseforeveryfunderpresentontheplatform,themarketwouldstop

andeventually fail, sinceeveryonewouldbewaitingonothers tomakethe firstmove

(LernerJ.,SternS.,2014).

InformationAsymmetrycannotbemanagedcompletelybythecrowdfundingplatform.

Thepowerandtheresourcesoftheplatform,areusuallylimitedtoitsboundaries;andit

canbedifficultfortheplatformtoofferapreciseanddeepanalysisofthefundraisersonce

theycreateanewcampaign.Theanalysiscouldincludethefinancialandcreditrecordof

entrepreneurs.Fromthepointofviewoffunders,havingaccesstothistypeofinformation

wouldmeanhaveaccesstoacompleteviewofthepersontheyareaskedtotrust,making

thetrustingprocedurealoteasier.

Samegoesforfunders;havingtherightinformationaboutpossiblefundraisersmayhelp

themtoselecttherightcrowdtofundtheirproject,makingthecrowdfundingprocedure

alotfasterandeasier.

2.5.2.RisksAssociatedwithCrowdfunding

Thereare fivemajor financial risks related toa crowdfundingplatform for theagents

involved.Wecanevaluatethepossiblechallengesbyanalysingaseriesofdifferentrisks

related to them; specifically: Risk of Default, Risk of Platform Closure, Risk of Fraud,

LiquidityRisk,andRiskofCyber-Attack(KirbyE.,WornerS.,2014).

Evenifwewillnotdiscussaboutthem,itisimportanttotakeintoconsiderationalsothe

risks associated with innovation in the open market, that include: Investment Risk,

Development Risk, Co-Ordination Risk, Motivation Risk, Control Risk, Security Risk,

GovernanceRisk,andCultureRisk(AmalarL,2010).

- 56 -

Agent risk of such sort may lead to risk of default or fraud, and unfortunately

crowdfundingintermediariesdonotcurrentlyoffertoolstoattenuatethesespecificagent

risks,exposingdangerousagentsparticipatinginthenetwork.

Oneoftheservicesinwhichplatformsinvestsubstantialresources, isthescreeningof

possiblebusinessesbeforethepresentationtothepublicof investors.Thesescreening

processesarecreatedinordertoallowfunderstohaveasmuchinformationaspossible

when making financial investment decisions, and offering appropriate and secure

projects.Thesepercussionsareinfactnecessaryinsuchcircumstancestoavoidtheissues

previouslypresented.Thepresenceofsuchattentionandsagacitybyplatformsincreases

theirprestige,butexposesthemtodifferenttypesofrisks,suchascyber-attacks.

Asweearliersaid,openinnovationrelatedtocrowdfunding leadstocertainproblems

conducing to the issue of Moral Hazard and the Principal-Agent issue. Unfortunately,

insideacrowdfundingplatform,thisrequiresanextraeffortbyfundersinscreeningthe

activitiesof thecreators.The informationtheyneedtogather,arerelatedtoboth, the

projectthatisbeenpresentedtothem,andthehistoricfinancialandcreditbehaviourof

the creator of the project. These research and analysis are time consuming as

consequentlycostlytothefunders,thatasaconsequencewillberecompensedmorein

termsofinterestsonthecapitaltheydecidetolend.

RiskofLiquiditymustbementionedandkeptisstrongconsiderationwhentalkingabout

risksassociatedwithcrowdfundingplatforms,sinceitisoneofthemostrelevantrisks

associatedwiththeseactivities.

Oncetheinvestmentisdone,andthecampaignisoverinfact,fundershavenooptionbut

toremainpartnersofthecompanyuntiltheunfoldingofthemarket.Itdoesnotinfact

exist an outside and secondary market on which obligations of this type could be

managed,soldorboughtafterthecreationoftheventure.Thislimitstheactionsofthe

fundersmakingthemfacereallyuncomfortablefinancialinvestmentdecisions,withvery

littleinformationaboutthecreatorattheirdisposal.Thishighlevelofuncertaintyleads

to an abandonment of platforms by funders and to a lowering of the position of the

phenomenonofcrowdfunding.

TheLiquidityRiskissuehasverystrongimplicationinthecrowdfundingmarket,thatmay

resultinthecreationofaclosedmarket,limitingtheentrancetotheactorsthatarewilling

tofacehighrisksanduncertainty.Theabsenceofasecondarymarketandthelocalized

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regulatoryrules, likespecificnational laws,aboutcrowdfundingandsimilarnetworks;

mightalsoleadtothecreationofclosedandconfinedwebsofinvestorsandcreators,that

hardlyconnectwithoneanother.Thenameoftheriskassociatedwiththisphenomenon

of separation of the networks is “Systemic Risk” (Kirby E., Worner S., 2014), and is

associatedwiththe limitationsthatthecreationofnationalregulationsimposestothe

opennessofthemarket.

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CHAPTERIII

CrowdfundingIntegratedinaBlockchain-BasedEcosystem:

DecentralizedApplications(DApps)

In the previous chapter, we analysed the different types of inefficiencies that a

crowdsourcingplatformmaypresent fortheparties involved,meaningcapital-seekers

andcapital-givers.InChapterIontheotherhand,weintroducedanewtypeoftechnology

thatcouldchangetherulesofthegameformanyindustriesandatthesametimeallow

for the creation of new ones. The introduction of the concept of blockchain and

tokenization, togetherwith the decentralization ofmanagerial and financial activates,

maycreatefavourablesituationsinwhichsomeofthepreviouslydefinedinefficienciesof

traditionalequitycrowdfundingcouldbemitigated.

InthisChapterwewillalsoseewhatthechallengesarisingfromtheintroductionofthis

technologymightbe, togetherwith thepossible futuredevelopmentof the technology

thathasthepotentialtodisrupttheindustry.

FromwhatwehaveseeninChapterII,wecanstatethatacrowdfundingintermediary

plays twomajor functions in the environment. The firstmajor functionplayedby the

crowdfunding platform is themechanism of creating a bridge of communication and

interaction between the two major parties involved in crowdfunding business. The

secondcrucialfunctionisthecreationofastructure,thatenablestherightfultransaction

offundsbetweenthetwoparties.

Theplatform,followingthesetwomajorfunctionsisabletoimplementalistoftoolsand

services,inordertomaketheplatformbetter,moresecure,andeasytousefortheusers.

Thoughtthedescriptionswewillprovideoftheplatformandtheservices,wewillmake

acleardistinctionbetweentools,underliningthereasonsthatledtoitsimplementation

andtowhichmajorfunctiontheyarelinked.

Wewillfocusononeofthemajorfunctionsthatacrowdfundingplatformperformsinthe

sustainmentoftheecosystem.Thefocusonthischapterwillbeonthemechanismsthat

regulatethefundingprocessesoftheequitycrowdfundingplatform.Wedecidedtofollow

thispathsince,itisinthisfieldinwhichblockchaintechnologycancomeinhandy.

Wewillseehowthetechnologyallows for thecreationof thesocalled“Decentralized

- 59 -

Application”(Dapp)andhowitcanbeadaptedtothecrowdfundingenvironmenttohelp

createaBlockchain-basedCrowdfundingPlatform,thatcanbeabletosatisfymanyofthe

needs of current crowdfunding clients, and resolvemany of the issues related to the

traditionalmethodsofcrowdfunding.

DAppshavethepotentialtoresolvemanyoftheproblemsassociatedwiththecurrent

state of the art of crowdfunding, and allow for new and better mechanisms for the

protectionofbothfundersandfundraisers.

3.1.Functionality,StructureandDesignofaCrowdfundingDApp

One of the most important innovation brought by the introduction of blockchain

technologyistheintroductionofacrowdfundingDApp.ThecrowdfundingDAppallows

for the integration in the system of many new functionalities, and creates a bridge

betweentheusersandtheblockchaintechnologyanditspotential.

Inorder toperformcertain functions ina standardizedandcomputerizedway, Smart

Contracts are used to administer the functions built inside the Crowdfunding

DecentralizedApplication.

AdeeplookintothefunctionalitiesofferedbytheDAppbackedbythetechnologyand

logics behind smart contracts, will help us understand all the applications and the

functionalitiesthataDAppisabletooffer,andthenecessitiesitisabletosatisfy.

TheCrowdfundingDAppisthebridgebetweentheusersandtheblockchain;istheholder

oftheprogramsthatregulatethenewfunctions.

Insection1.5.3,wegaveanexplanationonthefunctionsandstructureofsmartcontracts,

onhowtheycanbeconstructedandarebuilt.Thatexplanationaboutsmartcontractsis

necessary tounderstandhow theyhave thepotential tobe implemented in an equity

crowdfundingenvironment, tohelpamelioratemanyof thedifferent services that are

usuallyprovidedbyatraditionalcrowdfundingplatform.

Thestructureofthesmartcontractsthatwewillfurtheranalyse,refersspecificallytothe

all-purpose framework that is offered by environments like the one of Ethereum.

Ethereum, like many others, is in fact able to offer developers and companies the

possibility to enter in the network with a smart contract, in many different ways

regardlessoftheindustryinwhichtheyareworkingin.TheflexibilityoftheEthereum

networkcanallowtheintegrationoftransparentandcustomizableprotocols,withaset

ofgenerallydelineatedsmartcontracts.Thisisabletotomakethenetworksafe,secure,

- 60 -

immutable,anddecentralized;thoughdependentbythedecisionsofthefinalusersthat

aretheprincipalcontributorstotheequityandliquidityofthenetwork.

Inthissectionwewillseemanyofthefunctionalities,thestructureandthedesignofa

crowdfundingDApp.Wewilldosoinordertounderstandindepthhowtheseapplications

areconstructed,whytheyareconstructedthatwayandwhatistheleveloninteraction

betweentheactorsinsidethenetworkandtheDApp.

3.1.1.FunctionsPerformedbytheDApp

It is important to define first, five of the most important functionalities that a

crowdfundingDAppcanoffertobothsidesofthesystem,meaningcapital-seekersand

capital-givers.

The mechanisms explained below, give a detailed vision of the structure of a

crowdfundingDApp,andhowtheinteractionwiththemainplatformisperformed.We

will be able to see the differences between the common functionalities offered by a

traditional crowdfunding platform, and the ones offered by a blockchain-based

crowdfundingDApp.

Forthesakeofclarity,itisimportanttopointout,thatinablockchain-basedenvironment,

wheneverwetalkaboutfunds,werefertoanamountthatcanbegivenintheformof

cryptocurrencyorinfiatcurrency28.Thedecisiononwhethertoraisecapitalincryptoor

in fiat, depends on the necessities and the preferences of the funders during the

crowdfundingcampaign.Thedecisiontoallowboth,makesiteasierforinvestorsthatare

abletodecidetoinvestwithwhatevercurrencytheyprefer.

SmartPropertyTokens:

Thecapital-giversare investing incompanies inanequitycrowdfundingenvironment,

thismeansthattheyarebuyingaportionofthecompanytheyareinvestingin.Inorder

toprovetheownershipofthesectionthecompany,orasimpleproofoftheinvestment,

theyreceive“SmartPropertyTokens”fromtheDApptheyinvestin.Tokensrepresenta

portionof thecompany,andtheirprice isdeterminedbythe fundraisers.Thepriceof

tokensisbasedonwhatfundraisersbelievethecompanypotentialis,andonhowmuch

valuetheywanttogatherinordertomakethecompanygrow.

28Fiatcurrency:Fiatcurrencyismoneywithoutintrinsicvalue.Thevalueoffiatcurrencyisdeterminedbygovernmentregulations.Itcanbeconsideredofvalue,onlybecausethegovernmentusesitspowertoenforcethevalueofthatcurrency.

- 61 -

Eachprojectorentity,isabletoissueitsowntokens,thatarelinkedtotheprojectthatis

beendeveloped.Theownershipofthetokenscreatesabindingrelationshipbetweenthe

funder and the company, entitling the capital-giver to certain rights associated to the

propertyofthatgiventoken.

Tokens can be considered as holders of value, similar to the concept of shares of a

company, whose value is determined by the fundraiser at first, but can increase or

decreasedependingontherulesoftheopenmarketfortokens.

Atthebeginningofthecampaign,thefundraiserssetthenameandtheinitialvalueofthe

tokentheyarewillingtoissue,dependentalsoontheamounttheywanttoraise.Smart

tokensareissuedeverytimeacontributiontothecrowdfundedcampaignisdone.

Preciserulesregulatethedegreeandlevelofrightsandpowerthataretobegrantedto

thefundersattheendofthecrowdfundingcampaign,wherethecompanywillusethe

fundsacquiredtobuildtheprojectastheypromised.Theenforcementofthoserightsis

not given to a centralized authority, but to the software that regulates the relations

betweenthetwoparties.Asweknowinfact,thesmartcontractisinchargeofapplying

therules,andwillexecutealwaysassoonascertainrequirementsaremet.

Everytokeninordertobelinkedtocertainrights,isinpossessionofitspersonalprivate

key. The owner or holder of the private key related to the token, is consequently the

ownerofthetokenitself.

Trading of keys and tokens is allowed in a blockchain-based environment. this is of

particularimportance,sinceitallowsforthecreationofasecondarymarketfortokens.

Thesecondarymarketallowsfortheexchangeoftokensbetweeninvestors,solvingone

of thebiggestproblems for the traditional crowdfunding environment.Wewill take a

deeperlookintothepotentialofthesecondarymarketfortokensinsection3.4.2ofthis

Chapter.

Tokenscanbeconsideredtobevalidaslongasthecompanytowhichtheyareassociated

is running. In the crowdfunding phase, tokensmaintain a steady value set before the

beginningofthecampaign;assoonasthecampaignisover,thevalueofthetokensvaries

dependingontheperformanceofthecompanyandoftherulesofthemarket.

Ifthecampaignfailsbecauseofthereachingofthetimelimittoraisefunds,thetokens

becomevaluelessandtheamountoftheinvestmentisgivenbacktotheownersofthe

tokensthatinvestedinthefailedcampaign.

Ifthecampaigngoesthrough,thetokenscanbeexchangedandthepricecanfluctuate

dependingonhowthemarketisrespondingtothecompany,andonhowthecompanyis

- 62 -

performing.

Thefirstissuingofsmarttokensbyacompanyandtheinitialdeterminationoftheprice

ofthosetokens,iscalledtheICOor“InitialCoinOffering”.TheICOisthefirsttokensale

orlaunchinthemarketfortokens.

Thetokensalehelpsthecompanytoraisemoneybysellingsharesofitselftoanetwork

ofpartners.Thiscanbedoneevenoutsideacrowdfundingplatform,anditisusedlikethe

traditionalsellingofsharesinthepublicmarket.Itissimilarinfact,tothetraditionalIPO

concept,inwhichcompaniesdecidetobecomepublicandsellagivenamountofshares

toraisecapitalfornewprojectsorwheninneedofliquidity.Theyareinfactanalternative

tothethetraditionalCapital-FundingofVentureCapitalistsandEquityfirms.

2017hasbeentheyearinwhichtheindustryofICOshasboomedextremelyrapidly.The

datashowshowtheamountoffundscollectedbyICOs,hasreachedanastonishing4,4106

USDbillionsinjust2017alone.InJuly2017,theaveragecollectedfundsforanICO,was

of33.17USDmillions.Thegraphsbelow(Graph(2)&Graph(3)),showsgraphicallywhat

hasbeenjustexplained.

