Wednesday, May 2, 2018

Core Cryptocurrency Use Cases

As a market driven investor, I am skeptical of 99% of the crypto projects under development today. That said, there are a core set of use cases with massive market sizes that cryptocurrencies currently fill (and in some cases will soon fill)[0]:

1. Store of value (SoV) & investment
A digital store of wealth such as bitcoin can have multiple advantages over traditional ones such as gold ($7 trillion plus asset), USD, art, or land. This includes seizure resistance (a badly acting government or thief will find it hard to steal) and ease of transport (cryptocurrencies allow you to cross a border with literally a billion dollars in your pocket or mind).

This use case is already a real one for cryptocurrencies and generationally many millennials view cryptocurrencies as a digital asset to own. The primary drawback to cryptocurrencies as SoV is their volatility, which should decrease with adoption, liquidity, and derivatives. Until volatility decreases cryptocurrencies will still be used as an investable asset and partial store of wealth. Many people are willing to trade crypto price volatility for security or avoidance of high inflation in unstable economic or political regimes (see e.g. Venezuela). Similarly, some governments may want to hold assets divorced from the action or whim of other government-driven currencies. This is a multi-trillion dollar opportunity.

2. Offshore capital: Private assets & payments
Over $20 trillion dollars are believed to be stored in the Cayman Islands and in Swiss bank accounts. These offshore accounts are used due to their discretion and privacy. Digital privacy tokens like Monero and Zcash will subsume this use case over time[1].

On a related but different note, privacy tokens may be well optimized for grey or black market use cases. That said, it should be possible to build a privacy coin whose primary use case is discretion of assets (Cayman Islands/Swiss accounts) versus nefarious purposes (buying drugs online).

3. Money wrapped in code: Securitization platforms & asset ledgers 
A wide range of assets in the traditional financial system are value wrapped in contractual code - for example a stock certificate (or electronic form thereof) is really just contractual ownership of future cash flows or value of a company. Similarly, escrows, titles, loans, mortgages, trusts, wills, and derivatives are all value wrapped in contracts. Contracts are really an analog form of code. Smart contracting platforms like Ethereum, or regulatory compliant approaches like Harbor, are going to take analog contracts and convert them to digital ones. We should see lending, options, hedging, and other aspects on blockchain.

The nearest term example of this are ICOs, with $5.6 billion in ICOs are thought to have been raised in early 2018. Many of the tokens sold in ICOs are ERC20 tokens based on the Ethereum smart contracting platform. This is the earliest large use case in the conversion of financial contracts into code running on a blockchain, as well as unlocking global 24/7 markets. Smart contracts today are most interesting in their ability to create massive crowdfunding markets for all types of assets.

4. Persistent digital goods 
Adoption of ERC721 based persistent digital goods is early (see Cryptokitties), but this area will accelerate in the coming years as traditional gaming talent enters this market. This market will be smaller then the three other markets above, but it will be in the billions of dollars in its own right. Example applications may include games, esports, collectibles, and eventually fine art.

In summary, there are multiple large, multi trillion dollar use cases for cryptocurrencies today as financial products to store wealth, to maintain privacy and discretion of assets, and to convert analog contracts to smart digital ones (money wrapped in code). Additional, a smaller but real use case exists in persistent digital goods on blockchain.

Are there any markets I missed? Let me know on Twitter.

Thanks to Avichal Garg and David King for comments on this post.

[0] Payments are an obvious large use case cryptocurrencies were originally designed for. Bitcoin and Ethereum are used to buy into ICOs or to transact on exchanges today, while Monero is adopted on some grey or black market sites. However, high scale payments for cryptocurrencies have not taken off yet.  Part of this is due to technical limiations (hooray for Lightning!), part of it is due to price volatility (hence the call for stable coins) and part of it is regulatory (tax code or other issues). I do think payments will be a major area in the future, however have focused this post on current or nearer term uses.

I also think a lot of crypto projects are too early today. More of the technology and infrastructure in general need to be built out. Just as the first internet wave contained ideas that did not work out in one form, that came back and worked ten years later in another form (e.g. Webvan and Instacart), crypto will have similar failures today that will be successful 10 years later as a new approach.

[1] You can also imagine e.g. integration of Bulletproofs, zk-STARKs or zk-SNKRs into bitcoin or other chains as well taking on this use case. For now it seems these may be different (but overlapping) use cases with different regulatory implications. There are also interesting new protocols like Grin and Signal is workin on Mobilecoin. This is an area to watch.