Crypto Past, Present and Future

I ran the #1 fund in the world, up 495% in 1999, but still I couldn’t figure out how to analyze crypto.

Number Go Up? Or down?  Or?

• My friends ask me: “Are crypto tokens like stocks? What should I buy?”  
  

• My (boring old fogie) advice?  “First understand what you are buying.” Those that don’t often live to regret it.

I was dragged into crypto by my enthusiastic (and now wealthy) student mentees.  

“This can’t be that hard.” I thought.  “I’ve been a tech analyst for 25 years.”  

I read books and articles on “cryptoeconomics.” I felt lost.  

Why?

These books jump into analysis while I’m still trying to figure out: “What do I own?”

How can you start analyzing something when you don’t know what it is?

This post explores what these tokens are and what they might become.

Equity represents partial ownership in the value of the company. If the company does well and valuations hold, the stock should go up.

Often, tokens do NOT represent ownership.

Tokens represent participation rights in governance, decisions, validation of transactions (mining), health of the network, entry into communities. Some tokens such as NFTs (non-fungible, aka unique tokens) do represent ownership.

Why buy a token that doesn’t give you ownership?

Remember A Christmas Carol?  Ebenezer Scrooge definitely wouldn’t want to spend on anything, much less tokens where he didn’t understand what he was getting for his money.  Let’s take a page out of his book and ask some tough questions.

It might feel like Christmas if we crack this nut together.

Like A Christmas Carol, let’s approach this by looking at Christmas past, present and future, or in this case: Crypto past, present, and future.

• Past: how and why did crypto emerge?

• Present: what are different forms of tokens today?

• Future: what Web3 innovations might we see in the future?

Along the way, I’ll share questions you might ask to build your own understanding.

1. Crypto Past: Why (and how) did crypto emerge?

My quantum physicist friend Dr. Radhika Dirks says: 

“Revolutionary technologies start with 

(a) changed philosophy (triggered by an event), then 

(b) leverage science in a new way, resulting in

(c) technological breakthroughs.”

Change in beliefs → Find scientific solution → Create new technology

1. Philosophy: 

Trigger: 2008 financial crisis was created by a few rich bankers (and governments’ central banks), yet the aftermath was felt worldwide as people were thrust into a global recession.

How can we design incentives such that the greed of a few doesn’t lead to suffering of many? We can use math and cryptography (security created by math problems) to do business with those we don’t know or trust, through redesigning incentive systems and automating them in code.  We can distribute power instead of giving it to a few at the top.

2. Science: 

We have been thinking about incentives and war games for centuries, so what changed?

The 2008 financial crisis was a global failure of incentive structures.  Had science (our knowledge of cryptography) advanced enough?  Could we redesign financial incentives? 

Crypto seems new, but it’s not. 

Cryptography as a science has been around for centuries.  

Think war codebreakers, secret love notes passed in class, or pig-latin talk so parents can’t understand what we are saying.  As computers entered our lives, codes got programmed into software and their sophistication skyrocketed.

I attended Crypto 2018, hosted at UCSB (it should be a crime to make people sit inside in buildings right on the beach, btw!) by IACR, International Association of Cryptologic Research. IACR is 41 years old and even before that, cryptography was used to secure the Arpanet, the predecessor to the internet. 

When the financial crisis arrived and our collective philosophy changed on how we viewed our relationship with the financial system, the pure science of cryptography, honed over decades, was ready to support a technological breakthrough.

“Satoshi Nakamoto” (pseudonym of a person or group of people behind the Bitcoin whitepaper) said enough is enough!

3. Technological Breakthrough: 

Bitcoin, secured by SHA256 cryptography, allowed the decentralized transfer of financial assets where you could trust the ledger and transfer without knowing or needing to trust the person you were doing business with.

Trust in our global financial system was at an all time low, so we built a new way to build trust into the code and take it away from centralized powers.

Bitcoin, the token, has limited supply coded into it and is secured by the bitcoin network, what is thought to be the most secure blockchain network, thus called “digital gold”.

That’s Christmas…Crypto Past.  What about the Crypto Present?  What (or WTF) does a token represent today?

