by Scott Clavenna
March 21, 2018

We're adding to the vital market intelligence that Squared members get each week with this new blockchain series from our Chairman, Scott Clavenna. Don't forget, Squared members can also watch all the panels and presentations from the recent Blockchain in Energy Forum 2018.

Looking for bright spots in clean energy venture capital is, at best, an exercise in cherry-picking a handful of successes while ignoring the calamitous reality of overall returns from the sector.

At worst, it’s a fool’s errand; the model itself may be broken, as a number of recent papers have argued, and it remains to be seen whether other sources of capital are sufficient to reverse the trend.

Well, here comes blockchain, a new decentralized technology platform that could underpin a number of electricity market opportunities. Transactive energy, asset finance, cybersecurity, and a variety of electric utility operations could all potentially be addressed with blockchain-based solutions that offer lower costs of transactions, more rapid settlement times, or improved registries.

Blockchain also brings with it a method of fundraising that can circumvent the traditional equity-based financing of venture capital or private equity.

Typically using Ethereum’s ERC-20 token standard, these new software companies can issue tokens and sell them publicly, without diluting the capital structure of the company. In a way, these are crowdfunding mechanisms being used to fund a software development “project” that are often large enough to fund the operations of the company as well.

The irony is palpable: Along comes a new sector with qualities that VCs typically adore (software-centric firms with low capital and operating costs that can disrupt the entrenched players by changing the paradigm beneath the current market, i.e., centralized, hackable databases), yet these companies can literally mint their own money by creating tokens on the back of their platform and selling those to any investor, whether they are accredited or not.

And they have. According to GTM Research’s recent report on blockchain in energy, over $320 million has been invested in blockchain startups since the second quarter of 2017, an astonishing sum for the clean energy market. But looking within that total, only $58.6 million could be attributed to venture capital, though the number could be somewhat higher since not all venture capital is fully disclosed.

The SEC is casting a very cold eye upon initial coin offerings (ICOs), and could make them highly regulated in the near future if they decide that tokens should be treated as a financial instrument. This could quickly turn blockchain startups back to VCs for funding, but it wouldn’t change the fundamental challenge that VCs have faced in cleantech investing over the past decade: How do you bring disruptive technologies to a market that is so highly regulated, price-sensitive and just plain intransigent when it comes to startups?

At our recent Blockchain in Energy Forum in New York City, my panel of investors had much to say on the subject, but admitted they hadn’t put any real money to work yet. The interest is there -- these firms have funds backed by “strategic” limited partners, such as utilities and major energy firms, who seek better visibility into the energy startup landscape, and consider blockchain an area that presents both opportunities and threats to their businesses. But with the current nascent state of the market, and the ability of startups to raise money via public token sales, these investors hadn’t yet found the right opportunities to invest.

There was no denying their interest, as well as their belief that they offered more value to these startups than just capital. “The interesting thing about blockchain is that it’s really an integration of business model innovation and technology,” said Michael Horwitz of Greentech Capital Advisors. “And while you can experiment with some of these other funding methodologies, I think that with the experience and knowledge base that exists in the professional community, along with governance, there’s a lot that can be said for those in venture capital and private equity.”

Cassie Bowe of Energy Impact Partners noted the value of her fund’s limited partners: “We bring a lot of value to the table. We have 14 utilities that you could pilot with now. We also have 18 portfolio companies...where I could see a use case where they could leverage blockchain technology as a partner."

There's a sign of a bubble when investors have to explain their value to potential entrepreneurs. These investors are finding that many blockchain startups continue to have too little real-world experience to get them past the diligence phase of funds looking for later-stage or strategic investing opportunities.

Bowe explained: “According to your report, there are 40 total [blockchain in energy] pilot projects deployed. That’s usually the scale of deployment we’d want to see for a single company that we’re investing in, not for the entire industry.”

On how to vet the many blockchain startups coming to these funds for capital, Bowe thinks mainly about “defensibility at scale, and how it drives your pricing power. Who in this value chain is going to maintain the value and have the pricing power?”

It's unclear in many use cases if the technology provider has the pricing power, or if it's the grid operator, retail electric provider, or even the consumer. 

Horwitz added: “When thinking about diligence, you look at who is developing proof points with these big strategics. That is more important to this area than a lot of other technology areas that we’ve seen in the past.”

Ernst Sack is a partner at Blue Bear Capital, which also has strategics in its fund. He noted that major strategics like Siemens and Centrica are making investments in blockchain, but they may just be playing the field to gain visibility into new tech, as “having lesser-known names that are really committed to the space can be more valuable than having a big name” to really understand the space.

How does this play out for blockchain startups looking to exit? “The IPO markets are hardly open for social media companies, let alone blockchain companies right now,” said Horwitz.

Bowe added: “Most of the exits in our space -- period -- will be acquisitions, and most of those will be to strategics.”

I see white papers

Despite plenty of noise from the SEC about regulating ICOs out of existence, these companies have planned ICOs. I will be participating in none of them.

Keeping up with the blockchain

Here are some other blockchain stories I'm keeping an eye on.

Blockchain hype hits SXSW. (You should really just go for the music.) 

Nick Grossman of Union Square Ventures on why tokens are a critical piece of “cryptonetworks” and will underpin an Internet 3.0, with slides

Russia looks to the as-yet-unsanctioned blockchain to cut producers’ costs in the energy sector. 

Transactive energy comes to Ireland, via a new collaborative effort called EnerPort. 

Bloomberg's Paul Ford sifts through the hype and hope of blockchain.