INTERVIEW: Blockchain Capital’s origin story is steeped in gaming lore

When the sons of legendary investment banker Paul Stephens met Mighty Ducks star Brock Pierce, they were avid World of Warcraft gamers and he was amassing an empire of digital goods exchanges where players could buy, sell, and trade valuable in-game items and virtual currency. Together they would go on to form Blockchain Capital, the first venture capital firm to fund the blockchain ecosystem and were early investors in 70 of the best known crypto brands that include Augur, Bancor, BitFury, BitGo, BitPesa, Bitwise Asset Management, block.one (EOS), Blockstream, BTCC, Coinbase, CoinList, Circle, Filecoin, Harbor, KIK (Kin), Kraken, Messari, LedgerX, Orchid, Radar Relay, Ripple, Securitize, and 0x. Fifteen years later, the trio remain the closest of friends.

Having been there at the birth of the industry, Brad Stephens shared with me what the early days of crypto were like and his vision for the path going forward. The following is an edited transcript of our discussion:

Modern Consensus: Blockchain Capital today is one of the largest investors in the crypto space. How did you first get involved?

Stephens: Well, before there were cryptocurrencies, there were video game currencies, and Brock Pierce was considered “The Godfather” of the industry.

I got to know Brock in 2004. He was 24 and running IGE, a digital video game marketplace which was kind of like an eBay for virtual goods where Warcraft gamers could buy gold for their characters or sell their super fire swords and other game items. Bart and I were playing Warcraft and were huge customers. We loved his company and what he was doing so we flew down to L.A. to meet him and structured a deal to invest along with Maverick and Goldman Sachs.

Brock was the first to corner the market in digital goods before anyone even knew there was a market to be had. He had bought out five or six of his competitors and had this super profitable business, but it was all being done in the gray market. Publishers didn’t like the trading of goods outside of the game because it broke up the balance of gameplay for someone who had put hundreds of hours into earning the fire-winged dragon. They wanted to keep a purity of gameplay, which was important to these game worlds. There were auction houses in game but the publishers wanted to control them, control inflation, and keep the economies of these games robust and intact without artificial third parties coming in like Brock’s company. Technically, trading outside the game was a violation of the terms of service, and there was an ongoing battle between Blizzard and IGE for years, but it was a wonderfully profitable business and that’s how we first got involved.

A competitor at the time was Mt. Gox, which was an online exchange for Magic the Gathering game items started by Ripple and Stellar founder, Jed McCaleb. Bitcoin was added in 2010 and Mark Karpeles bought it in 2011. By 2014, Mt. Gox was handling over 70% of the world’s Bitcoin transactions when mysteriously 850,000 Bitcoins disappeared. The loss was valued at nearly half a billion dollars and stigmatized the nascent industry. Earlier this year, Brock launched a “Gox Rising” campaign to try to resurrect it. Why?

This is actually his third run at Gox. Brock tried to save it in 2014 and actually tried to buy it before it failed.

In 2012, IGE had moved to South Korea which had become the center of the universe for online games. At that time, one out of four Koreans were spending on average 30 to 40 hours a week in one of these online worlds, whether it was Aon or Lineage 2. We ended up merging with our biggest competitor in South Korea, ItemBay then ItemMania. We then had something like 99% global market share for video game secondary market sales.

It was at that time that Brock came to the board and said, “I want to buy a Bitcoin exchange called Mt. Gox.” It was similar to ours, a digital goods exchange. Billions of dollars of video games goods had been sold on our exchange for over eight years and hadn’t been hacked. Our technology was very stable. We probably could have absorbed the Mt. Gox business without their corrupt technology and could have saved the industry the black eye that is the Mt. Gox legacy.

Did you decide to buy Mt. Gox?

We didn’t, but it did get us excited about Bitcoin. I had no idea what Bitcoin was at the time, so my brother and I went on a six-month exploration project to find out. We talked to cryptographers and video game people, everyone we could, and looked at Micky Malka’s letter to investors for his first fund at Ribbit Capital, which was the best paper out there on Bitcoin.

Most of the content was coming from Wences Casares, founder and CEO of Xapo, who was considered “patient zero” of the crypto movement. He was the single most important person for the spread of Bitcoin throughout Silicon Valley and the tech community. The libertarians knew of it, anarchists knew of it, but the technologists had not heard about it until Wences went to a few YPO (Young Presidents’ Organization) events and started teaching people about what Bitcoin means and the history of the ledger. He had this personal narrative of how his family’s wealth was wiped out three times in the last hundred years due to currency manipulations and hyperinflation in Argentina, and how Bitcoin is the panacea for all these problems.