Graph(2):CapitalraisedbyICOsinUSDMillionsduring2017.

4,5 9,7 4,7127,80168,40

995,20

461,30330,00

802,90822,60683,50

0

200

400

600

800

1000

1200

USDMillions

Source: Coinspeaker,2017

- 63 -

Graph(3):GrowingN°ofICOsin2017.

InNovember2017,wehave the ICOs that raised singularly the greatest amounts yet.

QASH (Trading& Investing company) is leading the groupwith a 108,2USDmillions

raisedinonlyfourdays, followedbyWAX(68,4USDmillions)andGridplus(45,7USD

millions).Switzerlandisthethenationsthatiscurrentlymoreactiveinthecreationof

ICOs;4outof6 ICOs in factcomefromthiscountry, thanks to its favourablebusiness

orientedandinnovationorientedlegislations(Dr.DiemersD.,2017).Wewillgodeeper

inthisdiscussioninChapterIV.

Thebiggestdifferencefromthetraditionalmethodsofraisingcapital,relies inthefact

that through this technology, also new and small start-ups can have access to similar

financingtool;withouttheneedtorelyontraditionalbusinessangels,venturecapitalists

orbanksinordertoraisefunds.

CrowdfundingCampaign:

Beforewebegintodefinethedifferencesinthemechanismsrelatedtothenewsystemto

raise capital, it is important to note that the introduction of the technology does not

necessarilymakeitharderforuserstointeractwhittheplatform.Thefrontendofthe

platform, meaning the interaction with the crowdfunding platform by users, is very

similartothetraditionalmethodologyofcrowdfunding.Thenewtechnologystaysinthe

backgroundanddoesnotincreasethedifficultywithwhichinteractionsaremadeinside

theplatform,butsimplyhelpsimprovethequalityoftheservicesprovided.

Oneofthefirstelementsthatrequiretheinteractionwiththesystem,isthecrowdfunding

29

3 5 3

17 16

30 35

48

72

50

01020304050607080

N° ofICOs

Source: Coinspeaker,2017

- 64 -

campaign. There are several stages that lead to the success of a campaign, and they

dependontheachievementofcertainsteps.Theyespeciallydependontheachievement

of the objectives set before and during the campaign and in the end on the

accomplishmentofthefinancingobjective.

Oneofthefirstmajordifferencesbroughtbytheblockchaintechnology,isthestructure

andthemechanismsengagedfortheraisingofcapital.

Thefundsgivenbythefundersarenotdirectlytransferredtothecreators,buttheyare

stored ina separatedaccount,where theywill remain lockeduntil the fundinggoal is

reached,orthedeadlineforthecollectionofthefundshaspassed.Ifthecaseoccursin

whichthethresholdsarenotreached,thesmartcontractinsidetheDAppiscodedinsuch

away,thatwouldreleasethefundsbacktothefunders;thatwillbeabletoinvestthemin

another,moreprofitableproject.Ifontheotherhandthefundingprocesshasapositive

outcome, thesmartcontract thatmanages the funds,willmoveto thenextstepof the

crowdfunding procedure. This procedure consists in attributing the pre-determined

rightstoboththeownerofthetokensandthefundraisers,andunlockingthefundsraised

sothattheycanbeused,undercertainrules,bythefundraisers.

Inthisphase,throughtheuseofdigitalsignatures,fundersandfundraisersrelatedtothe

projectcanusetheirrightstoperformactionsonthefundslinkedtotheproject.These

rightsallowboththefundersandthefundraiserstohaveacertaincontroloverthefunds

andmakepossibleactionsandproposalstousethem.Wewillseeinnextfewparagraphs

what these rights are andhow important they are for the creationof adecentralized,

transparentandsafeenvironment.

Intheearlystagesofthecampaign,rulesneedtobedefinedwithrespecttotherightsand

powerthateachactorwantstoachieveorhaveduringthedevelopmentoftheproject.It

isofextremeimportancetohaveacleardefinitionoftherightsandtheobligationofthe

actorsinvolved,inordertoavoidfutureissuesrelatedtopoweranddecisionmaking.The

fundersforexamplewouldneedtoset,makepublicandhavecertainrightsontheamount

theyintendtoinvest,whileontheotherhand,fundraiserswouldwanttohavefullcontrol

overtheraisedfunds.Insidethesmartcontract,thatdefineseachone’srights,theserules

arewrittendownandbecomeinviolableonceanyonedecidestoparticipatetotheproject.

DecentralizedAutonomousOrganization(DAO):

A“DAO”or “DecentralizedAutonomousOrganization”has similar functionalitiesofan

investmentfund,butintegratedinablockchain-basedenvironment.Insteadofdirectly

- 65 -

investinginnewventures,fundersmaydecidetoinvestfirstinaDAO,andwaitfornew

projectstobeproposedtoit.OnceprojectsareproposedtotheDAO,theirvotingpower

makesthemabletodecidewhetherthemoneytheyinvestedshouldgotothatspecific

projectornot.

BeingmembersofaDAO,allowsuserstoproposeideastotherestoftheinternalnetwork,

andinvestinsomeoftheprojectsproposedbyothermembers.ADAOdoesnotcreate

physicalproducts,itdoesnotdevelopsoftorhardware;ontheotherhand,itisableto

receiveandpresenttoitstokenholders,differentinvestmentproposals.Inordertodoso,

itrequiresa“Contractor”,whichcanbeanyDAOtokenholderthatmakesaproposalto

theDAO;thisproposalcanbeacceptedorrejectedbyotherDAOtokenholders.

Notethattroughthissystem,thetokenholdershavethechancetomaketheDAOgrow,

bycreatingcontractsorproposalstoothertokenholders,thatwillmaketheDAOgrow

andgainmorefunds.

TherewardsforinvestingcurrencyintheDAOareindeedDAOtokensregisteredinthe

nameoftheaccountthatinvestedinthefund.Atokenempowersitsownertohaveclaims

overthecompany,meaningthattheinvestorwillgainvotingpowerandotherrightasan

associateoftheDAO.

Likesharesofanyothertraditionalcompany,thenumberoftokensreceivedisrelativeto

thevalueinvested.Pricefortokensfollowsthenormalmarketrulesofdemandandoffer,

andareeasilytransferableinsideandoutsideoftheDAO.

ProposalscanbedonedirectlytotheDAOandproposeacertainuseofthefundsstored

insideit.WheneveraproposalisdonetotheDAOforanewproject,theinitialquorumfor

atraditionalvotingis20%.Inthecaseinwhichtheamountrequestedbytheproposal,

wouldbethetotalityofthevalueaDAOhasaccumulated,thequorumnecessarytomake

theproposalpasswouldbeof53.33%ofthetokenholders(JentzschC.,2016).

Toavoidreceivinganexcessivenumberofproposals,aproposalfee(changeablewitha

proposal)isrequired.Ifthequorumisachieved,thetotalamountforthefeeisrefunded

tothecontractor;ifonthecontraryitisnotachieved,thedepositiskeptbytheDAO.

Theproposalshaveanexpiringdate,attheendofwhich,ifthegoalisnotreached,allthe

currency accumulated is returned to the contributors, and the total amount of tokens

createdareeliminated.

If the proposal is accepted, the DAO transfers the necessary currency in the Smart

Contractsthatrepresentstheproposition;andbydoingso,itstartsanewproject.

Oncethenewventureisupandrunning,decisionalpowerofusersisdirectlycorrelated

- 66 -

tothenumberoftokenstheypossess.Tokensaredivisibleinfractions,transferableinthe

secondarymarket,andidentical.

Oncethecontract isestablished,wheneverthecontractormakesaproposal,userscan

voteonitduringadefinedtimeslot.Whenthevotingwindowisclosed,arequestcanbe

filedbyanytokenholdertocertifythatthethemajorityandthequorumnecessaryto

makeadecisionhasbeenattained.

Inorder foranewdecisionabout theproject togo through, themajorityof the token

holdersoratleastaminimumamountofthem,mustagreeonthenewproposal.Thelevel

ofthequorumcanvary,andcanbechangedwithaproposal.Thequorumdependsonthe

numberofparticipants,thenumberoftokensissued,thevalueofcurrencyusedtocreate

tokens,andthetotalamountthattheprojecthasaccumulated.

TheDAOcomplexity canvarydependingon the role it is given to, and thenumberof

signatures,orconditionsitneedstofunction.Thismeansthatthenumberandthelevel

of interaction between the parties varies depending on the conditions that are

determinedtobepartoftheDAO.

DecentralizedAutonomousOrganizationscanplayanimportantroleinsideablockchain-

basedcrowdfundingenvironment.TheuseoftheDAOcanprovideaneasierwayforthe

protectionof investorstocomeincontactwith innovativeprojectsandinvest inthese

profitablenewventures.

WhatmakestheDAOwork,isalineofcode,andjustlikeasmartcontract,itisdeveloped

usingtheSolidityprogramminglanguage.Inordertowork,aDAOneedstobeuploaded

onablockchainthatsupportsit.Onceonthenetwork,itwillperformmanyfunctionin

themanagingoffunds,rightsandpermissions,aswellastheproduction,management,

andverificationoftransactions.

WhenaDAOisutilizedinacrowdfundingenvironment,itcoversoneofthekeyrolesin

thedesignoftheenvironment.TheDAOplaystwomajorroles:theroleoftheholderof

rightsforusersofferedbytheDApp,andtheroleofholdingthefundswhileanyprojects

isbeingfunded.WhendevelopingthecodeoftheDAO,particularattentionneedstobe

putinthefunctionalitiesembodiedinit,andtherightsitwillallowoncetheprojecthas

taken off. Rights and obligations of the two actors need to be clarified and specified

deeply;oncetheprogramhasstarted,itbecomesverydifficulttointerruptthecycle.

ADAOisabletocommunicate,ifnecessary,withothercontractsinsidethenetwork.This

allowsforawidelevelofpossibilitiesandfunctionalitiesacrossthenetwork, inwhich

- 67 -

automationofactiveswillsubstitutemanyofthecurrentlycommonlyusedapplications.

ThepotentialoftheDAOisenormous,giventhefactthatitrepresentscompletelythewill

of the owners or shareholders; technically allowing it to grow and evolve and

communicatewithotherDAOstocreateanevenbiggerdecentralizednetwork.

VotingSystem:

Oneofthemajordifferencewiththetraditionalenvironment,istheallocationofrights

amongusers.Thenewtechnologyallowsforastrongerallocationofrightsto funders,

thatallowsforadecentralizationofdecisionmakingthatcoulddisrupttheindustry.

Beforetheissuingoftokens,thefundraiserssetthelimitoftherightstobegiventotoken

holders.Every token canbeassociated to theabilityof a tokenholder to expressone

singlevote,whenevertherighttovotecanbeexpressedinadecisionmakingsituation.

Whenever a new proposal is issued by fundraisers, a vote can be used to allow the

generation of different actions, such as spending of cryptocurrency, interaction with

differentorexternalcontracts,oreventheeliminationofanotherproposal.Theexecution

oftheproposalthathasbeenvalidatedbythevotingactions,willbeexecutedassoonas

itreachesamajority.

Asexplainedbefore,therightassociatedwiththeholdingoftokens,likevotingrights,are

definedbythecreatorsofthecampaignbeforetheproposalbecomespublic.

Votingrightsdemocratizeddeeplytheenvironment;rightsandpowerareputbackinthe

handsoffinalusers.

WithdrawTrackingSystem:

When designing the DAO and its powers before the deployment of a project, the

fundraiserisabletocreatenotjusttherulesthatregulatevotingrights,butalsorulesthat

limit the withdraw from the funds raised. What it means is that there can be rules

embodiedintheDAOcode,thatlimittheamountofthefundsthatcanbespentbythe

fundraiserinagivendeltaoftime.Theserulesarecreatedinordertoprotecttheinterests

ofthefunders,whicharealsoentitledtodecideonhowthatmoneycanbespent. It is

importanttorememberalso,thatthenatureoftheblockchaintechnology,makesevery

transactionpublictoallthemembersofthenetwork;meaningthatallthemovementof

currency or the possible investmentsmade by the fundraisers, can bemonitored and

throughtheuseofvotingrights,alsobeblocked.

Oncethethresholdsetbythepartnersissurpassed,anytransactionthatrequiresaccess

- 68 -

tothefundswillnotbeallowed.Ifthefundersrequirenecessarilythatamount,whatthey

candoiscreateaproposal,onwhichfunderscanvoteweathertoallowforthespending

oftheextramoneyornot.

3.1.2.EquinityCrowdfundingDAppRelationalStructureintheNetwork

We now have a clearer vision on how the traditional crowdfunding platform can be

changed by the introduction of blockchain technology. We now also have a clearer

definition of some of the new actors that would compose a blockchain-based equity

crowdfundingenvironment.

IntheFigurebelow(Figure(13))therepresentationoftherelationshipbetweenthetwo

partiesandtheequitycrowdfundingDAppisshown.Inthefigureisisshownalsotherole

oftheDAOandtheservicesthatareembodiedinsideit.Theseservicesembodiedinthe

DAOaretheoneshighlightedinadarkertone.

Figure(13):RelationshipbetweenthetwopartiesinvolvedandtheDAppanditsDAO,in

theequitycrowdfundingblockchain-basedecosystem.

Fromthe figurewecanclearlysee theobligationsandtherightsassociatedwitheach

actor,andhowtheEquityCrowdfundingDAppplaystheroleoftheintermediarycreating

aninformationandrelationalbridgebetweenthetwo.

Itisimportanttorememberthough,thateveniftheDAppisactuallyplayingtheroleof

theintermediary,itisitselfdoesnotoperateanycontroloverneitheroftheactorsinthe

environment.ThemajorroleoftheequitycrowdfundingDAppistoimprovethelevelof

- 69 -

communicationbetween theparties in themarket, andallow them to collaborate ina

moresecure,safeandtransparentenvironment.

3.1.3.ServicesandFunctions

Aswehaveseensofar,therearedifferencesinthestructureofablockchain-basedequity

crowdfundingplatformwithrespecttoatraditionalequitycrowdfundingplatform.We

have also seen what are the new functionalities that an Equity Crowdfunding

DecentralizedApplicationmighthaveandwhateffectitwillhaveontheprotectionofthe

rightsofusersinthenetwork

Inthefollowingsectionwewillassociatethetraditionalservicesthatcanbeprovidedby

a traditional equity crowdfunding platform, with the functionalities that these new

decentralizedequitycrowdfundingapplicationscanhaveconstructedinsidethem.This

waywecanseehowthenewfunctionalitiesarerelatedtothedifferentservicesthatare

notoriouslynecessaryfornormalusersinsideacrowdfundingnetwork.

In order to be as clear as possible, the table below (Table (2)) shows the connection

betweenthetraditionalservices,andsomeofthenewfunctionalitiesassociatedwitha

decentralizedapplicationinablockchain-basedequitycrowdfundingecosystem.

