(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
What does the monetization of a new technology feel like? The last month in digital assets. Or, holding amazon stock from 1999 – 2007 – more on that below. Bear markets are painful and human memory’s are short. It’s important to remember three things in this environment: i) investing in emerging technologies is and will always be volatile, ii) it’s the technology, not the price that creates value, iii) things likely get worse before they get better
Investing in emerging technologies is and will always be volatile
New technologies seek to disrupt the status quo by offering a better solution to an existing problem or a solution to a problem most people don’t know they have. This process is the battle of educating new users and providing increasingly more value, both of which ebb and flow and require access to capital, which as we are being reminded now, ebbs and flows. Therefore, the value of assets in emerging sectors tends to ebb and flow. Amazon is one of the most notable examples. Amazon peaked in the Internet bubble in late 1999 at ~$90/share. Nearly two years later, at the trough, shares of Amazon were priced at $6/share.
But of course, all this is ancient history and if you look at Amazon’s chart today, that volatility is barely visible.
Amazon leveraged the digital disruption of the internet, to digitize, or de-materialize, brick and mortar retail. The internet allowed Amazon to offer customers a cheaper and more convenient way to buy and sell goods. Today, it is clear that Amazon is the winner, Walmart continues to try to keep up, and basically every other retailer has lost. If you owned shares of Amazon in 2001, I’m guessing things felt a bit less certain.
Digital asset prices are down 50-75+% over the last six months and will likely go lower. Amazon was down 80% a year into the post-bubble bear market and it got cut in half again before it made a bottom almost two years after it peaked, losing 93% of its value peak to trough. Digital assets, like Amazon, are leveraging the a technology that will underpin the next wave of digital disruption, or public blockchains. Also like Amazon, digital assets are competing to educate new users and provide increasingly more value. Given the market conditions, I thought it might be helpful to spend time articulating just exactly what value public blockchains unlock
It’s the technology, not the price that creates value
What is a blockchain?
A blockchain is a digital ledger that records the transaction history of a community of users. A blockchain expresses digital ownership via digital tokens that are created and exchanged via network participants. The digital token serves as the unit of account for each participants’ ownership in the blockchain eco-system
Ledgers have existed throughout history, with the earliest versions comprised of pen and paper used to track the exchange of goods and services. Today, ledgers are typically digital and are primarily owned and operated by centralized “trusted” third parties on behalf of the community of users. For example, most people reading this have a bank account. In this instance, your bank is the trusted third party that owns and maintains the history of deposits and withdrawals in your account (i.e., the ledger). In this example, ownership is represented via a digital representation of dollars, akin to the digital tokens issued and exchanged in blockchain ecosystems (i.e., unit of account that represents ownership of dollars in circulation). While the term transaction implies the exchange of economic value, which itself is just another form of information, entries in a digital ledger can also represent non-monetary value or other forms of information, including, but not limited to, digital content, intellectual property, and contracts
The trusted intermediaries (i.e, the bank in the above example) that facilitate the exchange of goods and services among a centralized digital ledger add value by reducing information asymmetry and the risk of moral hazard through third-party verification. Or said differently, they establish trust among market participants, often through imposing disclosures, monitoring participants, maintaining trustworthy reputation systems, or enforcing contracts. While there is nothing inherently wrong with centralized digital ledgers or the third-party intermediaries that provide trust and verification services to marketplace participants, centralized ledgers and the presence of intermediaries have many shortcomings, such as:
Centralized ledgers may be lost or destroyed; a user must trust that the owner is properly backing up the system
The transaction data may be altered; a user must trust that the owner is not altering prior transactions
In exchange for their services, intermediaries typically charge a fee for their verification services
Third-party fees are exacerbated when intermediaries gain market power, often as the result of the informational advantage they develop over transacting parties through their intermediation services
Intermediaries increase the chance that information will be reused outside of the original contractual agreement (i.e., market participants have limited control over their data)
As marketplaces scale, keeping data secure becomes challenging and information leakage more prevalent
Public blockchains are an upgrade to existing digital ledger technology. Public blockchains leverage cryptography, distributed systems, and digitally native tokens to enable the exchange of goods and services without the need to place trust in a third-party or centralized intermediary, overcoming many of the shortcomings of centralized digital ledgers
Blockchain based digital ledgers improve on existing digital ledger technology primarily in two ways: i) they lower the cost of verification and ii) they introduce a new mechanism to operate and scale economic networks via digital tokens. Blockchain systems lower the cost of verification as they remove the need for centralized intermediaries, which as noted above add cost to the transaction verification process due to the lack of trust among network participants. In blockchain systems trust in the intermediary is replaced with trust in the underlying code that all network participants run and trust in the rules that have been established to determine a valid transaction. The verification services that third parties provide in existing digital ledger networks are collectively owned and managed by the broader group of ecosystem stakeholders. The ability to perform the verification of transactions without a third party can lead to savings from increased competition, the absence of centralized control, higher privacy and censorship resistance, and the removal of single points of failure
