Blockchain on the brain and I can’t sleep.
There is a fundamental problem with the way I'm hearing blockchain discussed. I’ll be skipping over a lot of central aspects of the technology, so if you are unfamiliar, please check out the Satoshi white paper here, the Ethereum white paper here, and the Gnosis white paper here. These will give you a good starting point on blockchain fundamentals and what's going on in the current world of crypto currencies, although crypto currencies have been discussed since the 80’s.
Let’s start with the fundamental misunderstanding of blockchain technology solely as a currency. It’s easy to see why this would be the default perception (after all, the bitcoin white paper is titled “A Peer-to-Peer Electronic Cash System”). As early as 9,000 BCE, people were using grain for money, and over time money has been represented by a variety of objects, including shells, gold coins, and paper. Historically, people have looked to objects that are scarce, hard to replicate, and durable as a form of currency. Some forms of currency have had commercial use, while others have solely acted to represent value. For example, our USD is a piece of paper not good for much other than paying for stuff (see fiat currency). Silver, on the other hand, is useful for many industrial applications.
Blockchain is more like silver than fiat currency. If we believe that blockchain is inherently valuable as a building block for future business models, we should stop thinking of it simply as a currency, and more as a platform that is going to change the way we build all kinds of systems. Blockchain tokens represent the first time that a digital asset is able to exist in one place at one time, securely and with certainty. By thinking in these terms, I believe that we will be able to expand our view of the possibilities for what this technology can do. But how will these businesses get built?
ICOs in the house! ICO stands for Initial Coin Offering and involves the launching of a new token on a blockchain. ICOs certainly have the potential to change a lot about how companies get funded in the future. However, we should all realize that there are reasons for the SEC and their regulations around who can invest in private companies, the primary reasons being to protect individuals from getting scammed, and keeping them away from assets whose risks are tough to understand and can lead to bankruptcy. Typically, these private investments are restricted to qualified investors because rich people “can afford” the risks of potentially losing their money and should have (or can hire) the expertise to understand complex financial instruments.
Being a libertarian, I’m not a fan of protectionist regulations, but the rules were put in place for explicit reasons, and those reasons haven’t changed. A general best practice is for people to save the extra money they have in a combination of safe and risky assets in a measured way. Now, there is excitement about the ability for anyone to participate in ICOs, because at this time they are largely unregulated. However, if the only difference is that now any person can send crypto to fund / invest in an early stage company, that will almost certainly wind up being regulated in the same way investments are currently regulated. Yes, the ICO market is very hot and yes, some of these projects are getting massive amounts of funding very quickly, but let’s take a step back and look at the bigger picture.
Over the past few years there have been many individuals that have had massive windfall returns from their investments in blockchain protocols and specific tokens. Let’s use an example of someone using Ethereum (ETH). “Alex” bought $10,000 of ETH in January 2016 for $1 because he thought it sounded cool and just let it ride. Now, Alex has about $4,000,000 USD equivalent in his digital wallet and probably feels pretty good. But there are two big questions here: 1) where does Alex spend all this newfound wealth and 2) what about taxes?
Anyone close to the crypto space realizes that there is a liquidity problem. (This is less true for Bitcoin and Ethereum, but if you are looking to go down that rabbit hole here ya go.) Here’s a simple example. Alex bought his crypto using Coinbase and now has $4MM USD equivalent of ETH in his wallet. He wants to convert that to real USD in his bank account so he can buy some stuff. If he hasn’t done much to increase his limits, it could take him several months to get this money out. There are other ways to get more liquidity with BTC and ETH, but the point here is that illiquid markets create artificial damming of value.
The tax question may be an even bigger element of friction keeping value locked up in the crypto markets. If Alex were to liquidate all $4MM USD, he would need to pay taxes on the $3.999MM worth of gains. However, if he keeps it in crypto, he can postpone that taxation event to a later date, maybe indefinitely. So between liquidity and taxation, a lot of value is tied up in the crypto currency markets that would otherwise flow elsewhere.
Cue the market for ICOs. ICOs are a way for anyone to buy company specific tokens. These tokens can be used for several purposes: 1) a form of ownership in a company, 2) a form of voting, and/or 3) as a way to participate in whatever product, service, or application the company is offering. The first two sound a lot like equity, which I will discuss more later, but in regards to purpose 3, many players with massive illiquid returns carrying with them large potential tax consequences now have something to spend those returns on that provide additional upside and avoid triggering a taxation event, #WinWin. Because while turning ETH into USD can be tough, sending ETH is very easy. Just point a transfer at a wallet id and send away (Want to try it? Hit me at 0xE8d8c7bE6E9F5Ed7A3Fa7ceF090Bb5044c2735Bf ;-))
Jokes aside, it is my feeling that these returns are being spent more like lottery dollars than they are being used as investment dollars. When a person wins the lottery, they often spend that money in careless ways. Similarly, many people who have experienced these massive windfall returns and don’t have an easy form of liquidity are viewing these token launches as a way to put some of that value to work. The result is a heavily inflated ICO market on the back of the massive returns driven initially by the earlier protocol appreciation. The truth is that 90% of startups do not work out, as will almost certainly be the case with companies raising via ICO. I just want to echo a recent AVC post and say, “Be cautious.”
Enough doom and gloom. Tokens are great and going to totally change the world we live in. Also, this massive shift of value through ICOs is going to fuel many incredible projects that will pave the way for future companies. One in particular working on the liquidity problem, for example, is Omega One.
While I’ve spent a lot of time talking about what’s going on in the ICO market, the point I really want to drive home is that crypto tokens on top of blockchain technology represent a fundamental advancement in technology. It is the first time a digital asset can exist in one place at one time with certainty, and while this has led to tokens being viewed and used as a currency, that is a narrow application. There are so many things that this will change- the way games are built, the way media is stored, the way personal data is monetized (anyone working on this?) are just a few initial targets, with many more left to be discovered. My hope is that by expanding the perspective of this technology, we start developing truly revolutionary ideas that will change the world for good.
This is not a new pattern. Early radio hosts just read the newspaper out loud, and early movie stars performed as if they were still on a stage. The problem with a new technology is that typically, the first move is to push old models on top hoping to make it better, but true innovation comes when we can see the technology for what it is and what it will make possible that before was impossible. One method I use to do this is an innovation chart.
It’s simple. Write a list of old industries on the top and then list new technologies on the side. Then assess where they intersect and what opportunities that might unveil. For example, if you put something like cell phones as a new technology and maybe something like yellow cab as an old industry, you could arrive at an interesting place.
This is a space I'm spending a lot of time in and am always interested in talking to entrepreneurs working on cool projects, so please reach out!