YPO was this club with leadership circles for influential CEOs and a lot of crypto pioneers first heard of Bitcoin from these talks, including Fortress’ Pete Briger and Mike Novogratz, then Tim Draper became excited and the overall VC community woke to it. That was the start of a lot of awareness.

The entrance to the Blockchain Capital office is a museum of mining rigs from companies that are now defunct. Why?

It’s a reminder of where we came from as well as… haha, don’t be in mining. In 2013, we started mining and got to about 1% of the global Bitcoin mining network, which was much easier to do back then. We had these hand-welded mining rigs and were making tons and tons of Bitcoin but we exited in 2014 because it became financially superior to purchase Bitcoin instead of mining it. Equipment suppliers were flaky or more likely corrupt, “testing” the gear for weeks before shipping. Most of them went out of business. Friends don’t let friends mine crypto.

The Winklevoss twins amassed 1% of the world’s Bitcoin during that time as well.

I think they bought 1% of all Bitcoin at the time, not 1% of mining hash power. Much bigger!

Sounds like 2013 was a good year to get in on Bitcoin.

It was except we wanted to spend it and there were no exchanges or wallets yet. That’s when we funded GoCoin so we could spend it at retail, and Xapo so we could have a crypto credit card, and Coinbase so we could sell it back into fiat.

You invested in Coinbase, now valued at $8 billion, instead of Mt. Gox, which went bust—smart move!

Coinbase was the only crypto exchange with a bank account. They were banked by Silicon Valley Bank, and Silicon Valley Bank banked only them. It was the single most important bank account bringing the crypto world back to the fiat world, and our single biggest insecurity for 2013 through 2015. Had Silicon Valley Bank pulled their banking relationship, Coinbase would have died and crypto wouldn’t have taken off for years.

Back then, no one would bank crypto. There were a few very expensive, questionable banks in Europe that stepped in to fill the void, and Kraken ended up getting some of those relationships, but overall the banks were scared to touch crypto. If you have 99% of your business in a safe, stable area and 1% in crypto, you could have 99% of your accounts frozen if that 1% winds up doing something that is deemed illegal. Banks are highly aligned to not do anything that could mess up their core business.

In 2013, you, your brother, and Brock Pierce founded Blockchain Capital. How did you decide to roll the dice and fund such a high risk industry?

Well, we had already been funding a bunch of startups off of our Stephens Investment Management Group, which is our family office, and wanted to invest in a VC fund that was specific to blockchain. We met with Brock to find a blockchain fund and there really wasn’t any. Terra had a Bitcoin fund where they held Bitcoin like a custodian but they weren’t doing any venture yet. Mickey Malka of Ribbit had made some investments in crypto, but most of his fund was fintech. So together we decided to start the first crypto fund. We did it on a no-fee no-carry basis and went in a third, a third, a third.

It was originally called Crypto Currency Partners, which we folded in our earlier investments. We basically went around to the early crypto CEOs and said, “Bobby Lee of BTCChina, give us $50,000 of your stock and we’ll make you a $50,000 limited partner in the fund. Steve Beauregard, give us $50,000 in GoCoin and we’ll make you a $50,000 limited partner.” The investors in the fund were the CEOs or founders of our portfolio companies. We’d invest in their company and the CEO would invest in the fund, with a few exceptions like Coinbase.

Our pitch was you got the industry right but there’s risk. Give us some of your equity and we’ll give you 25 pieces of other equity so if your company fails, at least you’ll have a piece of your competitors. The companies were happy to work together because they were invested in each other. They were cross-pollinating and growing the ecosystem together. There wasn’t as much competition as there was coopetition. Everyone was trying to help each other.

That was Fund I, and the good thing for us was not only did we get exposure to the first 30 crypto companies which included BitGo, Chain, Circle, Coinbase, Kraken, but we also had 20 of the CEOs as limited partners which gave us access to information and connections that proved invaluable.

For the first year and a half, we were the sole VC in town. Bart and I ran the fund and Brock was out on the road bubbling up deal flow. When we closed Fund II in late 2014, there were still no institutions willing to touch crypto yet.