As noted briefly above, blockchain systems leverage digital tokens to incentive the behavior of network participants. For example, mining nodes are incentivized to only accept valid transactions by the opportunity to win a pre-determined quantity of digital tokens for adding the next block to the blockchain. If a mining node propagates an invalid transaction to the network, they will not receive their digital token reward and the work they put in to win the opportunity to publish the next block goes to waste (typically an economic input is needed to win the right to publish the next block, thus the cost of an invalid transaction is an economic cost)
In addition to lowering the cost of verification via a strong incentive to only publish valid blocks, digital tokens can also be used to reward network participants for performing actions that accelerate adoption, which often can lead to increased network value. In blockchain networks digital tokens are purchased and sold by developers, contributors, users, and investors - aligning all network participants to work together toward a common goal - the growth of the network. The distribution of digital tokens to network participants helps blockchain based ecosystems solve the “bootstrap problem” - the problem that networks tend to only become useful when they reach a critical mass of users. Further, they allow for a more egalitarian distribution of success if the network does succeed. Today, in the rare cases where networks succeed, the financial returns tend to accrue to the relatively small number of people who own equity in the network. Tokens offer a better way by offering a broader distribution of ownership
As an example, in Web 2.0, centralized entities like Facebook, Twitter, Netflix, exists primarily to establish trust among market participants to allow the cooperation among participants. For example, Facebook does its best verify that all users are who they say they and monitor and police harmful behavior, without these services the network would likely not be a place users want to collaborate and it would fail to attain the desired network effects. In blockchain systems trust in the intermediary is replaced with trust in the underlying code that all network participants run and is visible to all network participants. The verification services that third parties provide in existing Web 2.0 networks are collectively owned and managed by the broader group of ecosystem stakeholders. This unbundling is similar to SaaS vs on-prem. The unlock of SaaS is that it unbundles the cost of ownership for the customer – ie software or computer code effectively removes the need for human capital to support the deployment and upgrades of the software, which makes the total cost of ownership lower for SaaS. In blockchains the cost of verification is outsourced to computer code and decentralization
Blockchains are also digitizing assets other than money. Companies that need to maintain a public record, such as holding land title, marriage, or birth records, are considering how their problem sets might be addressed by blockchain technologies. Blockchains also have strong potential for storing and recording supply chain records. A blockchain can record each step in a product's life, from when it was created in a factory, to when it was shipped and subsequently delivered to a store, and finally to when a consumer purchased it. There may even be new industries, such as digital notaries who can prove a person had access to a specific piece of information by recording the hash of it into the blockchain. There are many potential uses and opportunities for blockchain technologies
While the price of digital assets has declined materially, the technology is real. At this point in the cycle, the goal of companies and digital asset protocols is to survive. The companies and protocols that build value will have price charts that looks like Amazon in 20 years.
Who did what this month?
Hamilton Lane has appointed Victor Jung as head of digital assets. In this newly-created role, Jung will be responsible for developing and overseeing the execution of the firm’s digital asset strategy. He will oversee this strategy globally and report directly to Frederick Shaw, Chief Risk Officer and Global Head of Operations. Link
Celsius Network, which amassed more than $20 billion in assets by promising interest rates as high as 18% on crypto deposits, paused withdrawals this week citing marketing conditions. Celsius had invested users' funds in Terra, where it was hoping to earn more than the rates it was paying. Celsius isn't regulated as a bank and deposits aren't FDIC insured. Link. Link. Link. Link.
Elon Musk told Twitter employees he wanted to integrate crypto payments into Twitter more broadly. Link.
Crypto firms have laid off more than 1,500 people in the last 2 months, driven mostly by crypto exchanges. Coinbase laid off 18% of its workforce (roughly 1,100 people), Gemini 10%, and BlockFi 20%. Link. Link.
Japan's parliament passed a legal framework around stablecoins, saying they can only be issued by licensed banks, registered money transfer agents and trust companies. The bill did not address existing asset-backed or algorithmic stablecoins. Link.
ADDX has just completed the Pre-Series B funding round, raising $58 million to expand our strategic initiatives and include a new slate of shareholders: SET Venture Holding, a subsidiary of the Stock Exchange of Thailand (SET), United Overseas Bank (UOB), Hamilton Lane (NASDAQ: HLNE) and Krungsri Finnovate, the corporate venture capital arm of Krungsri (Bank of Ayudhya PCL).
May saw VC investment of around $3.5 billion in crypto startups - the lowest since last October. Twenty new crypto VC funds were also launched, including a $4.5 billion fund from a16z. Link.
Jack Dorsey and Jay-Z are launching The Bitcoin Academy at Marcy Houses, the public housing complex in Brooklyn. The academy will provide education on crypto, with an emphasis on bitcoin, through in-person and online classes. Link.