Functionalities Services

CrowdfundingCampaign Matching,Payments,Banking,Dunning&DebtCollection

SmartPropertyTokens InvestorRelation

DAO InvestorRelation,Payment,Banking,Dunning&DebtCollection

VotingSystem(DAO) InvestorRelation

WithdrawTracking(DAO) InvestorRelation

Risk-ScoringSystem RiskScoring

SmartIdentityAuthentication Authentication

CrowdfundingApplication Contracting&Compliance,ITOperations

Table(2):FunctionalitiesofanequitycrowdfundingDAppassociatedwiththeservices

providedandnecessary.

As we can see, the services highlighted with a darker colour, are associated with

functionalitiesthatarenotpresentinthetraditionalequitycrowdfundingecosystem.

Theuseofthisnewtechnologyandinnovationisabletocreatenewfunctions,thatare

abletosatisfythesameneedsofcustomers,butwithsubstantialimprovements.

- 70 -

Major improvements brought by the new structure, are related to the Investor

Relationship side; given by the introduction of functionalities such as smart property

tokens,andtheuseofaDecentralizedAutonomousOrganization.

DAOsintroductionallowformanyadvantages inthefield;advantagesthat includethe

votingsystemandthewithdrawtrackingsystem,whichempowerinvestorsinwaysthat

werehardyimplementedbefore.InvestorRelationshipimprovementiswhatreallydrives

theadvantagesoftheintroductionofthistechnology.Withtheideabehindblockchain,

wecanhaveanempowermentofthepeoplethatsupporttheplatform;wecancreatea

safer environment where the investors feel at ease in the act of investing in new

businessesandinnovativeideas.

3.2. Blockchain-Based Equity Crowdfunding Environments: Business and

InteractionModels

Nowthatwehavea clearvisionof all the functionalitiesof ablockchain-basedequity

crowdfundingDApp,wecananalysehowtheintroductionofblockchaintechnologyand

theDAppcanchangetheinteractionmodelsinsidethecrowdfundingenvironment.

Therelationshipbetweenthetwomajoractorsandthethirdpartywillchange,andin

ordertounderstandbetterthelevelofinteractionandtheroleofeachpartyinvolved,we

presenttwodifferentinteractionmechanismstoexplaintransactionflowinthisnetwork

inwhichablockchain-basedequitycrowdfundingDAppisutilized.

It is fascinatinghowthe levelof independencyfromathirdpartyof thetwoagents, is

muchhigherinasysteminwhichtheblockchaintechnologyisutilized.

In a traditional system, the interventions of third trusted parties like a bank and a

crowdfundingplatformarenecessary.Inthetraditionalecosystem,theabsenceofthese

intermediaries would not allow for the development of services like banking and

payments,necessaryforthefinancialandcommunicationalneedsofcreatorsandfunders

inthenetwork.

Aswewill see, the role and theposition of these intermediarieswill changewith the

introductionofblockchaintechnology.Thetechnologyeliminatessomeofthetraditional

intermediaries and will simplify the network, by establishing a more direct

communication,easierandmoretransparentinteraction,andfairdistributionofrelevant

information, solving many of the issues related to the traditional methods of equity

crowdfunding.

- 71 -

Ontheplusside,theroleofmanagingtheallocationanddistributionoffunds,isnolonger

responsibility of the traditionally used crowdfunding platform itself or of a financial

intermediary,but it ismanageddifferentlyby thecrowdfundingDAppandtherelated

DAO;bothdecentralizedandconstructedtoallowahigherleveloftransparencyinthe

interactionsbetweenthecapital-seekersandcapital-givers.

The introduction of aDecentralizedApplication, has a strong effect on the traditional

structure of the crowdfunding network. In Chapter II we explained two important

contribution network structures, the “Peer-to-Peer ContributionMechanism”, and the

“Equity-BasedContributionMechanism”. In thenext twosectionswewill seehowthe

introductionoftheblockchaintechnologyhasaneffectonthestructureofthenetwork,

andhowtheDAppwillcomeintoplay.

3.2.1.Peer-to-PeerContributionMechanismTroughaDecentralizedApplication

Inthepeer-to-peercontributionmechanism,whereblockchaintechnologyisintroduced,

themajordifferencewiththetraditionalmethodliesintheholderofthemechanismthat

controlstheflowoffundsandtheflowofrights.Thisroleoftheholderofsuchmechanism,

isinfactplayedbytheDAOinsidetheCrowdfundingDApp,ofcentralimportanceinthe

network.

Aswecansee,theuseoftheDAppallowsforaresolutionoftheproblemoftransferof

rights of the shares between the creator and the funder. Thismeans that there is the

possibility for the creation of a secondary market, in which rights on tokens can be

exchanges, resolving one of the major problems related to traditional crowdfunding

platforms.

Throughthismethodfurthermore,theDAppcarriesouttheroleoftheholderofthefunds

devoted to the creator. This means that funds are not directly and immediately

transferredto theentrepreneur,butareholdby theDApp.Thisallowsthecreationof

systems inwhichaccess to the fundby thecreator ismanagedbycertain rules in the

handsofthosethatareholdingrightofthecompany.Thisempowersrightholdersina

waythatwasnotpossiblethroughtraditionalmethodsofcrowdfunding.

Thefigurebelow(Figure(14))showshowthestructureofthepeer-to-peercontribution

mechanismchangesas theblockchain technologyand theDAppare introduced in the

network.

- 72 -

Figure (14): Peer-to-Peer ContributionMechanism trough a decentralized application

Illustration.

Itisimportanttonotehowfinancialinstitutionslikebankshavenoroleinthissystem;

andhowtheinteractionofthelendersisnotlimitedtotheonestheycanhavewiththe

platform,butextendtootherlenderstoo.

3.2.2. Equity-Based or Royalty-Based Contribution Mechanism Trough a Decentralized

Application

Similar structure canbe found in the equity-based contributionmechanismstructure;

where entrepreneurs and investors can interactwith each other directly. Also in this

system,financialinstitutionslikebankshavenorole,andcanbeeliminated;trustthan

shiftsfromfinancialinstitutions,tothetechnologyitself.

Figure (15) shows how the the structure of the network changes for an equity-based

contributionmechanism,whentheblockchaintechnologyisintroduced.

- 73 -

Figure (15): Equity Crowdfunding Mechanism trough a decentralized application

Illustration.

Aswecanseefromthefigureabove,theequitybasedmechanismthroughadecentralized

application is very similar to the peer-to-peer interaction trough a decentralized

application.Asweknowinfact,theintroductionofdecentralizedapplicationthatworks

onablockchainbase,willallow for thecreationofapeer-to-peercommunicationand

financialinteraction.

The left side of the illustration, shows the possible interaction between different

investors,andthepossibilityforthecreationofasecondarymarketfortokens.

3.3.ServiceModulesforCrowdfundinginaBlockchain-BasedEcosystem

Theintroductionofablockchainbasedsysteminthecrowdfundingmodel,haseffectson

manyaspectsoftheindustry.Thetechnologyhasthechancetochangealsotheapproach

tocertainissuespresentinplatformsofthistype.Blockchaintechnologyisinfactnotonly

introducedtoresolvemanyoftheissuesthatwefacedwiththetraditionalcrowdfunding

mechanisms;butitisalsoabletotransformsomeoftheservicespreviouslyprovided.

In the Chapter II, we analysed some of the services that a traditional financial

intermediary and a crowdfunding platform can offer to users; in this sectionwewill

explainhowblockchaintechnologycanimprovesomeoftheseservices.

Notalltheservicescanbeimprovedthroughtheuseofblockchain;wewillfocusonlyon

thosethatcansupportablockchainapplicationandthatcanactuallybeimprovedbythe

technology.

Oncewe have identified the services improvable by a blockchain technology, we can

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implementtheminsideaspecificallydesignedDApp.

3.3.1.ServiceModulesImplementedwithBlockchainTechnology

Starting from a blockchain-based environment, we can take some of the traditional

crowdfundingservicesandtailortheminordertofitthenewsystem.Westartfromthe

definitionanddivisionofservicesprovidedbythetechniqueofmodularizationofservices

that we analysed in Chapter II. We than describe the evolution of the services,

reconfigured in theDecentralizedCrowdfundingApplication.Whatweknow from the

definitionofthetechnology,isthattheevolutionoftheservicesinthenewecosystemwill

beabletoofferthesametypeofservices,butwithahigherlevelofsecurity,transparency,

andalowerriskforallthepartiesinvolved.

Matchmaking:

This specific service has no particular difference from the traditional form of

matchmaking.

Themaindifferenceisthescopeofthecustomerbaseinwhichtheplatformwilloperate.

Withthereductionoftheminimumamountofcapitalnecessaryinordertofundanew

venture,themarketwilltackleasectionofthemarketuntilnowuntouched.Thefocus

will infactshifttothemassmarket, inwhichmanyindividualsarewillingtoinvest in

riskynewventureseveniftheyarenotinpossessionofagreatcapital.Whatcanalsobe

developedisamoreprecisesearchmechanism,thatallowsforapartialornullpublication

ofpersonaldata,butisabletosearchaccordingtoaselectedinterestortoaselectedlevel

ofreputation.

Contracting&Compliance:

One of the most important and interesting aspects of DApps, is the fact that the

contractingandlegalbureaucracyrelatedtocrowdfundingoranyfinancialservicethata

platform may provide; can be managed automatically trough smart contracts. Costs

relatedtolegalcorrespondenceandsecurity,canbedecreasedsubstantiallyallowingfor

theallocationofresourcesondifferentservices.

CustomerSupport:

TheprotocolsthatexistinsideaDecentralizedApplicationhasthemajorcharacteristicof

beingclear-cutandcomputerized;thismeansthatafullcoveredsupportisnotneededto

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interactwithit.Oneproblemcanstillarisefromthestipulationofthedigitalcontract,and

in the understanding by the final user of the code that composes the contract. This

problemiseasilyoversteppedthroughathoroughexplanationofthecodeembodiedin

the smart contract, in the sameway itwould be overstepped through the traditional

methods.

RiskScoring:

Duediligenceanalysiswouldstillbeperformedbyexpertsinthefield,sincetheanalysis

ofthefeasibilityofaprojectscanhardlybeautomatized.Whatthetechnologycandoon

theotherhandistheanalysisofallthepasttransactionsofthefundraisers,inorderto

accesstheirfinancialeligibility.

Insteadofbeingperformedbyanexternalthirdpartythathasaccessorholdssensible

privateinformationabouttheusers;thisfunctioncouldbeperformedbyasmartcontract.

Thesmartcontractcouldbeable in fact toassignascoreassociatedwithrisk toeach

individual by going through the transactions associated with said user. Since an

automated cryptographic system is in charge of the analysis of the data, there is a

reductionoftheriskofhavinglowersecurity.Thesecontrolscouldbeperformedthrough

asmartcontractembodiedintheapplicationproposingtheprojector,byasecondary

contractthathastheonlypurposeofassociatingeachusertoariskscore.

AuthenticationThroughSmartIdentity:

The application of Blockchain technology gives the possibility to any platform, to use

Smart Identity applications. The technology allows for a more secure and precise

authenticationsystemthatcanbeintegratedinthecentralDApporoutsourcedtoanother

Decentralizedsatelliteapplication.

This is of extreme importance in the definition of the identity of the funders and the

fundraisers; not just for fiscal purposes, but especially for security and transparency

purposes.

CrowdActivation:

The application of Blockchain technology does not affect the upfront services that a

platformprovidestousers.Crowdactivationservicesremainoutsideof thescopeofa

DApp,whoseprimary activitieswill beperformed in thebackground, offering amore

secure,andtransparentwaytotransferfundsanddata.

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InvestorRelations:

InvestorRelationshipissubstantiallyimprovedbytheintroductionofthistechnologyin

thenetworkformanyreasons.

Unfortunately, regulation related to equity investment is for now inexistent or very

limited for the use of tokens for crowdfunding investments, but the newness of the

technologyisgivingspaceforthedeepexplorationofthepossibilitiesofthetechnology;

allowingfordifferent,innovativeandsmartwaysforsupplyingshares.

Thissystemisabletogivevotingpowertotokenholders,meaningthattheyareentitled

ofdecidinghowandwhenthemoneytheyinvestedshouldbespentforfurtherprojects.

The transparency allowed by the technology also has the power to give rights to

shareholderstomakedecisionsaboutanypossibletransactionrelatedtothefundsthey

invested.Thelevelofcontrolbyfundersincreasesdrasticallythisway,empoweringthem

tomakeanyfinancialdecisionregardingtheinvestmentofthefundsinsidethecompany.

Furthermore,thenewsystemallowsforthecreationofasecondarymarketfortokens;

this increases the independence of investors and the security of themarket, limiting

financialrisksandpullinginmorepossibleparticipants.

During the fundraising campaign, communicationbetween the twoparties canstillbe

managed by traditional means of communication offered by the platform; once the

campaignisover,communicationcanbetranslatedintheformofvotingrights.Voting

systems can be implemented and constructed in different ways, allowing for the

distributionofmotivationsandthereasoningbehindcertainvotingdecisions;together

withpre-setmessagestobedistributedtocertainindividualsaccordingtopre-defined

rulesofcommunication.

ITOperations:

Theimplementationofthetechnologyintheplatform,changesthetypeofinteractionthat

existsbetweenthetwopartiesinvolvedinthetransactions.Therelationshipishandled

by smart contracts; ITOperations and coding are therefore fundamental for thewell-

being of such relationships. The use of the technology allows for an extreme level of

freedom in thedefinitionof the relationships.Themarket is stillwaiting for the right

legislationtodefinethelimitationsofthismarket,butuntilthen,projectsandinteractions

ofsuchsortarehighlyindependentfromanyregulationandlegislation.

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Payment:

Aswe can imagine, one of themost important innovation brought by the blockchain

technology is theuseof a secure, transparent, andvalid formofonlinepayments and

registrationoftransactionsamongusers.This iswhythetechnologyhasaparticularly

strongeffecton thisservice.Theuseofcryptocurrencyasoneof thepossiblewaysof

exchanging value, gives thepossibility todifferent services to come intoplay in these

networks.With the use of cryptocurrency in fact,we can have different integrated or

satelliteDAppsthatareabletoofferdifferentservicestouserssuchasdigitalwalletsor

exchangeplatforms.

Theseservicesrelatedtotheuseofcryptocurrencieshavemanybenefitsanddrawbacks

thatwewillnotanalyseinthisthesis.

Banking:

Banks could be easily eliminated from the framework, since the central role usually

playedbytheseintermediariesiseliminatedinadistributeddecentralizedsystem,and

substituted by the technology. Smart contracts in fact, take care of all financial

transactions and contractual relationships between partners; while the history of

transactionsisrecordedentirelyinsidetheblockchain.

Dunning&DebtCollection:

Asmanyotherservicesthatcouldbeperformedbythirdtrustedparties,smartcontracts

couldbeinchargeofcarryingouttheseservicesinastandardizedandtrustedway.The

powerofreinforcingtheseactionscouldbegiventothefinalusersortoenforcersthat

couldworkwiththepowergivenbyvotingrights.

