Source: Calvin & Hobbes - Bill Watterson
September 16, 2021
“Crypto solves nothing for me. Why should I care about decentralization?” I hear this critique from friends and family in the US all the time. And the simple answer is: crypto does very little for you right now—most of your problems are better solved via centralized solutions provided by centralized entities. The more complex answer is: crypto’s efficacy for a user is a product of his or her circumstances.
Blockchains do not yet truly touch Main Street, so to speak. But at first, neither did the mobile phone, the internet, the PC, the steam engine, nor more literally, the passenger car. The Internet and passenger cars were dismissed as frivolous obsessions, only to creatively destruct barriers to societal advancement.
Most era-defining innovations enter society looking like expensive toys. The rarefied trinkets usually come from upstarts who have the luxury of scrutinizing the system objectively. A privileged cohort of users tinker with the toys, improving their speed, cost, and versatility slightly. Changes to external conditions raise the incentives for broader groups to try out and eventually adopt the new toys. Finally, a threshold is tripped and the innovations diffuse from early adopters into society. No longer a toy, these technologies form a new substrate for a generation of entrepreneurs to build upon.
CalvinBall: How Era-Defining Innovations Change the Rules of the Game
In hindsight, we recognize the significance that the Internet and passenger cars had in advancing society. It may be less obvious why each unlocked so much value. While the Internet and the passenger cars increased freedom and productivity in and of themselves, both more seminally established better standards for activity. Behind each were new protocols that others could build on top of, or compose.
The internet protocol suite (TCP/IP) standardized how data would be packaged and transmitted digitally. Because it made the exchange of data quicker, cheaper, and more convenient, the Internet expanded the design space for innovators. By leveraging common rules for exchange, smart phones, social media, e-commerce, and online banking were conceived.
The assembly line, another suite of protocols, forged better industrial standards and used specialization to enable higher output. It was within these protocols that Henry Ford’s true genius laid. The assembly line made possible the Model T, the first mass-market passenger vehicle. Trucking, automation and mass-production of consumer goods eventually followed. A stacking of the protocols for the internet, personal computing, and automated manufacture set the bedrock for hyper-globalized trade.
To change the rules of the game is to deviate from the tacit equilibrium that had settled. Humans are hostile to wholesale changes to the code of conduct. Initially, the Internet was dismissed as vice while the assembly line was considered misanthropic. People grow accustomed to existing systems—they are a product of them. Only a genuine improvement to the status quo has a chance of becoming the new normal.
Disruptive technologies redefine standards for exchange. These new sets of rules encode better incentives, expand the range and speed of combinations, or are more easily enforced. When a better set of rules is unlocked, there’s no going back.
From Common Law to Code is Law
Common law established and enforced property rights for individuals and eventually businesses. This was a better arrangement than the previous one, where one’s property was at constant risk of seizure. Having established this protocol for physical ownership, individuals could live more densely and exchange value more freely. “Society” as a structure for human existence was unlocked. Anchored by strong property rights, trust-based agreements lowered the transaction costs for trade. These contracts have made up the backbone of economic activity ever since, but their cracks are beginning to show. All it takes is black swan event for a contract and the trust it relies upon to shatter.
Just as common law bolstered value and unlocked economic combinations in meatspace, blockchains will do the same in cyberspace. The laws of blockchains, or consensuses, will govern how value will traverse internet rails for the next few decades.
Blockchains are typically described as trust-less ledgers. They allow individuals to exchange digital value with little risk of censorship or blockage. Because blockchains are unalterable and maintained by a decentralized network as opposed to a single party, they act as a more robust source of universal truth.
Crypto-economic networks still require trust, but they require less of it. Trust is directed more towards code, and less towards single counter-parties. Software remains unbiased and un-tempted to renege, even when conditions turn chaotic. The bias of the engineers who build it is easily checked. Web3 code is auditable by anyone. By incentivizing long-term cooperation between economic agents, blockchains make even vaster economic activity possible.
Crypto radically simplifies triangulation, transfer, and trust. As Coase details in the Nature of the Firm, corporate models are a solution to these three transaction costs. As transaction costs fall, so too does the rationale for using corporate intermediaries—middle-men who control and charge for access to goods and services. If an individual or business can represent value on-chain, another individual anywhere with a mobile wallet can initiate an exchange of value instantly and at almost no cost.
Crypto, like the Internet, the assembly line, and common law forms a bedrock for innovation to flourish. Some of the smartest, most curious people I know are exploring how to use these new rules to alter the course of humanity.