Then in the summer of 2016, after we saw what happened with The DAO and how quickly they were able to raise $150 million, that was our aha moment when we decided to do an ICO ourselves. We began working out the details of how to do it compliantly and in April 2017 launched Fund III which created BCAP, the world’s first security token.  

In 2017, ICOs were all the rage. Ensuring you were compliant with U.S. securities laws must have been expensive and time-consuming, but obviously the right move considering the current environment. Did you consider the raise a success?

Definitely, BCAP was one of the best performing tokens of 2018. We were the first ICO to mandate KYC/AML [“know your customer”/anti-money laundering] and were uncertain whether it would crush any demand, but we knew we needed to play within the SEC’s framework for securities. We erred on the side of caution and thankfully the sale was a fast success, raising the entire amount ($10 million) in 35 minutes, even with KYC. But our decision was easy, we were obviously a security.

BitGo is now custodying it, Coinbase hopefully soon. Having professional custody and trading of a VC fund, which is an absolutely illiquid asset class that’s now liquid, is very exciting.

We created a structural path for other people to create security tokens by complying with Reg D 506(b), basically mirroring the high yield debt offering. No one had any clue how to do a security token through the U.S. legal system back then. We were the first to figure it out.

On Tuesday, the news broke that the SEC is suing Kik Interactive for conducting an illegal $100 million securities offering of digital tokens from its 2017 ICO. What effect do you think the current SEC actions will have on the crypto markets?

With Kik, we get into the grey zones. They’re well backed and with a respected team and it could take forever to get sorted out, but at least we have a case to start the dialogue. We’re about to see the Howey Test finally applied to crypto. From an investor perspective, capital formation will definitely take a pause as we see how friendly or not the U.S. is to innovation and crypto. This will be a defining case as to whether the crypto industry needs to move away from the U.S. Innovation won’t stop but overly zealous regulation from the 1930s with limited flexibility may make the U.S. a hostile environment for our industry.

What is the likely effect on Bitcoin if the tariffs from the trade wars tank the global economy?

As we have seen for half a decade, when there is global economic chaos, Bitcoin gets more attention as a safe haven inflation-protected asset class that is not correlated to other asset classes. So trade wars, implosion of Venezuela, Brexit, Chinese pending devaluation of the yuan, all drive Bitcoin interest.

After a long crypto winter, Bitcoin started to make a steady climb, crossing over $9,000 twice in the past few weeks. Even though right now it’s back under $8,000, people were getting excited about the prospect of breaking through $10,000, a price we haven’t seen since February 2018. What is your outlook as we make our way through 2019?

Well, 2013 to 2016 was about creating a fertile soil; 2017 a thousand trees flourished; 2018 was about pruning out the weak, the corrupt, and the dead; and 2019 the strong and well are thriving.

We’re in a period of BUIDLing, the fundamentals are there. We closed our Fund IV at $150 million in February 2018 and have been investing heavily in RegTech, leading the rounds in Securitize and Radar Relay.

We need more onramps and we’re about to witness more established companies shifting to crypto. We’re seeing the arrival of institutional custody that has created a lot of new large buyers. Major players jumping in like JPMorganChase, Fidelity, Amertrade, E*Trade, Square, and NYSE give a ton of credibility that this isn’t a fad that is going to go away.

What do you think the effect of Facebook GlobalCoin will be as it debuts early 2020, before the U.S. presidential election? What happens when 2 billion people adopt a currency no longer controlled by a government?

I believe Facebook’s aggressive push into crypto is the single largest news of the year, and has the chance to grow our ecosystem, wallets, and users exponentially. Purely from the global adoption perspective, Facebook has the ability to pop us into over a billion users, especially with the unbanked who are now folding into the global economy. It signals a huge leap forward for financial inclusion. Facebook GlobalCoin is going to increase awareness of digital currencies and Bitcoin, particularly across the major fintech and payment companies that are in the Facebook consortium.

Do you think the efforts by the U.S. government to break up big tech has anything to do with the rise of crypto?

Perhaps. Long term the establishment of supra-sovereign currencies should lead to the weakening of nation-states which I personally believe is a huge global net positive. A country’s currency printing press is the most powerful weapon of control, and as that control gets eroded by global currencies owned by individuals instead of countries, we are ushering in a new era of globalization driven by individuals with choice and freedom.