Monday, July 31, 2017

Cryptocurrency's Netscape Moment

Just as Netscape's IPO marked the real kick off for the Internet era, 2017 will be the starting gun for broad involvement of venture, hedge funds, and eventually average consumers in cryptocurrencies and related protocols and assets.

The recent run up in cryptocurrency valuations has caused a sudden and profound renewal of interest by entrepreneurs and investors in crypto[1]. In December 2013 there was a similar spike of interest in Bitcoin. As the time, there was a 10X run up and Bitcoin hit over $1000 and then crashed to ~$200. While the excitement in 2013 was largely transitory, this time feels different [2].

So what has changed?
There are multiple reasons why now is crypto's "Netscape moment":

1. Value store (AKA gold replacement) use case is becoming real.
When Bitcoin first launched, it was shrugged off as a toy. When each BTC was worth 25 cents, people would send them to each other as a novelty.

Recently, Bitcoin has emerged as a legitimate gold alternative and a hedge against the volatile times gold is often associated with. I have heard from multiple hedge funds that they have not seen the price movements in gold they have expected in "flight to safety" situations in the last 6 months. Instead, bitcoin has moved in step with what they previously expected gold to do. Bitcoin is slowly assuming the digital version of the role that gold (and gold company stocks) used to play for hedging strategies. One big impediment to BTC adoption as a large scale gold alternative is of course its own inherent volatility.

There are increasing numbers of anecdotal stories of families repatriating money, or people traveling across borders, with bitcoin. It is the only asset you can store in your brain and traverse borders

Just as there are other precious metal value stores beyond gold, there are other cryptocurrencies that are emerging as the potential silver and platinum of the market. Current contenders include LiteCoin, Zcash, and Monero [3].

2. New blockchains, technologies, and applications are emerging - growing the crypto market.
A few years ago BTC was the only game in town. While great as an asset store, BTC had a number of limitations that made it harder for developers to work with as well as limited its applications. For example, it has a hard to work with scripting language which is not Turing complete. BTC was purposefully designed with limitations that allowed it to function effectively as a value store.

Ethereum overcame a number of these limitations by providing a javascript-like scripting language which is Turing complete, as well as positioning itself as a distributed general-purpose computer, versus a distributed currency. Ethereum allows a number of more complex applications to be built on top of it. One of the primary applications of Ethereum's smart contracts is its ability to power a lot of other tokens and ICOs[4].

At this point, the argument is being made in the crypto community that any highly distributable, compute- or micro-payment based commodity should be able to be turned into a tokenized protocol. This would include things like compute (Ethereum), storage (Filecoin - a cryptocurrency with proof-of-reproducibility and proof-of-spacetime versus BTC's proof of work) but also items like power grids, wifi, and the like.

This wealth of new crypto protocols, applications, and tokens as well as newer cryptocurrencies like Litecoin, Monero, and Zcash, has driven recent developer and investor interest. In the Internet analogue, Mosaic and then Netscape allowed easier access to the Internet enabling a new class of startups (Google, Amazon, PayPal), but also a new set of developers to engage and build applications millions of people could access. Similarly, BTC's white paper and codebase has led to a whole new set of crypto projects with their own use cases and applications. While many of these have yet to be proven out, there is a lot of room for this technology to be applied.

3. New ways and infrastructure to monetize and raise money for crypto technology.
Ethereum smart contracts[6] enabled new crypto projects to crowdfund tens of millions of dollars to fuel their development and growth. These token sales are often implemented as smart contracts running on Ethereum. The ability to raise tens of millions of dollars in non-dilutive capital via an ICO (Initial Coin Offering) means that (a) some crypto efforts can avoid ongoing dilutive venture capital, (b) crypto efforts may be monetized quickly and (c) we are likely to see a fair amount of speculative investing and potentially abuse of these instruments (See SEC early response here).