2. Crypto Present: Tokens today can represent a lot of things (that’s good and bad) 

Tokens are the building blocks of cryptography which secures a distributed ledger (database) that acts as a single source of truth. 

If this feels overwhelming, don’t worry. I’ve gone to hoards of conferences and worked in the space on and off for years.  It always feels overwhelming (yeah, not helping…), but it does get better, I promise!

Tokens can represent many things:

• Governance: Tokens can give you the right to vote, like shareholder voting rights. Tokens can separate this governance right from ownership rights, similar to different classes of voting shares in stocks.

• Community aka DAOs: Some tokens give you access to a community or DAO (Distributed Autonomous Organizations). Tokens are used for entrance and to pay active members for their contributions to the community.  

  • DAOs can be created to buy things, like the US Constitution DAO. 

  • Other Communities or DAOs give you opportunities to invest, learn, and earn.  

  • Some DAOs are set up like consulting service firms where you can bid on jobs.  

  • Unintended consequences abound with incentive experiments.  DAOs are no exception. Early participants in popular DAOs (where the token value increases) have been known to earn $50,000 per hour for basic coding.

• Money: Although Bitcoin and Ethereum are considered property by the IRS, both tokens can be exchanged for goods and services.  Square and Shopify allow stores to accept multiple cryptocurrencies as payment instead of credit cards. For a while you could buy a Tesla using Bitcoin.

• NFTs (non-fungible tokens) - One token is not the same, fungible, as the next. Tie the token to a unique asset which can be digital art, music, or a physical item.  NFT’s greatest innovation is incorporating programmable royalties into the token. Most of the time NFTs DO represent ownership.

• DeFi: Under the ethos of taking back finance from Wall Street, 0X asked if they could create a peer-to-peer network where people could come and trade tokens with each other.  It was challenging to find someone else wanting to trade the same token at the same time without using a central exchange.  DeFi solves that by creating pools of people wanting to lend, borrow and trade the same pairs of tokens, and it is considered “decentralized” because it’s controlled by a smart contract instead of people.

• Stocks: Oops!  Just when I told you tokens were not like stocks!  Here we are… For a real mind trip, you can tokenize stocks! There are mechanics and legal limitations to doing this, but consider a case where an exchange buys and takes custody of a share of stock and then codifies ownership tying it to a specific token (like an NFT). 

But, most of the time a token is NOT a share of ownership.

You may own your Bitcoin, but Bitcoin gives you the opportunity to use and participate in securing the bitcoin network (if you choose to mine Bitcoin).

You don’t own a share of the bitcoin network, you own a percentage of the supply of Bitcoin tokens.

To Navigate Christmas…Crypto Present… Ask these 3 questions and keep learning!

1. What does this token represent?

One of the great examples of unintended consequences of the network being different from the token was Ripple.

In 2017, the Ripple network was all the rage for its speed and use case for financial transactions.  One of the best parts of the network was you could use the rails and move money on it without ever using the token.  

The XRP token was out there but had no relation to its network, the ripple network.  

November 2017, I was walking along the San Francisco Bay with the CIO of Blockchain Capital, and speculators had rallied the XRP token 1000% in 30 days.  He told me the developers working on the ripple network became millionaires in months and walked out the door to go lie on a beach.  They lost half their engineering talent in 30 days.

No way to run a business!  

1. How does the token value change vs the ecosystem health (like a stock vs the company)?  Are they tied?

In DeFi aka Decentralized Finance (automated pools for trading and earning yield), people came into 2021 thinking they were playing one game, only to find out they were in the middle of another.

Know the game you’re playing.

DeFi exchanges TVL (total value locked, i.e. money in the exchange) has doubled, from $100 billion to $200 billion in a year.  So you would think the tokens that represent those networks would also do well.  

The token value of the largest DeFi exchanges has declined by 75-90% since summer 2021 while the size of the market increased 100%. 

What gives?

A bit like musical chairs for yield seekers, DeFi has turned out to be a game of the newest networks offering unsustainably high rates of return to attract investors into their pools, then once they grow in size, yields go down, and growth slows… Then that network’s token value declines as investors move on to the next high growth opportunity. 