Oneofthepossibleapplicationofsmartcontractsisfurthermorethepossibilitytocreate

special funds financed by transaction fees, that could be used as collateral for the

eventualityoftheneedofaninsurancerepayment.Thepossibilitiesaremany,andcanbe

similartotheonesalreadyexistinginthetraditionalnetwork;thedifferenceliesinthe

useofsmartcontracts,whoseexecutionismandatorywhenevercertainconditionsare

met.

3.3.2.PlatformInteractionsandServiceProvision

In section 2.3.3., we described the structure of interaction between the actors in the

traditionalcrowdfundingnetwork.Inthissectionweprovideadescriptionofthesame

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environment,inwhichblockchaintechnologyhasbeenintroduced.

Figure (16), shows how the ecosystem of relationships and services changes as we

introduceblockchaintechnology.Thefigureshowstheroleandthepositioninthemarket

ofablockchain-basedCrowdfundingDApp;anewimportantelement,whichdrastically

changes the structure of the system. This interaction network is in contrastwith the

traditionalsystemofinteractionshowninChapterII;thenumberofactorpresenthasin

factchanged,togetherwiththedistributionofkeyactivities.Someserviceproviderscan

beeliminated,andtheirfunctionsabsorbedbyothers.Newserviceprovidersareableto

performinsuchawaythatbenefitsthetwomajoractorsinvolved,whileintroducinga

high levelofdecentralizationandreductionofrisk,usuallyassociatedwithblockchain

technology.

Figure (16): Equity Crowdfunding platform interaction and service provision in a

blockchain-basedecosystemthroughtheuseofaDApp.

The Figure shows how some of the activities like Banking and Payments, that are

traditionally performed by third partymembers, are embodied inside the DApp. The

figurealsoshowshowsomeoftheserviceslikeCrowdActivationandCustomerSupport,

are better performed by the Crowdfunding Intermediary such as a traditional

crowdfundingplatform,ratherthanaCrowdfundingDecentralizedApplication.

Thereisadistinctionbetweenthetypesofservicesthatcouldorshouldbeperformedby

acomputerprogrammesuchasasmartcontract,andthosethatarebetterperformedby

Seekers

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a traditional platform. Not all services can benefit from a total codification and

computerization; there are activities that require a certain level of flexibility and

adaptation,thatcomputerscienceisnotabletoprovide.

Itisimportanttonoticethough,howtheDAppisabletointegrateinitscode,manyofthe

servicesandtherolesthataretraditionallycarriedoutbyexternalthirdparties.These

third party service providers like crowdfunding partners and payment providers like

banks, can be eliminated from the network, decentralizing drastically trough the

blockchaintechnologymanyofthemostimportantactivities.

3.4.EffectsofDecentralizedApplicationsonCrowdfundingInefficiencies

Blockchaintechnologycanbeappliedinmanyindustriesthatarecurrentlyinneedofa

decentralizedapplication.Wedecidedtofocusonthecrowdfundingindustry,becauseof

theextremegrowthishasbeenhavinginthepastfewyears,andthehugepotentialthat

theintroductionofthetechnologyhasinthedemocratizationofthissystem.

Thecrowdfundingecosystem is inneed foranewsystemof interactionsbetween the

parties involved, that will reduce the current inefficiencies and costs, related to

crowdfunding.Now thatwehave explainedhow the traditional crowdfunding system

worksandhowablockchain-basedcrowdfundingsystemcouldwork;wecanexplainhow

theintroductionoftheblockchaintechnologycouldalleviatetheinefficienciescurrently

presentintraditionalequitycrowdfundingplatforms.

ThissectiondescribeshowtheblockchaintechnologyandtheuseofDAppsandDAOs,

can reduce or even eliminate some of these inefficiencies. In order to do so, we will

analysetheapplicationofthesetoolsintheecosysteminthreedifferentmatters.Firstof

all,wewillshowthegeneralimplicationoftheapplicationofblockchaintechnologyinthe

crowdfundingecosystem;togetherwiththeconsequencesithasingeneralwithrespect

tomarket inefficienciescurrentlypresent inthemarket.Wewill thanexplainhowthe

functionalitieswedescribedofthedecentralizedapplicationcouldsolvetheinefficiencies

we identified inChapter II for the traditionalequitycrowdfundingecosystem.Wewill

finallyassociatesomeofthefeaturesoftheequitycrowdfundingDAppwiththeresolution

of key financial risks, that through the technologywill be reduced and in some cases

completelyeliminated.

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3.4.1.MarketInefficiencyReductionwithBlockchainTechnology

Aswehaveseeninthepreviouschapters,thetraditionalcrowdfundingplatformspresent

somemajormarketinefficiencies29.Theseinefficienciescanbesummarizedbytwomajor

problems that represent the market’s and network’s limitation. These problems are

AsymmetricInformationandMolarHazard.

Asymmetricinformationrepresentsagroupof issuesthatrevelthemselvesbeforeany

interaction takesplace.Asymmetric information in fact, refers to thedifferent levelof

knowledgethatcharacterizesthetwopartiesinvolvedbeforeanyinteractiontakesplace.

While on the other hand, Moral Hazard refers to all the issues that arise once the

transactionhastakenplaceandthereisamismatchbetweenwhatwasexpectedandwhat

actuallyhappenslaterontroughtheevolutionoftheproject.

We will show how with the introduction of blockchain technology, these issues are

stronglyreducedandinmostcaseseliminated.

Whenweintroduceblockchaintechnologyanditsapplicationsinsidethecrowdfunding

system, we can see changes in the network from the first steps of the crowdfunding

process.

Startingfromthescreeningofthepossibleprojectstobepresentedtothepublicinfact,

theintermediaryroleofthecrowdfundingplatformcanpotentiallybeeliminatedsince

everyoneusingtheDAppinadecentralizedenvironment,canpresenttheirprojecttothe

fundingpublic.Itisimportanttonotethat,ontheotherhand,thismightcreatetheissue

ofanoverflowof information, thatwillnecessitateasystemfor theassessmentof the

credibility and reliability of the creators of such campaigns. Mechanism based on

reputation can also be implemented in order to allow fundraisers to certify their

professionalismandconvincecapitalgiverstoinvestintheirprojects.Ifthatwouldbethe

case, the DApp can, also in this case, come into play by creating a standardized and

mechanistic system of reputation and place itself as the trusted intermediary. The

importanceandthereliabilityofthereputationsystemcanbeseeninnotoriousexamples

suchasAmazonore-Baythatbasetheirnetworkonthis feature.Thesuccessof these

platforms,helpsusrealizehowthisfunctionalityofsmartreputationcouldreallywork

alsointhecrowdfundingandsharingeconomyfutureecosystem.

Thedecentralizationoftheeffortinofferingareputationsystemwilldefinitelyreducethe

29 Section:2.5.Ineficiencies

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costsofadministrationandwillbemoretransparentthanthecurrentone.Thecrowd-

poweredsystemwillthangivebenefitstoboththeactorsinthemarket,reducingcoston

oneside,andincreasingtransparencyontheother.

Forwhatconcernstheissuesthatariseonlyaftertheinitialinteractionbetweenthetwo

parties,theycanbeloweredthroughtheestablishmentofformsofsecurityintheDApp

that protect the interests of the funders. Hidden Actions can hurt funders, that in a

traditional crowdfunding ecosystem have very limited rights and right enforcement

mechanismsattheirdisposal.Oncetheinvestmenthasbeenprocessedandtransferred

tothefundraisersthepowerofthefundersisdrasticallyreducesandtheyhaveverylittle

controloverthecapitalinvested.TheimplementationofdefinedrulesinsidetheDAppto

protecttheinterestofthefunders,doreducetheamountofeffortrequiredbythemto

enforce their rights. These rulesmanifest in the form of Voting Rights andWithdraw

Tracking; these rules substantially improve the power that the funders have over the

fundstheydecidetoinvestinnewventures.

Theleveloftransparencyandtheimplementationofvotingrighthavealsotheeffectof

reducingnotonlythetwomajorproblemsofHiddenInformationandActions,butalso

reduce the relatedproblemof thePrincipal-AgentProblem,givingback the control to

thosethataredirectlyinvolvedinthefundingprocess.ThePrincipal-AgentProblemissue

can be solved also by making sure that both the funder and the fundraiser are in

possessionofsharesortokensofthecompany,aligningtheinterestsofthetwo.

Thepresenceofvotingrightsandthecreationofcertainrightsonthespendingof the

funds collected, is of extreme importance for the participation of the funders in the

process of crowdfunding. The absence of these rights would not push investors to

participate,making themarket fail. It is important to remember though, that it is still

important that the fundraisers remain an important presence both financially and

manageriallyinsidetheorganization.Thedesignersofthecompanyareprobablyinfact,

themostvaluablecomponentwhenitcomestodecisionmaking.They,aretheindividuals

thathavethemostinsightontheindustryinwhichthecompanywillbeimmersedinto,

andareprobablytheonesthatwillbeablemorethanothers,togivethemostaddedvalue

tothecompanyonceitwillbedeployedinthemarket.

Another major innovation brought by blockchain technology are smart tokens. The

introduction of smart tokens has major benefits, in the sense that will allow for the

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creationofasecondarymarketthatwillnotonlypushfunderstoinvestinmorethanone

company,butwillallowfundraiserstocollectfundsmoreeasilyandfaster.

Theuseofsmarttokensandtheimplementationofvotingrightsontheotherhand,might

havesomedrawbacksontheindustry.Thesenewrightsmightallowfunderstoimpose

entrepreneurs to pursue more short-term returns rather than long-term once. The

creationofasecondarymarketfortokensmightinfactmotivatefunderstopursuesuch

astrategy,backedupbythe improvementof thepowertheywillbeableto imposeto

entrepreneurs.Onepossiblesolutiontothisproblemwouldbeadiversificationbetween

thosethathaveshorttermandthosethathavelongtermvisionsorexpectationsonthe

projectstheyinvestin.Thesubdivisionofinvestorsonthebaseofobjectives,willallow

fundraiserstoselecttheirfundraisers,andhaveagroupofshareholdersthatwillnotjust

lookattheirowninterests,butwillhaveinterestsinthewell-beingofthecompanyand

theprojecttheyarebackingup.Thebestdecisionentrepreneurscanmake,istobepart

oftheinvestmentpool,inordertomixtheirvisionandinterestswiththeonesoftherest

oftheinvestors.

Themajor improvement givenby the technology is the fact that itwill create amore

transparent,decentralized,anddemocraticwaytofundsmallandbigbusinesses,where

theinterestsofboththefunderandthefundraisersaretakenintoaccount.Fraudswill

not be necessarily eliminated, but the fact is that they will be traced and will be

permanently written inside the distributed ledger could discourage - more than the

systemisdoingnow-maliciousactsformhappening.

3.4.2.MarketInefficienciesThatCouldBeSoftenedbyDAppFunctionalities

Insection3.1.1wetooka lookatthenewfunctionalitiesthatanEquityCrowdfunding

DecentralizedApplicationcouldbringtothetable.Inthissectionwewillseehowthese

new functionalities canhelp to reduceand in somecases eveneliminate,manyof the

limitationsthatthetraditionalcrowdfundingsystempresentsinmicroeconomicterms.

CrowdfundingCampaign:

Oneofthefirstproblemsrelatedtocrowdfundingistheallocationof fundsduringthe

crowdfunding campaign. In the traditional system, the crowdfunding platformwould

have to relate on a third party like a bank to hold the funds, or do it itself. This

methodologymightraisesecurityandtrust issues,whichblockchaintechnologymight

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resolve.

ADAppapplicationinthefirststepsofthefundraisingcampaign,isabletofunctionasa

holder of the funds raised. This important function, eliminates the need of the

introductionofanexternalandcentralizedthirdparty.Thefundsthatareraisedduring

the campaign in fact, arenotdirectly transferred to the fundraisers, but arekept in a

separateandautonomousaccountcreatedbytheDApp.Insidetheseaccounts,thefunds

are locked until the right amount is reached or the campaign expires. These security

measures,definedbyconditionsunderwhichtheDApphastoundergo,givethefunders

ahighlevelofprotectiononthefundstheydecidetoinvest,whichimprovesalsotheir

willingness to invest in new projects. These security measures usually consist in

thresholdsoffundstobereached,ortimelimitsafterwhichthecampaignexpires.Ifthese

conditionsattheendofthecampaignarenotmet,thefundsinvestedareautomatically

transferredbacktothefundersbythesmartcontractsembodiedintheDApp.

These security measures though, are not constructed to protect just one side of the

transaction.FundraisersinfactareprotectedtoobyfunctionalitiesoftheDApprightafter

the end of the crowdfunding campaign. As soon as the campaign is over and all the

conditionsfortheprojecttogoonaremet,thefundsareavailabletothefundersforuse

through the development of the project, andwill be used by them to construct their

company.Themostimportantthingtokeepinmindisthefactthattheamountofrights

andprotectionofthetwopartiesandtheresolutionofthemarketinefficiencies,canbe

pre-determinedthroughthecodingofthesmartcontracts.Thegoalwouldbethoughto

createabalancebetweenthetwoforcesandallowbothpartiestoworkinanenvironment

thatistransparent,andmoreimportantly,secure.

SmartPropertyTokens:

Aswepreviouslypointedoutinsection2.5.1,traditionalequitycrowdfundingplatforms

donotallowforthecreationofasecondarymarketfortheexchangeofshares.theSmart

Propertytokensinablockchain-basedcrowdfundingplatform,willsubstitutetheroleof

sharesandwillthanrevolutionizethefinancialmarket.Blockchaintechnologymakesit

notfeasibletofalsifytokensandownershipofcertainassets,allowingforarisklessand

costlessmarketizationofthem.

Theintroductionofasecondarymarketfortokens,revolutionizetheequitycrowdfunding

market;inthesensethatgivesinvestorsthepossibilitytoexchangetokensfreelyandin

asecureway.Thisisnottheonlyupsideofthecreationofasecondarymarket;infact,this

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optiongivesthemthechancetoavoidmanycomplicationsrelatedtotheinvestmentin

newcompanies,likethePrincipal-AgentProblemwediscussedearlier.

DecentralizedAutonomousOrganization(DAO):

TheutilizationoftheDAOstructure,allowsfortheadaptationofthesystemissuchways

that allows for the customization of the project involved, in linewith its needs.Most

importantfeatureofthetechnologythatinteractswiththeDAOisthevotingsystem,that

increaseexponentially theresilienceof theproject.This featuresupportsanydecision

thatcanbemadebytheparticipants.Thesedecisionscanincludealsotherelocationof

theprojectintoanewblockchainservice,thatmightfitbetterthecompanyneeds.

Allofthisallowsfortheempowermentoftheinvestors;thatwillhavemorecontrolover

thefundstheyinvest,andmorecontrolovertheactionsofthefundraisers.

Funders have an exceptionally high control over the funds,making them in charge of

almost any decision that the company is deciding to undertake. Funders have in fact,

controloveralltheaccessestothecompanyfunds,makingthemabletoallowornotthe

useofthecapitalbymanagersandowners.Byhavingcontroloverthefunds;thereisa

consequentialstrongreductionoftheprincipal-agentproblem.