The First Domino: Why Crypto Tackled Finance First
Crypto put finance, both public and private, in its cross-hairs first. Decentralization disrupted the financial domain before tackling other areas because it was the most explicitly perverted and archaic. Satisfaction with incumbent financial institutions, public and private, was already so low that users were especially willing to experiment with the new “toy”.
Argentinians, Brazilians, and Venezuelans have been plagued with unsavory monetary and fiscal policies for decades. For much of recent history, South American workers and businesses could not opt out of earning or saving in an inflating currency. If a better store of value were to materialize, they would presumably jump on it. Bitcoin and Ethereum showed up, and so they did.
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Shifting the focus to broader financial services, global savers and investors have grown deeply resentful of “digital” banking and trading. And for good reason. They’ve had to endure pitiful customer service and several breaches of trust. The infrastructure of dollar finance, Swift and ACH, has its roots in the 70’s. It is slow, clunky, and expensive. The spectre of the financial crisis looms—institutions act in good faith until it's not in their interest to do so. Robinhood, for example, has been guilty of unilaterally suspending trading. Whether this episode was driven by preferential treatment of key clients or by genuine liquidity constraints, customers were left holding the bag.
DeFi, or decentralized finance, completes the mission that FinTechs started. FinTech upgraded the front-ends of financial services without addressing the warped plumbing and incentives of legacy banking. DeFi disassembles and rebuilds the entire stack.
Decentralized protocols like Uniswap, Sushiswap, and Raydium enable those with crypto wallets to trade tokens non-custodially and without counter-party or censorship risks. MakerDAO allows any user to instantly take out loans collateralized by crypto assets. Aave is a trust-less money market where users can borrow or lend crypto assets. Synthetix and Drift Protocol offer ways to trade synthetic assets and derivatives 24/7. 185B USD, the total value currently locked in decentralized finance, will seem cute in hindsight. A cornucopia of better, faster, cheaper, and less vulnerable financial services sits in the wings of the crypto stage.
In my view, the forest of DeFi has been missed for the trees. This is because much of the contemporary activity on DeFi is self-referential and rarefied. For normal users, yield farming and liquidity mining are difficult to understand and even more difficult to participate in. Such speculation feels exclusionary and intimidating. I implore you to put aside the noise and focus on the first principles.
A fairer and more open financial system has life-changing implications for individuals and businesses operating in the real world. As my readers will know, it is here at the intersection of main street and crypto that I am most interested, personally and financially. Just as the internet is now inextricably woven into your life, so too will crypto be.
Crypto’s Mainstream Wave Starts as a Consumer Ripple
The internet democratized information. Crypto democratizes value. To execute this transition, crypto:
A) Lowers transaction costs between buyers and sellers, resulting in more exchange
B) Unlocks untapped value in existing goods, services, and assets
C) Enables the creation of completely new products and services
As value increasingly shifts on to commoditized crypto infrastructure, we will witness the financialization of everything. With broader options for capital raising, consumption, connection, and wealth preservation, each and every one of our lives improve. Consider the following transformations, some of which we will investigate more thoroughly:
1. Real Estate: The world's largest asset class is atomized and traded on-chain
2. Fractionalization: Real assets are fractionalized: land, cars, art, wine, and watches
3. Fundraising: Creators raise capital through crypto markets, tokenizing assets, communities, and future earnings
4. Insurance: Autonomous contracts, informed by oracle networks, bridge the uninsured
5. Human Capital: Digital guilds assemble human capital more effectively
6. Profit x Creativity: Passions like art and music become asset classes
7. Media: Content is hosted on decentralized networks; creativity is un-censorable
8. IoT: The IoT revolution kicks off as low-power, wide area connectivity proliferates
Real Assets: Un-gating Communities Via Tokenization
For most people, a home represents the single biggest portion of their net worth. It is the investment upon which the American dream hinges. But the home is becoming an unattainable vestige of our parent’s generation. Ownership is concentrating. Pension funds, designed to protect retirements, are now undermining them. With funds and other huge marginal buyers in the housing markets, home prices are at all time highs. Many have asked: are millennials the rental generation?
Just as the index fund invited average citizens into the stock market, fractionalization will welcome broader participation in hard assets. For the most part, real assets trade binarily: either completely or not at all. This paralyzes the asset class. Via tokenization, the world’s largest global asset class will be sliced up into bits and traded in real time like stocks and bonds. It’ll start with the simplest assets and scale.
CurioInvest has fractionalized collector cars through issuance of fungible tokens on Ethereum. Single-family homes will be fractionalized into liquid tokens that entitle holders to residency and/or cash flows. MakerDAO and Centrifuge bring real world assets like mortgages, trade receivables, consumer loans, and renewable energy projects on-chain. Buildings, infrastructure projects, and agricultural projects will enter the fray. This transition drastically increases the liquidity of these assets. Soon individuals who’ve never laid eyes on London will own slices of High Street retail.