The ability to raise non-dilutive capital, and in some cases cash out early, will drive a gold rush mentality as well as a fair amount of financial speculation. Coinlist is an interesting new tool in this area.

4. Outside of crypto and ML, there are few good entrepreneurial markets right now.
Every technology cycle include a period of mass focus on a handle of key areas (social, mobile, machine learning etc.). Some of these movements result in massively outsized companies (Facebook, Whatsapp, Twitter, Instagram, LinkedIn, Uber, etc.) and others fizzle out (location services, nanotech, energy 2.0). As we end one investment/entrepreneurial cycle there is often a gap in clear areas to work until the technology world hits on the next interesting area. Right now there is a major lull in mainstream software innovation. 

Given a dearth of alternative interesting large-scale markets and technologies to work in, entrepreneurial activity has accelerated in this market.

5. Some people got rich [7].
Cryptocurrency stands out as an area of interest in part due to all the people who suddenly made a lot of money in the price run up of the last 6 months. As people make tens or hundreds of millions of dollars, entrepreneurs, investors and press take notice. A lot of people are going into crypto out of ambition, greed, or simply because it seems increasingly de-risked due to ICOs and price rises.

6. Capital inflows.
We still live in a low interest rate world, with few good places for investors to deploy capital. While most institutional and consumer capital has been sitting on the sidelines for cyptocurrencies, it is now easier then it has ever been to buy and store these assets thanks to companies like Coinbase/GDAX and Kraken. Increased ease of trading in turn has driven recent adoption on a global basis.

To date, institutional investors and hedge funds have largely stayed on the sidelines. In part this is due to a lack of tools for institutions to invest and hold crypto. It is also driven by the conservative nature of most of these investors, with Abigail Johnson from Fidelity as a notable counter. Once large institutional investors inevitably move off of the sidelines and into crypto, there will be a large run up in valuation of currencies (and given the lack of savyness, probably a bunch of crap tokens will also get temporarily expensive too - see e.g. last internet bubble).

With the recent run up, over a dozen crypto hedge funds have been founded[5] since Metastable. This incremental capital coming into the industry should make the recovery from the recent crypto crash occur much faster then in 2013. However, if the past is any guide to the future, it is highly likely there will be at least one or more major corrections (e.g. 10-90% drop) in crypto prices on the way up. It is going to be a volatile and bumpy ride.

Cryptocurrencies are having their Netscape moment. Unlike December 2013, this time there is sustainable entrepreneurial and investor interest. Bitcoin has started to prove itself out as a gold alternative. New protocols and blockchains are driving a burst of innovation as well as ease fundraising via ICOs. A lack of non-crypto entrepreneurial opportunities is also driving people in. While there is a long way to go to prove out many non-currency applications, this technology and its implications are here to stay.

Thanks to David King and Avichal Garg for commenting on drafts of this post.

[1] There are of course those who have been bullish for years now, like Naval Ravikant, Fred Wilson, Chris Dixon, Balaji Srinivasan, etc.

[2] As a random aside, I think if Satoshi Nakamoto had been a more traditional public person or founder, crypto would have been embraced by the investment community more quickly. Absent a public figurehead to run on the cover of Fortune, crypto took longer to catch on with investors than it might have.

[3] Litecoin differs from BTC in that it is memory-hard proof-of-work versus BTC CPU-hard proof-of-work approach. Zcash and Monero have extra aspects of anonymity that differ from BTC.

[4] Ethereum smart contracts have been abused in the past, leading to the split between Ethereum (ETH) and Ethereum Classic (ETC). (Hint: if you hold one consider ETH. By the way, none of this post is meant as investment advice. I am a naif in this area so do your own research.)

[5] Although a number of crypto teams are still raising seed rounds and or SAFTs to fund initial white paper design and eventual build out.

[6] The fact that many token sales are via Ethereum smart contracts is one reason ETH value has grown rapidly.

[7] This definitely seems to be the biggest driver of new VCs entering the market.

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