VotingSystem:

Whenwearedealingwithequitycrowdfunding,theriskoffraudbythefundraiserstothe

detrimentoffundersissignificant.Havingasubstantialamountofcontroloverthefunds

invested than, has particular importance in these situations. The voting system is

designedandhasbeencreatedspecificallyforthispurpose.Withthevotingsystem,the

risksarereducedbycreatingthisrightenforcementmechanismthatgivesthepowerto

funderstocontrolthefundstheydecidedtoinvestintheventure.

TheDAOisabletocreateademocraticenvironment,allowingshareholderstobepartof

thedecisionmakingprocessandenforceactions.

This security mechanism works as a deterrent for managers to undertake selfish or

maliciousactsthatwillhurtthecompany,andconsequentlyshareortokenholders.This

canbeconsideredaninitialsolution,totheprincipal-agentproblemandthemoralhazard

problem.

Theincreaseofcontrolbyusers,isnottheonlybenefitbroughtbytheapplicationofthese

mechanisms.Moreautomatedcontrolmeansthatthecostsfromactualcontrolperformed

bythefunders,aresubstantiallyreduced.

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Probablythemostinterestingconsequenceoftheintroductionofthevotingmechanism,

isthepossibilitytoleverageonthesocalled“WisdomoftheCrowd”.Votingmechanisms

canbeimplementedatmultiplelevelsinsidetheDApp,thismeansthatfunderscandecide

where their knowledge could be of best use inside the organization. Every step and

function carried out andnecessary inside the organization, couldbenefit fromhidden

knowledgeinsidethecrowdthatfundedtheorganization.Thepositiveinterventionofthe

crowdisnotjustlimitedtothecrowdfundingcampaignandthemoneymanagement,but

especiallyextendstosituationsinwhichtheirknowledgecouldbecrucialforshapingthe

company’sstrategicpath.

The introduction of such voting rights is the clear example of the potential of the

decentralizationbroughtbyblockchain technology.Voting rights areoneof themajor

featuresofademocraticsystem;wherethedecisionmakingpowerisnotinthehandsof

few,butinthehandsofalltheparticipantstothenetwork.

WithdrawTrackingSystem:

Thewithdrawtrackingmechanism introduces two important functions, thathaveasa

consequencetwoimportantbenefitswithinthecrowdfundingsystem.

The fist function is the ability for the system to create a limit to the amount that the

managerortheentrepreneurcanwithdrawfromthefundsthathavebeenaccumulated.

Thismechanismcreatesabalancebetweenthetwopartiesinvolved,allowingforadecent

leveloffreedomofmovementforthemanagers,andatthesametimeafairamountof

controlof theresources for the funder.Thisalsoreduces theprincipal-agentproblem,

creatinganequilibriumoftheforces.

Thesecond functionallows for the introductionofahigher levelof transparency.The

function in question is the unquestionable truthfulness of the transactions that are

written on the blockchain. This mechanism makes it very hard for anyone to make

maliciousor suspicious transactionwith the fundsstored in theDAO.Moralhazard is

thereforereduceddrastically,andfraudsbecometraciable.

These rules allow the funders tohave two separate control over themoney that they

invested;theyareabletovoteforallowingatransactiontogothrough,andtheyareable

tokeeptrackofallthetransactionslinkedtothefundstheyhelpedraise.Transactionthat

doexceedtheconditionspreviouslysetbetweenthetwoparties,areontheotherhand

automaticallyblockedbythecode.

Controloverthemoneyinvestedisoneofthemajordemocraticimprovementthatthe

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blockchaintechnologyintroduced.

Risk-ScoringSystem:

Asymmetric information in the crowdfunding market can still be an issue even in a

blockchain-basedenvironment.Itcanbehardinfact,tocollectinformationandverifythe

credibilityoffundraisers.Therearethough,systemstoovercometheseissuesthatcanbe

builtinoneoftheDAppsthatworksintheenvironment.Thesesystemscancomeinthe

formof“ReputationSystems”and“HistoricScanning”.Suchfunctionswillhelpfundersto

haveaviewofthepastexperiencesofthefundraiserstheywouldliketoinvestin,andwill

givethemageneralviewontheyreputationtheybuiltaroundthemselvesthroughpast

projects.

ThesefunctionscanbeperformedbyasecondaryorsatelliteDApp;orevenimplemented

andbeautomaticallyactivatedinsidethemaincrowdfundingDApp.Thesefunctionscan

alsobeperformedbyanexternalthirdpartylikeanexternalfinancialinstitutionthatis

abletoaccessinformationaboutthepastfinancialrecordsofthefundraiser.Confidential

information does not have to be divulged necessarily, but the solution might be the

creationofasmartcontractthatallowsfortheassignationofascoretoeachindividual,

definingtheirreliabilitybasedontheircredithistoryorpasttransactions.

Somecrowdfundingplatformsmayalsodecidetohavetheirownsystemforthedefinition

oftheriskrelatedtoaninvestment.Itisimportanttokeepinmindinfact,thattherisk

associated with an investment does not only depend of the financial record of the

fundraiser,butalsoonthefeasibilityoftheprojectpresented.

Themodalities withwhich fundraisers can be screened and categorized can come in

differentformswithdifferentlevelsofcomplexity.Theconcepttokeepinmindisthatthe

blockchain technology provides a framework for the registration of all economic

activities,transactionsandmovementofownership.Traceabilityofcurrency,assetsand

interactionisextremelyaccurateallowingforasubstantialreductionoftheproblemof

AdverseSelectionandInformationAsymmetry.Asthenetworkgetsmoresecurewiththe

resolutionoftheseissues,userswillbemorewillingtoparticipatetothenetwork,making

itevenmoresecure.

SmartIdentityAuthentication:

Particular attention is naturally given to the issue of security in the crowdfunding

ecosystem,andonanywebplatformingeneral.Itisimportantforanyuserinteracting

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with someone else on the platform, to be exactly sure to whom they are talking or

interactingto.

Whenexchanginginformationorinvestments,anyonemustbeabletotrusttheidentity

ofthepersontheyareinteractingwith.SmartIdentityfunctionalityhasbeenconstructed

forthispurposespecifically.

Through the use of smart identity authentication, the fundraisers are disclosing their

identitytothepublic,showingwillingnesstobecooperativeandtransparent.Thismay

induceinvestorstotrustthefundraiserthatmakesthemabletohaveafullviewoftheir

credithistory.

Funderscanalsousesmart identityauthentication,allowingotherusersto learnfrom

their experience as successful funders, and push them to participate themselves to

lucrativecampaignsorinvestments.

Smartidentityimplementationcanalsohavepositiveconsequencesfromalegalpointof

view. Since actions can be linked more easily to people with no margin for errors,

responsibilities can be associated to the right identity easily and fast. The process of

identifyingpeoplewillthenbesimplified,andcostswillbereducedtogetherwiththerisk

ofmoralhazard.

Theuseofadigitalandsecureidentity,willnotonlyhelpgovernmentsanddebtcollection

agenciesperformamoreaccuratejob,butwillalsoallowuserstobeentitledcompletely

totheiridentity.Theywillbeabletocontrolandshareattheirwilltheirpersonaland

sensibleinformation,withoutgoingthroughathirdpartywhoseintegritycouldnotbe

provenforsure.

Table (3) representsa summaryof thepossibleapplicationsand functionalitiesof the

crowdfundingDAppwediscussed,associatedwiththepossibleinefficienciestheyhave

beencreatedtosoften.

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Functionalities ApplicationPossibilities SoftenedInefficiencies

CrowdfundingCampaign Self-governingManagementofFunds

MoralHazard&AdverseSelection

SmartPropertyTokens InvestmentTrading Principal-AgentProblem

DAO Self-governingManagementofFunds

MoralHazard&Principal-AgentProblem

VotingSystem(DAO) RightsEnforcement MoralHazard&Principal-AgentProblem

WithdrawTracking(DAO) Transparency MoralHazard&Principal-AgentProblem

Risk-ScoringSystem Screening AdverseSelection

SmartIdentityAuthentication RightEnforcement&Screening MoralHazard&Adverse

SelectionTable (3): Inefficiencies softened by functionalities od a decentralized crowdfunding

application.

Whatweanalysedinthissectioncanbeconsideredsomeofthemajorpositiveinfluences

thatanEquityCrowdfundingDecentralizedApplicationcanbringtothecrowdfunding

environment. Many market inefficiencies of the traditional equity crowdfunding

environmentcanbemitigatedthankstothetechnology.Theimprovementswillcreatea

more decentralized and transparent environment, in which both actors will bemore

willingtoparticipateandenlargethenetwork.

3.4.3.FinancialRisksThatCouldBeSoftenedbyDAppFunctionalities

Insection2.5.2,wetookalookatthepossiblerisksassociatedwiththeuseofanequity

crowdfunding platform. In this section we will see how the introduction of a

CrowdfundingDecentralizedApplicationandblockchaintechnology,couldreducerisks

usuallyassociatedwithtraditionalcrowdfundingplatforms.

Through this section, it is important to keep inmind howwith the use of blockchain

technology,theneedofatrustedthirdpartyisstronglyreduced.Thetrustshiftedfrom

centralizedparties,tothedecentralizednetworkandthetechnology.

RiskofDefault:

Riskofdefault,inacrowdfundingdecentralizedapplication,canbeconsistentlyreduced

thanks to the first phase of the blockchain-based crowdfunding process. During the

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fundingstage,thefundsarenotdirectlytransferredtothefundraiser,insteadtheyare

putinaseparateaccount.Theaccountwillbeunlockedandtheamounttransferredtothe

DAOinthecaseinwhichthecampaignissuccessful,orgivenbacktothefundersinthe

caseoffailureofthecampaign.

DuringtheperiodoftimeinwhichthefundsaremanagedbytheDAO,themechanism

associatedwithit,makessurethatthefundsaresecure,andtransactionsnotallowed.The

controlinthiscaseisofthefunders,thatwillactintheirinterestsandtheinterestofthe

companytheyinvestedin,mitigatingtheriskofdefault.Thefunderscaninfactimpose

controloverthefundsthroughmechanismslikethetransactionspendinglimitandthe

votingsystem.

Thesearetheearlystagesoftheapplicationofthetechnology, inthenearfuture,new

developmentscouldleadtothecreationofalgorithmsthatwillimprovefurthermorethe

avoidanceofthisrisk,likestrongerreputationsystemmechanismsorbettermechanisms

fortheselectionoffundraisers.

RiskofPlatformClosure:

Oneofthecharacteristicsthatdistinguishesblockchaintechnologyisthefactthatitisnot

centralized;thedecentralizationofaDAppinfact,allowsittobeimpossibletobeshut

down,sinceitisdependentbythenetwork.Inadecentralizedsystem,theDAppistheone

thatholdsthemostimportantfunctionforthecrowdfundingnetworktobecarriedon,

whilethecrowdfundingplatformcoversservicesthatcanbesubstitutedbyasecondary

entityrightaway.

Wheneveraplatformisshutdown,therelatedDAppandthesmartpropertythatused

theplatformtoenterthenetworkdonotdisappear,sincetheyaredependentfromthe

networkthatwillnotbeeffectedandcontinuetorun.

RiskofFraud:

Theuseofablockchain-basedapplicationhasthepotentialtoreducedrasticallythistype

ofrisk,throughtheuseofmanyofthefunctionalitiesthatwehaveseensofar.Tonamea

few:VotingRights,TransactionSpendingLimits,UnforgeableSmartTokens,andsoforth.

Together they are able to offer users a transparent environment, inwhich actions of

fundraisersarepermanently recorded into the ledger,making itnearly impossible for

themtolettheiractionsgounnoticed.

MoralHazardandRiskofFraudarecloselyrelated,meaningthatfurtherdevelopmentin

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functionalitiessuchastheattributionofCreditScores,willinfluencealsothereductionof

thisfinancialrisk.

Whenusingthisnewtechnology,weneedtopayparticularattentiontohowthesenew

mechanisms could be perceived and understood by the public. The structure of the

coding,andthemeaningofsomesmartcontractscouldbetrickyformanyoftheusers

approachingthenetworkforthefirsttime.Onepossiblesolutionistorelyonwell-known

platforms,credibleestablishments,composedbyindividualsthathavethereputationof

creating fairandstandardizedsmartcontractsandDAppsstructures,approvedbythe

publicorexpertsinthefield.

LiquidityRisk:

AswehaveseeninChapterII,thetechnologyintroducedtheconceptofsmartproperty,

andwith it, the possibility to trade smart tokens freely on secondarymarkets. Smart

tokenscanbethantraded,transferred,andsoldfreelywithouthavingtoholdthemuntil

maturity.Weunderlinetheimportanceofthisfeature,thatallowsinvestorstocommitto

shorter investments horizons; a characteristic ofmajor importancewhen it comes to

start-upsandthecrowdfundingenvironment.

Thecharacteristicsassociatedwiththetechnologyandmorespecificallysmartproperty,

arethanallowingforasubstantialreductionintheriskofliquidityinsideablockchain-

baseenvironment.Thetechnologyandthisframeworkareabletocreatedifferent,easier,

andmoreunaffiliatedequitycrowdfundingplatforms.

RiskofCyber-Attack:

Since thewhole system relies on the internet in order to function, the issue of cyber

securityarises.Thenatureoftheblockchaintechnologythough,makesitextremelyhard

for a decentralized ledger to be hacked. In order to hack an entity constituted on a

blockchainledger,andmanipulateinformationthatarestoredinsideit,thehackerwould

havetobeabletohavesimultaneousaccesstothemajorityofthenodesthatcomposethe

network.Suchanattack,calledthe51%attack,wouldrequireanunthinkableamountof

computingpower,andununthinkableamountofGastocompletethatoperation.

One of the other few precautions to take is the way in which smart contracts are

constructed.Smartcontractsarenotflawless if thecodingisnotdoneright.Thereare

companiesthatspecializedsolelyonthedevelopmentofsuchcontracts,whichareagood

startingbaseforwhoeveriswillingtocreatetheirownDApp.

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PotentialSystemicRisk:

Systemic risk is linked to the liquidity risk. In a traditionally constructedmarket, the

exchange of stocks or tokens can happen also between parties thatwork in different

countries or under different legislations. The process of interconnection between

different legislations andpossible different currencies, usually slowsdown the selling

processandcanleadtoliquidityrisk.

At the time of writing, the legislation about cryptocurrency and blockchain-based

crowdfundingisnotwelldefined,meaningthatblockchain-basedinfrastructuresarefor

now still independent form any form of national or international legislation. The

decentralizednature,andtheuseofdigitalprotocolsforthemanagementofactivitiesand

transactions, allows many to ignore any national legislation in term of movement of

currencyandvalue.The lackofaproper legislationontheotherhand, isdiscouraging

manyinthepursuingofblockchain-basecrowdfundingprojects,forthefearofdeveloping

aprojectthatmightbeshutdownassoonasanotherlegislationbecomesvalid.

Manycountriesaredevelopingatthemomenttheirownlegislationonthecryptomarket

andinthefirstfewyearsofthedevelopmentofthetechnologywemightseeaseparation

betweensomeofthemajormarketliketheAmericanoneandtheEuropeanone.Oncethe

technologywillhavesettledandwillbeunderstoodbyalllegislators,theinternetnature

ofthetechnologyandtheprocess,willallowforamergerofallthemajormarketandthe

creationofaglobalandopenone.

