Ethereum’s First ICO Blazes Trail To A World Without Bosses
If it weren’t for horses, Joey Krug might not have ever gotten into ethereum. Growing up in the small farming town of Knoxville, Illinois, he and his younger brother used to ride their bikes through fields of corn and soybeans looking for trouble. One day, when he was about 9 years old, Krug came across the farm of a local school teacher, who raised and rode horses. He instantly fell in love with the powerful creatures, and pedaled home as fast as he could to ask his parents for one.
Perhaps not realizing the entrepreneurial spirit already growing in their son, they offered him a deal. “They said, ‘No, but if you go there and you muck stalls every day for a year, we’ll get you a horse,’” he says. “I think they assumed there was no way I was going to do that. But I did. I went there every day, mucked stalls, brushed the horses. And so they finally got me this pink horse, a quarter horse named Shimmer.”
When not riding horses, the young boy excelled on his family’s computer, figuring out ways to hack it so it would turn on in the wrong order and get stuck trying to permanently boot up the CD-ROM. By the time he enrolled in an eighth-grade beginner’s computer course, it took him only 15 minutes to do 45 minutes worth of work. Instead of going home, the 12-year-old Krug deposited $20 of birthday money into an off-shore book, and placed a bet.
Not only did the bet win him $20, jump-starting more sophisticated models tracking race distance, jockey and track conditions in a spreadsheet, but it merged his love of horses with computers. Now 26, Krug is the co-chief investment officer at Pantera Capital and a cofounder of Augur, an open-source no-limits betting platform built on the ethereum blockchain that lets anyone build any kind of betting market, without a bookie.
Today, Krug and a team of open-source developers scattered around the world launched Version 2 of that platform, which amounts to a significant leap forward in the world of decentralized applications that function similar to the internet but without the need for trusted third parties. If successful, the profound upgrades could be used to more than just place horse-bets without a bookie; they could mark a turning point in the next generation of the internet.
“When you think about centralized power, it kind of always corrupts,” says Krug, 26, who might in other circumstances have the CEO title, if not for the unusual nature of the project he cofounded. “Somehow, somebody takes too much power, and they do something they shouldn’t. And if you think about regular businesses, too, they have the same incentive, to make as much money as possible. And so Auger is very different. It’s sort of like public infrastructure.”
Born in July 1995, Krug grew up surrounded by farms, but his family weren’t farmers. His mom was a physician’s assistant, and his dad an ER doctor. During his freshman year of college, he discovered bitcoin on Overclock.net, a forum dedicated to expanding computer processing power. Shortly thereafter, Krug read retired Congressman Ron Paul’s The Case For Gold and was struck by how irresponsible bureaucracy had led to a U.S. debt of more than $10 trillion at the time.
After hearing further stories from his parents about how another bureaucracy, around the U.S. healthcare system, had deprived them of the joy they once felt helping others, Krug briefly enrolled in Pomona College, based in Claremont, California, with a double focus on computer science and pre-med, hoping he could streamline the process. Fate would have it, though, that he’d get permanently derailed by blockchain. Still, his goal of fixing broken bureaucracy never wavered.
After founding a bitcoin club at school, Krug built a bitcoin point-of-sale app and went door to door to try to convince local Claremont businesses to accept the cryptocurrency. Unable to find customers, he moved to San Francisco in search of another way forward. At around this time a team of researchers at Princeton published an influential paper on creating decentralized prediction markets, or distributed autonomous organizations (DAOs), where betting is used as an incentive to create valuable data about the future. Unlike brash predictions carelessly made around the internet without repercussions, these predictions would have monetary repercussions, but no bookies, or any other middlemen to oversee them.
“It’s interesting from a wide range of aspects,” says Krug, reminiscing about the paper, which also influenced ethereum inventor Vitalik Buterin, now 26. “All the way from my horse-betting days to a real world informational standpoint, you can get data about the real world that you wouldn’t necessarily have without it.”