1. Does an increasing token value hurt or help the health of the network? 

High ETH gas fees - the cost of moving ETH around the ethereum blockchain in order to transfer the money to the seller - means it could cost you $8 in gas to buy a $6 beer.   

Cute once, annoying the second time.  

Side note: If you think paying $8 in gas for a $6 beer is bad…check this out:

In 2010, Laszlo Hanyecz spent 10,000 Bitcoins at a local pizza restaurant called Papa John's to buy himself two pizzas. At $40K today, those two pizzas cost him $400 million!

Nonetheless, gas fees are a problem.

As ETH appreciates, the token price makes gas and minting (creating) NFTs so expensive. This decreases people’s ability to experiment. It’s only economical for those who are selling very expensive NFTs.  How is this inclusive? 

Programmers start designing things off-chain, on layer 2, to get around the flaws in the incentive design of the ethereum blockchain.

This is a signal…and not a good one.

People get excited over Layer 2 “solutions.”

Ask yourself: Why is this solution needed?

Understand how tokens and their blockchains interact, how their fortunes are tied together (or inversely related), and run scenario analyses in your mind (or in a journal).

Keep asking questions!  

3. Crypto Future… What could we build (if regulation was not an issue)? 

We’ve only just begun.  It’s EARLY!

Web3 is brimming with innovation and new ideas.  

Tokens can represent many things. What are the exciting things they could do?

1. Redesigning incentive structures and payment patterns

Many revolutions start as an evolution.  Bitcoin and reducing transaction friction by being able to trust the ledger, the transaction, without knowing or trusting the person you are doing business with is revolutionary.

Other concepts, like selling digital cartoons online via NFTs, are more evolutionary (though underpaid graphic designers turned millionaires may disagree with me here!).

The experimenting we are doing in Crypto Present will result in revolutionary financial products only possible with blockchain technology and cryptography.  Layer in AI and quantum… 

Imagine the possibilities of aligning incentives, customizing financial products for each individual person, like a hyper-local solution, and paying royalties and sharing royalties linked to incentives, not to centralized control.

2. Removing middlemen and friction to earning royalties

Speaking of royalties. Royalties coded into the asset are NFT’s greatest invention. Today those royalties match typical royalty structures (code pays the artist instead of the record label or agent).  It’s evolutionary because it’s the same system as before, just now it’s in code.

What would revolutionary royalties look like?

Could they be dynamic?  Could they have different payouts in different situations?  We have already seen IP broken out in different ways.

What else might we see? 

What can you dream up?

3. Linking previously unlinked financial markets

This one is personal for me.

I have worked with companies where parts of their business are registered with regulators, for instance money services businesses (MSB state licenses), but they are also participating in DeFi exchanges, many of which have no compliance programs.

Imagine if you will…

A regulator walks into a bar… nope… wrong joke!

A regulator walks into a company and the company says, well, over here, we have this compliant business, with licenses, Know Your Customer (KYC) checks, Anti-Money Laundering, and… over here, well, we are living in the wild west with none of that…

How do you see that playing out? (Me: not well…)

Leaders in crypto projects looking into their Crypto Future are faced with the choice: wait for compliance to catch up and get passed up by competition, or take a chance on regulation and race ahead to capture the market.

My dream is to create a Web3 Fabric.  

Why fabric? 

Fabric is created by weaving together multiple threads.  It becomes stronger than any one connection.  A Web3 fabric uses blockchain technology to build connections between past and future financial organizations and instruments.  Financial innovation can flourish across this Web 3 fabric.

• Web3 fabric would connect traditional finance with Web3 finance (DeFi and crypto exchanges) through a common language of compliance. 

• Web 3 Fabric would enable new financial products and financial collaboration can be built using blockchain technology to benefit clients of traditional finance while respecting the ethos of Web3.

• Web3 Fabric would simultaneously solve for privacy and transparency, so we can build new revolutionary financial products.

That’s my Crypto Past, Present and Future.  

What’s yours?