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CHAPTERIV

Blockchain-BasedEquityCrowdfundingPlatform:TheBloomioCase

Whilelookingforacasestudy,werealizedhowdifficultistodefinelegallyanentitythat

worksontheblockchain;andespeciallyhowharditistodefinethelegalandfinancial

identityofatoken.

Weliveinatechnologicalerainwhichwehaveveryfewinsightsonwhat,when,andhow

complex and disruptive innovationwill appear in themarket, putting regulators in a

thought decisional position. Regulators are battled between the creation of a fast and

responsive regulation, usually not backed up by sufficient information; or legislative

paralysis,resultinginaprocrastinationofthetacklingoftheissue.Thecommonlyused

strategyistheonethatusescaution,thathastheresultofstabilizingalreadyestablished

technologies, limiting an efficient and punctual introduction of new innovation in the

market.

It is importantto informthereader, thatgiventheearlystageofthe lifeofblockchain

technology,eachcountryiscurrentlydevelopingtheirowninterpretationoftheidentity

oftokensandblockchain-basedapplications.Fornow,infact,nolegislationorregulation

has been formed, that refer to the legal parameters around blockchain technology or

tokens. The difficulties in the definition of a common ground in the cryptomarket, is

unfortunatelyresultinginasubdivisionoftheglobalmarket.

In this chapterwewill analyseoneof the first examplesof ablockchain-basedequity

crowdfundingplatformthatwehadtheprivilegetocomeincontactwith.Theplatformis

called:“Bloomio”andisbasedinSwitzerland, inwhat isbecomingtobeknownasthe

“CryptoValley”,inthecantonofZug.

Theplatformisstillunderconstructionandtheteamisworkingonthedevelopmentof

all themost important services and functionalities, while collaboratingwith the local

governmentforthedefinitionofthelegalstatusofthecompanyandmostimportantlyof

thetokensthatitwillissue.Thepurposeofthischapteristoexplainhowtheconcepts

thatweanalysedintheory,canbeactuallyimplemented,andwhatcanbetheadaptations

necessaryforarealphysicalapplication.

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4.1The“CryptoValley”RegulationSinceBloomiohasitslegalheadquartersinthesocalledcryptovalley,itisimportantto

understandhowthisregiongainedthisepithet,andwhataretheadvantagesofstartinga

blockchain-basedbusinessinthecantonofZug.

The crypto valley is positioned in a region that ismostly known for its decentralized

political system, and matchless business environment. The region of Zug offers high

possibilityofgrowthwithitspro-businessenvironment,acceptance,andaccessibilityof

thelocalgovernment.Theregionattractsmanyinternationalandleadingcompanieswith

a system that allows for a low taxation, culture of financial privacy, and a business-

friendly environment. The region is in fact the crypto-powerhouse for companies like

Ethereum,Xapo30(Bitcoinwallet),Shapeshift31(globalwebtrading),Monetas32(financial

servicesforunbankedindividuals),andMelonport33(digitalinvestmentfund),together

withmanyothers.

Eventhoughaproperlegalframeworkhasnotbeendevelopedbyanycountryyet,the

regulatoryframeworkofthecantonofZugseemstobealotlessrestrictiveandmoreopen

todiscussion,thantherestoftheEuropeangovernments.

Switzerlandisalsorankingasthefirstcountryintheworldforattractingandretaining

talentaswellascompetitivenessandproductivity.Furthermore,thepoliticalsystemin

Switzerlandisneutral,stable,highlyresponsive,citizen-controlled,anddecentralized;all

these characteristics are in line with the bottom-up approach of the blockchain

technologyandthecryptotechnologiesthatareemerging.

4.1.1.CryptoValleyAssociation

AllthefavourablecharacteristicsoftheZugenvironment,andtheincreasinginterestof

entrepreneursinblockchaintechnology,hasledtotheformationofwhatisknownasthe

“Crypto Valley Association” (CVA). This association is independent, government-

supported,andhastheaimofcreatingtheworld’sleadingblockchainandcryptographic

technologies ecosystem, taking advantage of the region’s advantages. The association

wants to create a network to support and connect start-ups and fully operational

30https://xapo.com/31https://shapeshift.io/#/coins32https://monetas.net/33https://melonport.com/

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enterprises,bringingthemtogetherintheefforttofosterblockchainandcryptographic

technology.

Oneofthemostimportantaspectoftheexistenceofthisassociation,isthefactthatitis

collaboratingwiththegovernmentinthedefinitionofafavourablelegislationthatwould

fosterthedevelopmentofblockchain-basedbusinessintheregion.

OnDecember11th2017,PresidentoftheCVAOliverBussmann,wasinvitedtorepresent

theassociationand thecrypto technology industry, at theSwissGovernment’s second

FintechRoundtable;inwhichthefuturestructureofthelegislationoncryptographyand

blockchain technology was discussed. According to Bussmann, the government will

developaprinciple-basedapproachforthemanagementofICOs,allowingforacertain

level of freedom of movement, rather than a precise definition of inviolable rules.

Guidancewillbenonethelessallowedtobeprovidedbyself-regulatingassociations(like

theCVA)andthegovernmentitselfinthecaseoftheneedforclarification.

ThegreatadvantageoftheSwisslegislationisthefactthattechnically,anycitizenisable

torecommendachangetothelawthoughwhatiscalledtheSwiss“DirectDemocracy”.

This gavea greatmomentum to the introductionof theblockchain technologyand its

potential.The firststeps in thecreationofavalid legislation,weredone in June2016,

when three blockchain-related proposals were presented to the Swiss Parliament’s

FederalAssembly.Thesemotionshadtheaimofsimplifyingtheprocessofanticipationof

the ramification of the blockchain technology by the financial sector34, improve the

leadingpositionofSwitzerlandinthefieldofblockchaintechnology35,andfacilitatethe

growthandthedevelopmentofblockchain-basedstart-ups36.

Unfortunately, thosemotionsweredenied,but itdidnotstopSwitzerlandprogressive

wayindefiningastrongandprotectedmarketforcryptotechnologies.

CryptoValleyAssociation’sCodeofConductThemostrecentachievementinthefieldofcryptotechnologyregulation,comesonthe

9th of January 2018 from the crypto valley association, that in accordance with

governmentregulators,wasabletoconstructSwitzerland’sFirstICO’s“CodeofConduct”

(CoC).

34https://www.parlament.ch/de/ratsbetrieb/suche-curia-vista/geschaeft?AffairId=2016338035https://www.parlament.ch/de/ratsbetrieb/suche-curia-vista/geschaeft?AffairId=2016348436https://www.parlament.ch/de/ratsbetrieb/suche-curia-vista/geschaeft?AffairId=20163472

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Thecodeofconducthastheaimofbringingclaritytothenewmarket,andguideproperly

ICOsonhowtoconductinaccordancewithlegal,moral,andsecurityobligations.

The authority carried out by the CVA, makes the CoC mandatory to follow for each

companythatwantstoparticipatetothemarketandbepartoftheCVA.

Thedeclaration isupdatedannually,and iscomposedbyvaluesandprinciplesagreed

uponandrespectedbyallmembers.

TheCodeofConductisdividedinfourmainchapters:Mission,CoreValues,GeneralCode

ofConduct(CoC),andDecentralizedEcosystem(DE)CodeofConduct(DECoC).

Theirmissionisto:

“DeveloptheWorld’sBestEcosystemforBlockchainandotherDistributedLedger

TechnologiesandBusinesses.37”

Around this concept, and around the principles of decentralization and of

democratizationthattheblockchaintechnologyis linkedto, thecorevalueshavebeen

agreed to be: Trust, Transparency, Collaboration, Integrity, Innovation & Quality, and

SecurityBeneficence.Thesevaluesarestronglyinlinewiththeprinciplesthatarebehind

thecreationofthetechnology.Ontheplusside,theseconceptsandruleswillbereviewed

annually,inordertokeepupwithtechnologicalandorganizationalchanges.

ThecoreofthecodeofconductincludesguidelinesontheBusinessConductaswellas

guiding on the “Governance” and “Conflict of Interests”, “Property Rights” and also

importantguidanceontheproceduresfor“DisciplinaryActions”.

Itisimportanttonotealso,thattheCoCgivesguidancealsoonthe“BooksandRecords”

procedures.Forthispurpose,theCVAhasestablishedapartnershipwithPwC38,together

withwhichtheylaunchedonJanuary18th2018,thefirstofwhatisbeingestablishedas

the“QuarterlyReportonInitialCoinOfferings39”.Themainpurposeofthisstandardized

reportistotracktheevolutionandthedevelopmentoftheindustry,whichisstillgoing

underaquickexpansionandthroughcontinuouschanges.

TheDecentralizedEcosystemCodeofConducthasbeencreatedinordertoensurethat,

the launch of any activity inside the Association, is done in compliance with high

37https://cryptovalley.swiss/codeofconduct/ 38https://www.pwc.com/39https://cryptovalley.swiss/crypto-valley-association-collaborates-with-pwc-strategy-on-ico-report/

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standardsofprotocols,qualityandledgerenforceability,aswellasinlinewithregulations

onfinancialmarkets.

4.1.2.FINMAinterpretationandLegislationonTokens

FINMAistheSwissFinancialMarketSupervisoryAuthority,andstartingfromSeptember

29th2017-duetoasubstantialincreaseintheICOconductedinandfromSwitzerland-it

decided to investigate the ICO phenomenon. FINMA recognizes the potential of the

technology; however, since each ICO differentiate from a technical, functional and

businessstandpoint,ananalysisof thephenomenonwasmandatorytodeterminethe

legitimacyofthisnewfundingmethodology.

At the moment, as the investigation goes on, FINMA warns consumers on the risks

associatedwithICOs.ICOsaresubjecttohighpricevolatility,andusuallybackedupby

earlystageandconsequentlyhighlyriskyprojects,withvery littleornoguarantee for

futuredevelopment.Thegeneralwarningwasaddressedtothegeneralpublic,driving

theattentiontotherecognitionoffakecryptocurrenciesandfraudulentactivities,given

therecentmarketcircumstances.ThegovernmentandFINMAtransparentlyadmitthey

donothavealltheanswersinthefieldofcryptotechnology;theyaremovingforwardas

fastastheycanandtogetherwiththepublic,constructingasystemthatwouldnotlimit

innovationandwouldfostereconomicgrowth.

Regulations specifically related to ICOs, are not present in Switzerland or in the

internationallegislationsystem.Whatispresentontheotherhand,areregulationsand

laws on Equity and Debt capital-raising, deposit-taking and all activitiesmanaged by

financial intermediaries. These laws have been created to protect both sides of the

markets togetherwith the intermediaries involved, in order to have a functional and

optimalfinancialmarket.Thismeansthatinsomesituations,someICOsmightalreadybe

coveredbyexistingregulations,andwheneveranICOissuingtokens,breaksregulatory

law or is designed to circumvent financial markets law, enforcement procedures are

initiated.

ThisregulatorysystemallowsthanforthecreationofICOsandtokenizationofequity,

giventhatissuersandotherparticipantswillanalysetheirprojects,determininginwhich

existingSwissregulationthestructureoftheprojectandthefunctionalitiesassociatedto

thetokensfall.

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A broad approachwill be taken by FINMA in the assessing of ICOs and TGEs (Token

GeneratingEvents),fromwhichananalysiswilloriginateofthefunctionsandattributes

of ICOs,aswellasananalysisof thepurpose, functionalities,and legalstateof tokens.

Tokensinparticular,haveanextremelyimportantroleinthisindustry,bothintheSwiss

economyandintheInternationaleconomy.

ThereareexistingregulatoryareasinwhichaTGEorICOcouldcurrentlyfallintheSwiss

regulatoryframework,andtheyarelistedbelowas:

- Provisionforcopingwithmoneylaunderingandterroristfunding:Wheneverthe

production of a token by a TGE involves activities of financial intermediaries

(moneytransfers),theprovisionsrefertotheAnti-MoneyLaunderingAct.

- Provision on banking law: The application of the banking regulation is set off

wheneverthereistheacceptanceofpublicdepositsasanobligationofrepayment

totokenholders.

- Provisionsontradingofsecurities:Ifthesituationoccursinwhichtokensqualify

assecurities,thetokenissuerisrequiredtohaveasecuritylicence.

- Provisions in collective investment schemes legislations: Whenever assets

aggregated as components of the TGE are managed by an external party, a

potentiallinktocollectiveinvestmentschemeslegislationscouldappear.

MME40isaSwisslegal,tax,andcomplianceconsultingfirm,thathasbeenworkingwith

manycompanies(includingBloomio)insideandoutsidetheblockchainenvironment,in

order to help them to be in complete legal compliance with Swiss and international

regulationsonbusinesslaw.

OnSeptember26th2017,MMEhaspublishedanindividualandself-regulatedframework

forthedefinitionoftokenscalled:”ConceptualFrameworkforLegal&RiskAssessment

ofBlockchainCryptoProperty(BCP)”(Dr.MullerL.,D.MeyerS.,GschwendC.,HenshelP.,

2017).LukaMuller,oneofthefundersofMMEandCVA,specifiesthanthedefinitionof

token that has been provided in the paper, is not the definitive definition, but on the

contrarythe“GenesisVersion”astheycalledit.

40https://www.mme.ch/

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Themainaimofthepaperittoeducatethepubliconthisnewtechnologybycreatingan

initial framework to define the elements that compose it. Highly important for users

though, is also thedefinitionof the risks associatedwith thisnew technology, able to

improvetheirinvestmentplans,buttowhichtheyneedtopayextremeattention.

The paper introduces the definition of tokens as a new type of property, or better,

Blockchain Crypto Property (BCP), which are divided in three main categories. The

divisionoftheBCPincategorieshasbeendonetofacilitatetheconstructionofaneasier

legal,regulatoryandtaxassessmentfordifferenttypesoftokens,aswellasaneasierrisk

assessment.

Thethreemajortokencategoriesarecalledrespectively:BCPClass1(nocounterparty),

BCPClass2(counterparty),andBCPClass3(co-ownership).Weprovidebelowabrief

descriptionofthethreeclassesoftokens.

BCPClass1:

Arenativecurrencytokens,infrastructuretokensorapplicationtokens;whichdonotgive

theowneranyrightwithregardtoalegalperson,andcannotbeassociatedwithaphysical

asset.

BCPClass2:

Grant right against a legal counterparty. Contractual and participation rights, can be

consideredasClass2.

BCPClass3:

Aretokenswhichhavespecific functionsprogrammed inside them,areregisteredand

store on the blockchain, and use the technology associatedwith smart contracts. Co-

owningrightarereinforcedbytheuseofthesetokens,andtheholderofthetokenscan

participateintheco-ownershipofphysicalorintellectualproperty.

Riskassociatedwiththetechnologyandtheuseoftokenshavebeendividedinfourmajor

risk classes: Functionality & Protocol-Related risk, Storage & Access of Private Key-

Related Risk, Regulation & Money Laundering-Relate Risk, and Market-Related &

CounterpartyRisk.