Initially, Krug joined forces with college friend Jeremy Gardner, now 28, and Jack Peterson, now 37, to build their own implementation of a project that had been circling around the cryptocurrency community, called TruthCoin, that used a modified version of the bitcoin blockchain to incentivize making accurate predictions. Buterin caught wind of the project and approached Krug, explaining that he was in the final stages of launching ethereum, a blockchain similar to bitcoin, but with a computer language that would make it much easier to write more elaborate instructions, called smart contracts, to directly connect bettors to each other.
To pay for all this, over a 45-day period in the fall of 2015, Augur ran the first-ever initial coin offering (ICO), in which tokens were issued on the ethereum blockchain. The privately-held Forecast Foundation, based in Estonia, sold or distributed 11,000 REP tokens to be used on Augur, 80% of which went to “the crowd,” or people interested in participating in the prediction market, 16% of which went to the Augur founding team, including Buterin, and 4% of which went to support the foundation itself. A total of about $5.2 million was raised for the development of the platform by selling more than one million ether tokens and 12,000 bitcoins used to pay for the tokens. At the current rates those tokens would be worth nearly a half-billion dollars.
But this was the very earliest days of what would come to be known as the ICO craze. Not only were the terms of the ICO more generous than many later capital raises using blockchain, but the founders’ objective was more philosophically aligned with the principles of decentralization inherent in blockchain. Just two years later an Augur competitor, Gnosis, raised more than twice what Augur did ($12 million) by selling a fraction of the tokens (5% instead of 80%), in a mere 15 minutes. That left the Gnosis team with 95% percent of the tokens, then valued at nearly $300 million, making them independently wealthy with little more than a white paper describing their idea. Between then and October 2018 more than $20 billion was raised in ICOs according to news site Coindesk’s tracker, before the bubble burst amid regulatory uncertainty around whether or not these tokens qualified as securities.
While REP tokens are able to accumulate and lose value, similar to securities, and are currently worth $20.90 each, for a total liquid market value of $230 million, according to data site Messari, they are unlike securities in that they are crucial for the proper functioning of the prediction market, giving them the unofficial status of “utility tokens.” So-called “reporters” in the Augur ecosystem are required to stake their REP (short for reputation) tokens while they are helping determine the outcome of an event. If the reporter reports in consensus with others, they receive a small portion of the protocol’s fees and their REP remains intact. A reporter can dispute the system 21 times, with their required stake doubling each time, before a fork, or copy, of Augur is automatically created and essentially two different versions of the truth exist.
“Ultimately truth is going to be a public consensus that ends up being determined in the long run by which world does it appear that people want to live?” says Forecast Foundation operations director Tom Kyser. “And presumably that world is going to be the one that the general public and consensus believes accurately reflects reality.”
In the early days of the build, a team of independent and paid coders from around the world worked largely under the management of Augur co-founder Jack Peterson, a biophysicist with a Ph.D from the University of California. After initially laying much of the groundwork for the code, Krug was selected to be a Peter Thiel fellow in June 2016 and the following year joined as the co-chief investor at cryptocurrency and blockchain investor Pantera Capital, which has approximately $500 million in assets under management.
The month after Krug joined Pantera, on July 9, 2018, the first version of Augur was launched, “a very slow, expensive, difficult to use version,” according to Krug. But one that showed that a gambling platform without bookies was possible, and that any kind of market could be built on it. “At that point, nobody had any idea whether this would actually work at all,” he says. “A lot of these were untested ideas.” In version one, dedicated users would have to wait between six hours and 12 hours just to download the app, and could then create markets, determine potential outcomes and make bets denominated in the highly volatile, and increasingly valuable ethereum cryptocurrency.
In total 2,895 markets were created on version one generating volume of 69,662 ether, or roughly $15 million to $20 million depending on the price of ether over the two year period, according to the Forecast Foundation, which helps oversee development. 2,609 unique visitors made more than 15,000 transactions. 650 reporters staked 1,385,843 REP tokens for fees resulting in 5,758 REP in disputes. To give an idea of how much that’s worth, on the early platform’s busiest day, $2.5 million worth of assets were locked in active bets at the same time. To give an idea of how much is at stake here, the global online betting industry alone, dominated by middlemen that connect bettors, including FanDuel and Draft Kings, generated $53 billion revenue last year, according to Grand View Research, and is on track to have a compound annual growth rate of 11.5% from 2020 to 2027.
