Following the 2008 financial crisis, both Main Street and Wall Street agreed that power was too concentrated at the financial institution level. People wanted more control, birthing the era of Bitcoin, and later, other forms of digital assets. The digital assets movement was based on putting power back in the hands of customers, users, and communities – to democratize decision making, governance and value accrual.
However, the 2017 initial coin offering boom turned into a money grab for easy financing without proper governance and oversight built into the tokens or their issuing companies. ICOs were often done quickly and without proper details, forcing investors to give project leaders the benefit of the doubt that as their project matured, it would self-govern.
This need for self-regulation was evident back in 2018, when early discussions around token governance were first formulated. The venture capitalist Mikal Khoso wrote:
“Part of the maturation of the ICO as a fundraising mechanism will be the establishment of frameworks for what rights token ownership should afford investors. Ideally the market will self-regulate and create these frameworks.”
Unfortunately, this has not happened. Token holders are left with little recourse on how to force companies and their management teams to follow through on their initial promises.
This is less of a problem in traditional finance, where debt and equity markets have clearly defined stakeholder structures for investor recourse, resulting in governance systems that protect investor interests and prevent rogue executives from running amok with a company. That said, many investors incorrectly believe that owning debt or equity ensures that you have direct control over a company’s assets.
If a company has $100 million in cash on the balance sheet, the only claim you have on those assets is if the company files for bankruptcy. Otherwise, this cash only directly benefits debt and equity holders if there is governance in place to prevent management from making terrible decisions (i.e. an independent board of directors), or if you trust management to create a high return on this cash.
To date, digital assets investors have yet to be shielded by similar legal and market protections. So where do you find checks and balances in the digital assets industry when token issuance is not regulated and legal precedent has not yet been set for token holders’ rights?
Often management teams are aligned with their investors and this is not an issue. In cases where they are not, investors can force change. A recent Willis Towers Watson report suggested a primary role of investors is stewardship. "Arguably, good stewardship is the most useful function the asset management industry performs," it said.
Activist investors are often portrayed negatively. They are viewed as self-interested, when in reality, their efforts are typically beneficial to all stakeholders. An “activist,” by definition, is merely an agent for change, and in many cases, it is only the activist investor who can see clearly and objectively enough to help a company recognize that change is needed. In fact, according to McKinsey, it is beneficial for companies to role-play and think like an activist investor, to help uncover their own internal blind spots.
"Done well, an activist role-play approach is substantially more provocative than a standard strategy review. The tone can be aggressive, even confrontational. Adopting an activist perspective can help set a higher bar for operating improvements," McKinsey said.
The growth in ESG investing (environmental, social and governance) has shown that investor pressure can influence company decisions even without having any legal rights. BlackRock, the world’s largest asset manager, released an open letter warning companies that it would “be increasingly disposed to vote against boards moving too slowly on sustainability.” In BlackRock’s words, social purpose “is the engine of long-term profitability.”
Essentially, companies are being held accountable simply by the threat of losing access to strong investor bases. They want management teams to protect more than just shareholders; they want them to protect all stakeholders, which includes employees, the environment, their city and their social surroundings.
Recently, Arca has played the role of an “activist investor” in the digital assets space by submitting a proposal to Gnosis after uncovering what we consider to be gross mismanagement of resources, a lack of internal controls and fiduciary responsibility, and an un-communicated roadmap that strays away from their original white paper. While we have yet to see any tangible benefits, our conversations with Gnosis have spurred them to announce that they will redo their tokenomics for the GNO token, including more collaboration and input with token holders and community members.
This is the ethos of digital assets. Token holders have rights, even if not explicitly laid out in a white paper or a court of law. Our right is to stand up to management teams and project leaders who are making misaligned, or outright negligent decisions, and to pressure them through the court of public opinion to do right by their token holders and communities.
By highlighting blind spots, mismanagement, or projects veering off course, we, token holders, can move this industry forward. This is something that Arca feels strongly about and is part of our core values. The digital assets ecosystem needs to adopt the best practices of traditional finance. A strong governance system is one element that will help keep companies in this space on track and will hold them accountable. The digital assets industry should welcome this movement, since the genesis of digital assets was to give more control back to the community.
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