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Theuseofafunctionality-basedmethodfortheclassificationoftokensandtherelative

risks,ratherthantheuseofaspecificcountry’slegalconcepts,allowsforanapplication

of these definition to all jurisdictions, disregarding the national or international

regulatoryframeworks.RelatedtothedefinitionsprovidedintheMMEpaper,different

national legislations may arise; but at least the public would be informed on the

technology and the tokenized ecosystem, having a common knowledge of the

characteristicsthatdefineadigitalpropertyandcoins.

MMEalsogivesalistofadvicestoanyonewillingtostartablockchain-basedortoken-

basedproject.The firstone is tobesmart; it is important to figureout thecompanies

blockchainandtokenfunctionalities.Alltheinformationandthedefinitionofthebusiness

caseandlegalanalysismustbedefined,inorderfortheprojecttounfoldpositively.

The second recommendation is not to commit fraud. As simple as it may sound, the

importanceofagooddisclosurecommitmentabouttheprojectandtherelatedtokensis

importantinthisnewmarketandforthecommunity.

Thirdly,MMEadvisesnewentrepreneurstothinkglobally,meaningthatthecompliance

onregulationsshouldnotbedonejustonSwisslaw,butalsooninternationallaw.

Taxesshouldalsobeconsideredwhenevercarryingouttheseprojects;theunderstanding

oftherelatedtaxsystemisofextremeimportanceduringatokenlaunch.

Finally,communicationisofextremeimportanceduringandafterthetokenlaunch.The

fundraiserowestotheinvestingpublic,toletthemunderstandwhatishappeningtotheir

investments.

MME is a strongpartner ofBloomio, and it is helping the company tobe in complete

compliance with regulations in order to enter the market in complete safety and

compliance.

4.2.TheOriginofBloomio,TheVisionoftheFundersandtheLegalBattle

Thecasestudyweanalysed in this thesis is theoneofBloomio,anequityblockchain-

basedcrowdfundingplatform,thatwillpresumablychangetheconventionalwayofdoing

businessforcompaniesinthefield.

We had the chance to interviewMaxim Lyadvinsky, Bloomio’s Chief ExecutiveOfficer

(CEO);andFrancescoDeSantis,Bloomio’sChiefMarketingOfficer(CMO).Thankstotheir

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testimony, wewere able to understandwhat their company stands for andwhy this

platformcameintoexistence.

TheideaofthecompanystartedfromthedefinitionoftheproblemsrelatedtoVenture

Capitalfunding;withalltheissuesthatgofromliquidity,lackofcapital,riskoffraudand

limitedqualityinformation.

Bloomiohasbeenfundedbythreeassociatescomingfromdifferentfields,inwhicheach

one of them have been successful. The three funders are Maxim Lyadvinsky, former

founderofAcronis,thathasbeenworking,investinganddevelopingmultiplestart-ups;

EmileOsuba,asuccessfulfinanceexecutivethatcancounton17yearsofexperienceina

topEuropeanfinancialbank;andAlexeyRaevsky,cybersecurityandblockchainexpert.

OnNovember2017,LukaMuller,oneofthemainfiguresofMME,joinedthecompanyas

the legal, taxandcomplianceadvisor; inorder tohelp thecompany tobe incomplete

compliancewithSwissandInternationallaw.Thisfigurewillbeofextremeimportance

insidethecompanyinordertomaintainthehighestlegalintegrity,andtocross-withthe

highestlevelofexpertiseavailable-the“legalgreyarea”aroundblockchain.

Bloomio defines itself as the first platform that will initiate the journey of perpetual

reformin theprocessof fundingstart-ups,byalsoenabling investors to invest innew

ventureswithaslittleasfiftydollars.

Bloomiofundersrecognizedthegrowthintheindustryofcapitalizationofstart-upsand

theincreasingimportanceandpotentialofblockchain.Thefundersalsorecognizedthe

limitationof thecurrentstateof ICOsdevelopmentandevaluation,andrealizedthata

crowdfundingplatformthatwouldresolvemanyoftheseissue,havenotbeencreatedyet.

Bloomioalsoparticipatedandwasrecognizedasoneofthe25winningstart-upsinthe

competitionheldby the “International Institute forManagementDevelopment (IMD)”,

former school of the funders, where they first decided to create this platform. This

positioning in theranking increases theirnotoriety inside thestart-upecosystem,and

togetherwiththat,allowsthemtoworkdirectlywithsomeofthebestMBAStudentsat

IMDduringthefirsthalfof2018aswell.

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4.3.CompetitiveAdvantageandKeyFeatures

Bloomio partners and collaborators, have years of experience inmany fields, starting

frommanagement,blockchaintechnology,cybersecurity,finance,law;andcancounton

beingsettledinoneofthemosttechnologicallyandregulatorydevelopedregionsofthe

world.

WhatBloomiooffersisthehighestfinancialstandardstostart-upinvestmentsforboth

sidesofthemarket.Bloomiohasasetofservicesdesignedforinvestorsandfundraisers,

thatwouldhelpbothachievetheirgoalsandcreateamoretransparent,freeandsecure

market.

4.3.1.CompetitiveAdvantages

FinancialintegrityisoneofthemajorconcernsfortheBloomioplatformanditspartners,

thatdecidedtoconstructtheplatformaroundthisconcept,creatingafair,transparent

andvaluable crowdfundingplatform forprojectsand for investorswilling to invest in

them.StartingfromthisconceptBloomiohasfivemajoradvantagesthatisproposingto

themarketofequitycrowdfunding.

BlockchainTechnology:

Blockchain technology allow for financial transactions to become highly secure, and

protectsinvestorsandfundraisers.Furthermore,thepromiseofdecentralizationbrought

byblockchaintechnology,willchangetherulesofthegame.Evenifitisstillanemerging

technologyandwearejuststartingnowtoseethefullpotential,Bloomioreallybelieves

blockchain technology to be the next frontier in the creation of a better business

environment.

“Blockchainisnecessaryasameantotransmittoourcustomerswhatthemainvaluesofthecompanyare;andexplainthefinancialandtransparencystandardsmissingonother

platforms”FrancescoDeSantis(CMO)

Blockchainwillhelpreachnewmarketsandespeciallynewcustomers,involvinganyone

who is willing to invest in valuable projects, regardless of the financial availability.

FrancescoDeSantissaidintheinterview:

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“OurTargetwillbethosewillingtospendbetween 1000and20000SFr,abiggeraudience

thanotherventurecapitalists,butequallyhungryforinvestments”FrancescoDeSantis(CMO)

On the plus side, the application of the technology brings a new and higher level of

security, transparency and freedom, that has never been proposed in the equity

crowdfundingmarket.Theadvantagesoftheuseofblockchainhasalsoamorepractical

benefit; some characteristics of the technology allow for the reduction of the project

relateddocuments,withconsequentbenefitsforthesecurityofinformationstoredonthe

blockchain,whichareuntouchablebyanyone.

“Regulatorsaremorecomfortableinapprovingouroperationsifweshowthatwecannot

accessuser'sfundsandcannotalteruser'stransactionsstoredintheblockchain.”MaximLyadvinsky(CEO)

BankingandSecurityBackground:

Bloomio’sexecutiveteamiscomposebyvaluableandprofessionalindividuals,thattake

the issueof security very seriously.AlexRaevsky is in chargeof cyber security inside

Bloomio; togetherwith EmileOsuma - in charge of the banking structure - they have

developedasolidandsafeenvironment.SecurityisoneofthemainconcernsforBloomio,

that realizes the limitations and the threats that can come from an on-line service,

especiallywhenthereareinvestmentsinvolved.Bloomiocancountonthemanyyearsof

experienceofitscollaboratorsandthestrongtrustthatexistsbetweenthem.

Forwhatconcernsbanks,therelationshipoftheplatformwiththemwillbelimitedto

investmentopportunities.Theuseofthetechnologywillallowfortheeliminationofthe

bankingintermediary,buttheinteractionwiththemcouldstillbeofimportanceforthe

constructionof investmentopportunitiesforbanksandtheirclientsinemergingstart-

ups.

“We'dliketocollaboratewithbanks,offeringaccesstoalternativeinvestmentsfromtheir

bankingapplications”MaximLyadvinsky(CEO)

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Blockchain has a major role also here, in the creation of a secure and decentralized

environment. The technology offers in fact a very high level of decentralization and

securitymeasures,withreallylowcostsofadministrationfortheplatform.

ExpertBroadDueDiligence:

Wheneveraprojectispresentedtotheplatform-inordertopresenttoinvestorsvaluable

investment opportunities - a due diligence analysis is necessary. Differently from the

otherplatforms,Bloomiohasdecidedtorelyonthirdpartyevaluation.

“Theuseofathirdpartyduediligencepractice,avoidsthepossibilityofourplatformtomakeabiasedevaluationoftheprojects.Wewanttogiveinvestorsthepossibilitytoinvest

invaluable,profitableandsafeprojectsnotdirectlypromotedbyus.”FrancescoDeSantis(CMO)

Duediligenceisaverydelicatematterandisoneofthemostimportantservicesthata

crowdfundingplatformcouldprovide.Bloomiowantstobeasunbiasedaspossibleand

givethepossibilitytouserstoinvestinvaluableandprofitableprojects,backedupbya

well-defined structure and business plan, profitable and secure for all the parties

involved.

SwissQuality:

Swiss quality plays an important role in the definition of the validity of the Bloomio

Platform. The favourable regulation, the business oriented environment and the

decentralized government of the country, makes it the perfect environment for the

developmentofprojectslikeBloomio.Bloomiowantstomakesurealsotobeincomplete

compliancewithSwissandInternationalregulations,anditisthereasonwhyBloomio

includedLukaMullerintheadvisoryboardofthecompany.

“Governmentregulatorsarecurrentlynotwilling/abletoprovideanyguidanceinthisfield,whichiswhyweneedtolaythelegalfoundationforthesetypesofproject.Ourteam

hasdonequitesomeworkregardingthetokenizationofshares(orcreatingsocalled

cryptoshares)”MaximLyadvinsky(CEO)

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The connection of the company to one of the major legal experts on blockchain and

“crypto technology”, shows how strongly the company feels the necessity to be in

completecompliancewiththelaw;andhowvaluabletheirexperienceandtheBloomio

project can be, in helping the development of new regulations and legislations. The

collaborationwithself-regulatingentities,willnotonlyfosterthegrowthoftheindustry,

butwillbenefitalltheactorsinvolvedinthisnewcryptomarket.

Process:

WheninteractingwithBloomio,userscanbenefitfromthemultipletoolsavailableforthe

definitionofwhatarethebestprojectsforthemandwhenready,investeasilyandina

safeenvironment.

Thoroughanalysisoftheprojectspresented,selectionofpartners,investorrelationsand

the multiple services available, is what defines the process presented by Bloomio.

Accordingtothecompany,thisprocesswillnotjustconnectprivateinvestorswithstart-

ups in need to raise funds, but will create a comprehensive structure that aims at

maximizinginvestmentopportunitieswithaseriesofuniquefeatures.

4.3.2.BloomioKeyFeatures

Inordertodistinguishitselffromtherestoftheequitycrowdfundingplatform,Bloomio

presentssomeindistinguishablekeyfeaturesthatmakesituniqueinthecurrentstateof

theEuropeancryptotechnologymarket.Someofthesefeaturesaredependentfromthe

relationshipthattheplatformhaswithblockchaintechnology;butothersaredeveloped

tobeanevolutionandanimprovementofwhatiscurrentlybeenofferedintheequity

crowdfundingindustry.

Start-upRanking:

Beforethepublicationofanewprojectontheplatform,thefeasibilityoftheprojectneeds

tobeaccessedproperly.Bloomioputsextremeimportancetotheapplicationofaproper

duediligence,tobeabletopresenttoinvestorsvaluableandprofitableprojects,whileat

thesametimepushingfundraiserstodevelopbetterprojectswithhigherchancestobe

fundedproperly.

Duediligenceprocedureislefttoanexternalandunbiasedthirdparty,whichissuesafive

starrankingsystem,thathelpsinvestorsevaluatethepotentialandtherisksassociated

withtheinvestmentinaprojects.Thefivekeypointsonwhichtheevaluatorsfocusonfor

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thedefinitionofthescoresare:TheTeam,theProductIdea,theLevelofInnovation,the

ProductState,andtheProductMaturity;thesefiveevaluationpointconstituteafairbase

ofevaluationforeachproject.Showingtheresultoftheduediligenceismandatoryforall

thecompaniesthatwanttoraisefunds;butmostimportantly,start-upswithoneortwo

starsarenotallowedtoraise funds foraperiodofsixmonths,afterwhichanewdue

diligencereportisfiled.

Theevaluationofeachproject iscustomizedaroundthestructureof theprojectbeing

evaluated,andaroundthenatureoftheindustryinwhichthatprojectwillbeplaced.The

evaluationofthepresentedprojectsisthefirststepinthecreationavaluable,stableand

transparentequitycrowdfundingplatform;wecanseefromthemeasuresemployed,that

Bloomioanditscollaboratorsunderstandverywelltheimportanceoftheseprocedures.

Start-upAcceleration:

Bloomioaimsathelpingstart-ups to raise capital,but itseffort in thedevelopmentof

valuable entities is not limited to that function. The platform in fact also helps new

companiestocreateastructureofconnectionsthatwillhelpthemgrowintheindustry

theyareentering.Bloomiohascreatedanetworkofthird-partyservicestobeconnected

with start-ups andhelp thembuild their team,R&Dprocesses, go-to-market strategy,

salesforce,andeverythingtheyneedtogrowandscale.

Bloomio is able to collaborate and help different levels of start-ups. One of the other

characteristics that differentiate Bloomio from the rest of the market, is the fact the

platformrecognizesthat,itisnotjusttheearlystagestart-upsthatneedfunding.Some

start-upsneed funds tomake theirbusinessstart,butotheralreadyestablished firms,

mayneedfundstoscaleoperationandexploitthefullpotentialoftheidea.Forthisreason,

Bloomiohascreatedfourdifferentstart-upcategories,thatwouldmakeiteasierforusers

toidentifythetypeofcompanytheyaredecidingtoinvestin.Thesubdivisioniscomposed

by: Seed, very early stage companieswhich are raising funds to establish operations;

Series A, in which some preliminary KPIs have been developed and need funds to

translateideasintoareality;SeriesB,inwhichtherearealreadyrevenues,butgrowth

needstobefosteredwithfunds;andfinallySeriesC,forwhichthemainfocusforfunds

wouldbetoscalebusinesstoexploititsfullpotential.

- 106 -

Tokenization:

BlockchaintechnologyallowedBloomiotoimplementthetokenizationofstart-upequity,

inorder tosimplify transactions,andmake investmentsmoresecureandtransparent.

Tokenization facilitates the investment procedure for both funders and fundraisers.

Fundershaveaneasierwaytosupportthestart-uptheybelievein,andfundraisershave

afasterandalotmorefunctionalwaytoreachtheirgoals.

Eachstart-upisinchargeofdetermininghowbigisthesharetheyarewillingtotokenize

andwhatwillbethepriceofeachtoken.Bloomiohelpstheminthesedecisionsbykeeping

availableallthesupportiveservicesnecessary.