One of the more prolific applications built on version one was Guesser, a venture-backed outfit based largely in Madrid that uses election forecasting models developed by the same market research firm employed by Marco Rubio in his 2016 Presidential campaign, Optimus Analytics, to let users bet on anything from how many times U.S. President Donald Trump mentions “China” in a speech, to whether or not he’ll be re-elected later this year. “Today in politics, people rely a lot on public polling as a source of data for how a betting market might behave,” says Guesser CEO, Jose Garay, 24. “We provide them with a data engine with orders of magnitude more data points than you can get from simply public polling. And this allows you to set a very straight forward probability, a very solid price, on each outcome.”
The problem was, ether’s fluctuating price meant that if a market didn’t fulfill for months down the road (imaging placing a bet on who wins the U.S. Presidential election today) users could accurately predict the future, but still lose money if their staked funds decreased in value. In addition, with the price of ethereum increasing from about $1.00 when Augur concluded its ICO to $316 today, many ether owners have been hesitant to trade it, resulting in low liquidity. “If Augur version two has to crack one problem, or one challenge” says Garay, “It’s bringing liquidity in big volumes.”
While Jack Peterson was largely responsible for managing the somewhat autonomous team of developers working on version one, Krug worked overtime in addition to his job at Pantera Capital to help bring version two over the finish line. As of today, Pantera hasn’t invested in any startups building on Augur, choosing rather to let the firms raise their own seed capital, then look to the best of those firms for a possible Series A investment, says Krug. “We’d like to invest in whoever we think is doing the best.”
Among the notable changes in version two, Augur now has a scam filter that moves likely-fraudulent markets to an area on the site not immediately accessible to new users, and is integrated with a number of distributed applications (dapps) that also don’t rely on trusted third parties. For example, it is integrated with the 0x open source software that enables free peer-to-peer bets instead of the fee that was previously charged. Instead of betting ether, users bet DAI, a stablecoin pegged to the U.S, dollar, powered by another dapp called MakerDAO, that provides a free, open-source programming interface for anyone who wants to accept the token. Instead of relying on a trusted third-party to convert a user’s funds from ether or another cryptocurrency to DAI, Augur is now also integrated with Uniswap, another dapp to automatically provide liquidity on ethereum. Think of it as a DAO of dapps, among the first of a new kind of company without bosses. “Everything is sort of interweaved together to broadcast data in an automated fashion,” says Krug.
In a lot of ways, the launch of version two of Augur is a return to an earlier, more idealistic—perhaps more naive—time when blockchain innovators might get rich, but that’s not what they set out to do, according to Buterin. In addition to encouraging Krug and the founding Augur team to switch from building on a fork of bitcoin to ethereum, Buterin provided technical insight into how to simplify Augur game theory in a way that more efficiently incentivized truth-telling, and in-turn owns an undisclosed amount of REP.
“At the beginning, it was much less certain that crypto could have worked as a thing at all. And so the teams that were going in were generally teams that have believed in the vision that we’re really doing this collective project for the public good,” says Buterin. “Obviously you have to fund developments, but we’re definitely not going to be greedy about it. And I think what happened over time, and as the model got validated, it started to be definitely this kind of change in mindset where just the fact that it seemed like a clear profit opportunity made it something closer to a kind of regular startup thing.”
Now, that’s not to say the Augur developers are philanthropists. While Krug and the Forecast Foundation team declined to share how much of the original ICO capital they still hold, they explained that the idea isn’t to ever turn the foundation into a profit-generating entity. Rather, the goal is for the organization to follow a similar path as Melonport, a DAO for hedge fund infrastructure, and slowly dissolve once the code on which anyone else can build is complete. At that time, and that time alone, Krug says he might start looking for profit.
“Someday the foundation will run out of money and basically, kind of disappear and this becomes an ongoing community developed open source software project,” he says, “At which point, we could maybe create a for-profit entity on top that does actually try to aggressively make money.”