Bloomiowillalsoprovidetheserviceofholderoftokens,actingasthecustodianofthe

start-ups shares.Theplatformwill give the serviceof issuing the start-up tokens that

representtheequityofit,incompleteaccordancewithstart-upfounder’sdecisions.

Bloomioisapioneerinthisindustry,andtogetherwiththegovernmentislearninghow

theindustryworksandhowitwilldevelopinthefuture.Therearemanydifficultiesin

thecreationofaprofitableandregulatedentity,giventhefactthattheycannotrelyon

othersexperiences.

“Bloomioisthefirstprojectthattriestotokenizeindividualshareholder’srights(inthiscasetherighttoparticipateintheproceedsofliquidationandsale)andtradethemonthe

blockchain,sothereisunfortunatelynotmuchpriorworkwecanrelyon.”MaximLyadvinsky(CEO)

SecondaryMarket:

Asaconsequenceofthetokenizationofequity, thecreationofasecondarymarket for

tokens is one of the most important and interesting features that Bloomio has

implemented. The possibility to exchange tokens after the end of the campaign is an

important tool in the equity crowdfunding ecosystem. Investors are able thisway, to

managemoreefficientlyandstrategicallytheirinvestmentsandprotecttheirinteresta

lotmoreeasilywithrespecttothetraditionalequitycrowdfundingmethods.

The Bloomio market for tokens is now only restricted to the internal projects and

availableonlytothedirectusersoftheplatform.Thischoicehasbeendonefortwomajor

reasonsthatwerebroughtupbycompanylayers.MrLyadvinskyexplainedhowsomeof

the projects that are supported by the platforms, may have some problems in the

identificationofthecustomers.Asaconsequence,thecompaniesmighthaveproblemsin

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thedeterminationofwhoisthepersoninpossessionoftokens.Tokenscouldgothrough

unknownhandsandbecome“dirty”evenifthelastbuyeris“clean”.

Secondly,tokenscanremainclean,butbyopeningthemarkettoexternalones,thereisa

chancethat theymightneverreturntotheplatformoncetheyaresoldonanexternal

market.

“AfteraliquidityeventBloomiomightneedtokeepsomecashforeverwaitingforatoken

toreturntoBloomio”MaximLyadvinsky(CEO)

StatusGems:

Bloomioalsodecided to implementapoint-based reward scheme, according towhich

everytransactionorsocialactionsinsidetheplatform,willallowtheusertoaccumulate

whatarerefeedtoas“StatusGems”.Theaccumulationofthesegemswillallowusersto

unlockpremiumfeaturesliketheaccesstocampaignsbeforetheofficiallaunch,andother

additionalBloomioservices.

Gamificationofactivitiescanspurusersnotonlyto investandparticipatemoreinthe

platform,but is canalso increase thenotorietyof the industryand thecompany itself

outsidethecircle.

Beingblockchain-basedequitycrowdfundingabrandnewfieldofstudyandwork,itisof

extremeimportancetofinddifferentwaystoattractcustomers,sothattheywouldfirst

ofalllearnaboutthisnewmarket,understandit,andfinallydecidetobepartofit.

4.4.FutureDevelopments

Thepotentialoftheinnovationandthepresenceofsomefavourableregulations,might

makethecryptotechnology industryexpandrapidly in thenext fewyears.Blockchain

technology ispromisingthecreationofamarketthatwill foster innovationandatthe

sametimedemocratizethefinancialworld,andmanyotherstogetherwithit.

Likeanyotherinnovationthough,itpresentsnotnegligibledrawbacksthatwouldhave

tobeaccessedandtakenintoconsiderationwhenexploringthefutureapplicationofthe

technology,andhowitwillfitintheexistingenvironment.

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4.4.1.TheFutureofBloomioandtheCryptoValley

TheZugcantonisworkingconstantlyinordertomaintainitsreputationastheworlds

“CryptoValley”.Theecosysteminthisregionisnotonlycomposedbyinnovativestart-

upswith the sole goal ofmakingprofits; but thewhole community of companies and

regulators, are working together to promote innovation, and create more and better

opportunities.ThisattitudeiswhatdistinguishedZugfromtherestoftheregions,andit

isthisattitudethatwillfostereconomicandindividualgrowth.

Oneofthebiggestobstacleinthegrowthofthecryptomarketisandwillbetheregulatory

framework.Therelativelynewtechnologystilloriginatesadecentlevelofhesitation,so

itisuptoregulatorstoadoptaninnovativeapproachtoputthemindsofconsumersand

investorsatease.Fortunately,FINMArealizesthatthechancesforSwitzerlandtogrow,

arecloselyrelatedtotheirabilitytoinnovate;forthisreason,futureregulationswillbe

developed with the goal of removing unnecessary regulatory obstacles to permit the

developmentofnewandinnovativebusinessmodels.

RegulatorybodiesarenottheonlyonesthathaverealizedthatthefutureofSwitzerland

andthefinancialenvironmentmaydependontheevolutionoftheFintechindustry.Start-

up incubators are in factworking in order to help these new companies emerge and

organizetobesustainableintheneweconomicenvironment.Start-upsarethebackbone

ofinnovationanddigitalization,anditistheregulatorsandtheincubatorsresponsibility

to cooperate in order to create an innovation and creativity friendly environment for

thoseentrepreneursthatarecourageousenoughtodeveloptheirideas.

Switzerland has been considered for quite some time now, the global centre of the

financialworld,anditisworkingtowardtheevolutionintowhatwillbetheepicentreof

Fintech innovation.Thisprediction isdrivenbytheconstanteffortbyboth innovators

andregulators,tofostertheexplorationofthenewfrontiersofblockchaintechnology.

Thewidedistributionofblockchain,dependsontheeffortinnovatorswillmake,inthe

adoption of the technology in already established industries, in order to show its full

potential.

Bloomioisoneofthefirstattemptstointroduceblockchaintechnologyinanindustrythat

wasalreadywellestablishedandstructured.Inthedefinitionofthefunctionalitiesofthe

- 109 -

platform, we can see how many of the inefficiencies usually associated with equity

crowdfundingproviderscouldbemitigatedwiththeintroductionofthisinnovation.

Bloomioistakingthefirststepsintoanunexploredgroundthatontheotherhandmight

providetremendousopportunitiesofgrowthandthedemocratizationofoneofthemost

profitableindustriesintheworld.

IquestionedMrLyadvinskyonwhathebelievesthefutureofBloomioandtheindustry

willbe.Whathetoldmewasthedisplayofthewillingnessofinnovatorslikehimtobring

somethingnewtothetable,explorethelimitsoftheindustry,andexpandasfarasthe

companycanreachtobecomeoneofthemajorplayersintheindustry.MrLyadvinsky

anditscollaboratorsinitiative,sumsupthewillingnesstoprovethemselvesandgrowas

professionalsandpeople.

AccordingtoMrLyadvinsky,thecreationofBloomioandthesefirstservicesprovided,are

justthefirststepsintothehugedisruptionthatthetechnologywillbringtothefinancial

industry and others. Themix of this response to customer needs, and the increasing

relevanceoftheinnovation,willhelpcompanieslikeBloomiobecomethemajorplayers

intheindustryofthefuture.

Switzerlandchoiceoffosteringblockchain-basedapplicationsandstart-ups,mightresult

to be an extraordinary decision for the future development of new and profitable

industries.

When discussing the future of blockchain technology and its application in the

crowdfundingindustry,weneedtokeepinmindthat just likeanyother innovation, it

doesnotcomewithoutsomedrawbacks.Alltheconsequencesofthetechnologyneedto

beaccessedandkeptintoconsiderationbyanyonewillingtoinvest.

WehaverecentlyseenanincreaseinthenumberofpublicICOs,whichcanhavenegative

consequenceswithrespecttotheprotectionoftheinterestsofconsumers.

The technology allows the formation of autonomous ICOs, not backed up by any

institutionorplatform.TheseICOsconstitutethemajorityoftheonesrightnowinthe

market,andsomeofthemhavebeenabletoraisemillionsofdollarsovernight.

ThemajorityoftheinvestorsintheseICOsareinvestinginthesenewtokenssolelyfor

speculativereasons,withoutrealizingtheimmenserisktheyareexposingthemselvesto.

The promise of a fast enrichment is pushing beginner investors to look for the next

- 110 -

cryptocurrencythatisexpectedtogrowfast.Theiranalysisisusuallybasedsolelyona

poorlywrittenwhitepaperandaflashywebsite,andsometimesnotevenonthat.

Wehavetheclearexampleofthisstatementwith“DogeCoin”,afakecryptocurrencythat

hasbeendevelopedbyanAustraliandeveloperwiththesoleintentiontoprovethelargely

spreadblindinvestingattitudetowardICOs.DogeCoinonJanuary7th2017hasreached

amarketcapitalizationof2USDbillion,wherenoprojectexiststobackupitsvalue.

WhatisimportantinthesesituationsistoremindinvestorsthatbehindeachICO,thereis

ateamofpeople,andthataproperduediligenceisnecessarybeforedecidingtoinvestin

anewproject.ThisiswhencompanieslikeBloomiocomeintoplay;theyassesstherisks,

and most importantly they educate investors on the real meaning of the technology

behindthecryptomarket.

According toMr Lyadvinsky’s expectations, the industrywill grow, andwe think that

blockchain-basecompanieswillbepowerfulenoughtosubstitutemanyofthecurrently

availableservices.Consumerwillbecomemoreawareofthetechnologyandwillrealize

therightwaytouseit,takingadvantageofitsfullpotential.

- 111 -

Conclusions

This work has been built around both the positive and the possibly disruptive

consequences of the implementation of Blockchain technology in growing market of

equitycrowdfunding.

Aswehavedescribedthroughthisdissertation,theintroductionofblockchaintechnology

canintheorymitigatemanyoftheinefficienciesrelatedtothetraditionalmethodologies

of equity crowdfunding.Wehave alsodemonstrated that the actual applicationof the

technologyinarealcaseispossibleandprofitable,likeinthecaseofBloomio.

We have started this work by analysing the concepts behind blockchain technology,

describingindetailsthefunctionalitiesaswellasthepossibilitiesthatthisinnovationis

abletooffer.Wehavespecificallyfocussedontheconceptof“tokens”andthepossibility

ofthe“tokenization”ofequityandassets,allowedbythetechnology.

Later we described the structure and the functionalities, but most importantly the

limitationsofequitycrowdfundingplatforms.Furthermore,wehaveillustratedhowthe

currentstateoftheartcreatesmanyconstraintsintermsofbarrierstoentry,security,

transparencyandfreedomofactions,especiallyforpossibleinvestors.

Inafollowingsectionwehaveanalysedhowtheintroductionofblockchaintechnology

would alleviate many of the inefficiencies widely acknowledged in the crowdfunding

ecosystem;andhowthestructureassociatedwithit,hasthepotentialtocreateamore

transparent,safe,anddecentralizedenvironmentforstart-ups.

Companies looking for capital, and small investors looking for risky but profitable

investment opportunities, can meet in a blockchain-based environment, with the

guaranteeofinteractinginasafeandtransparentecosystem.

Wehaveproposedthecase-studyofBloomio,aSwiss-basedcompany,whichiscurrently

thefirstentityintheworldtohavestartedworkinginthecreationofablockchain-based

equitycrowdfundingplatform.Thiscompanyisstillworkingonthedevelopmentofafully

functionalenvironment,thatwillbeperfectlyoperationalattheendofMarch2018.This

newplatformwillallowentrepreneursto“tokenize”apercentageoftheircompanyand

sellthosetokenstoraisecapital,throughtheinternalsecondarymarket.

- 112 -

Suchtechnologyallowsforthetokenizationofpropertyandcreateswhatarecommonly

known as ICOs (Initial Coin Offerings). Transactions, proofs of property, user’s

information, and accounts,will be all stored in ablockchain application, basedon the

Ethereumframework.Thiswillgrantatransparentandsafeenvironmentforbothparties

involvedinthetransactions.

Thecreationofasecondarymarketforthesetokenswillrevolutionizetheventurecapital

market,notonlybycreatingamoretransparentandfastwaytoraisecapital,butwillalso

introducetheventurecapitalisticconceptsintothemassmarket.Theintroductionofthe

technology and the tokenization of equity, permits themassmarket to participate in

venturecapitalisticactivitiesevenwithsmallcapitals,rangingbetween1000and20000

SFr(inthecaseofSwitzerland).

The biggest limitation remains the legal framework which these blockchain-based

companiesareworkingin.Innovation-asitusuallyhappens-isfasterthanlegislation,

thatfrequentlydoesnotallowaproper,andtime-efficientintroductionofthetechnology

inthemarket.TheZugCanton,inwhichBloomioandmanyothershavetakenoffice,has

ontheotherhandrealizedthepotentialofthistechnology,andit isworkingtofavour

blockchain-basedcompaniesandthedevelopmentofnewprojects.

The collaboration between the Swiss government, some independent self-regulating

associations, andblockchain-based enterprises, is fostering thedevelopmentof the so

called“CryptoValley”,whichmightbetheepicentreofthecreationofblockchain-based

applicationsandofthedisruptionofthefinancialsystemandofmanyindustriesaswe

knowthem.

- 113 -

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ListofFiguresTables

Table(1):DifferencesintermsoffunctionsbetweenTraditionalFinancialIntermediaries

andCrowdfundingasFinancialIntermediaries.41

Table(2):FunctionalitiesofanequitycrowdfundingDAppassociatedwiththeservices

providedandnecessary.

Table (3): Inefficiencies softened by functionalities od a decentralized crowdfunding

application.

Graphs

Graph (1): The increasing volume of capital that equity crowdfunding platforms are

raisingandwillcontinuetoraise.

Graph(2):IncreaseinthenumberofICOsin2017.

Graph(3):USDmillionsraisedthroughICOsin2017.

Figures

Figure(1):Messageandtransactionsinteractionsscheme.21

Figure(2):Shorterblocktime29

Figure(3):Biggerblocksize29

Figure(4):Subtreeselectiondifferences.30

Figure(5):Crowdfundingplatformbusinessmodelillustration.42

Figure(6):peer-to-peer“SeparateAccountModel”interactionillustration.43

Figure(7):peer-to-peer“NotaryModel”interactionillustration.

Figure(8):peer-to-peer“GuaranteeModel”interactionillustration.

Figure (9): “Low Responsibility” interaction model for a, equity-based crowdfunding

platform.

Figure (10): “Medium Responsibility” interaction model for an equity-based

crowdfundingplatform.

Figure (11): “HighResponsibility” interactionmodel for a, equity-based crowdfunding

platform.

Figure(12):NetworkPartnerInteractioninthecrowdfundingsystem.

Figure(13):RelationshipbetweenthetwopartiesinvolvedandtheDApp,intheequity

crowdfundingblockchain-basedecosystem.

Figure (14): Peer-to-Peer ContributionMechanism trough a decentralized application

- 123 -

Illustration.

Figure (15): Equity Crowdfunding Mechanism trough a decentralized application

Illustration.

Figure(16):EquityCrowdfundingplatforminteractionandserviceprovisioninablockchain-basedecosystemthroughtheuseofaDApp.