Tokenization unlocks untapped potential within real assets. Crypto markets infuse traditionally illiquid assets with new dynamism. By releasing trapped value, crypto invites anyone with an internet connection and wallet to store wealth in previously inaccessible assets.
Supercharging Entrepreneurship
Entrepreneurship, defined broadly as creation, has been historically constrained for a number of interlinked reasons. To start, creators either need to self-fund (expensive, risky) or bring on value-add investors, with few middle-ground or alternative options. Unfortunately, poorly chosen investors can dilute the equity and the overall value proposition. As normal consumers and investors, the extent to which we can invest at early stages is surprisingly limited. Public bonds, equities, and to an extent, hard assets are on the menu for us. But for the most part, we can’t really invest in our interests. Our passions and our portfolios remain mostly divorced. A new kit of financial primitives, underpinned by blockchains, allows us to simultaneously invest in and contribute to the communities and rituals that give our lives meaning.
Non Fungible Token Raises: A New Model for Product Incubation
Venture Capitalists are primarily focused on technical projects, leaving stranded alternative creators like athletes, writers, game developers, film producers, content creators, and artists. This is probably because these niches are less intrinsically “productive” and thus more difficult to estimate the economic success of.
For artists and musicians, the only route to monetization has been via an intermediary with strong distribution (remember Coase). Such arrangements can be exclusionary, costly, and dilutive. Entrepreneurs in these domains remain underfunded and betrothed to rent-seeking middlemen like art galleries, game studios, music streaming services & record labels, and movie production companies.
Artists were the first to leverage NFTs to circumvent galleries and art dealers to monetize their passions directly. Using marketplaces like Opensea and Rarible, artists market their art, retain a larger portion of primary sales proceeds, and earn a slice of secondary sales in perpetuity.
As investors/supporters, we can support artists directly and browse an infinite trove of digital creations. Artists may encode non-monetary privileges within the NFT, such as exclusive access to events or the opportunity to collaborate directly. Compared to physical assets, NFTs are more liquid and far less costly to maintain and protect. Once custodied, we may fractionalize our digital assets and sell fungible interests on the open market. We may soon be able to use our digital collectibles as collateral for on-chain loans.
This model is clearly better: more fair to and lucrative for creators, more capital efficient and convenient for buyers and speculators. Galleries are obviated by open digital markets and appraisers are obviated by the embedded provenance and ownership that non-fungible tokens provide. From here, it is only a small jump to go from using non-fungible tokens to sell finished masterpieces to using them to fund future masterpieces.
Securing the Bag: Marrying Profit and Passion
The creators behind Ethereum: The Infinite Garden, a film that intends to explore Ethereum’s ecosystem and implications for the future, recently funded itself entirely on-chain. It managed to raise 1,036 Ether (roughly $1.86MM at the time) from 600+ backers. Large backers earned non-financial privileges like features in the credits and exclusive NFT artworks. If the film is successful, the value of these NFTs will readjust accordingly, rewarding those who funded the early vision. Things get even more interesting when we consider how NFTs can be embedded with direct cash flows. This can take two forms.
Bond-Like NFT: An existing product with an expected stream of cash flows can be tokenized and sold into investor’s wallets. These investors are entitled to the forthcoming distributions.
Equity-Like NFT: A teaser NFT can be sold today and embedded with network ownership, access, or rights to potential future sales. The proceeds from the NFT sale go towards the exploration and development of the ultimate project. As soon as the artist monetizes the final product, the pro-rata proceeds would be automatically diverted towards those wallets who initially funded the project.
Royal, a new initiative contrived by EDM artist 3LAU (Justin Blau) and JD Ross, plans to roll out both. 3LAU was the first artist to tokenize an album, netting $11MM across 33 NFT sales. Royal will enable supporters to bet on their favorite musicians’ music. As those songs slot listens on streaming services, a portion of the royalties flow to the NFT holders. As current and expected future royalties fluctuate, so will the face value of the NFT. Upon regulatory exploration, Royal expects to offer NFTs that fund future recordings as well. Sales of these equity-like NFTs would function as a seed round for a music startup.
Source: nft.3lau.com, First Tokenized Album, 33 NFTs sold for a total of $11.6MM
Enjoying and sharing music is innate to human beings. We like to be the one who found the next breakout artist when he or she was still emerging. Music gains popularity as taste-makers initiate its diffusion into society.
“I always tell people that artists’ popularity is completely dependent on the fans and the listeners, not the companies and the distributors. If the fans like the music, they share it, they go to the shows, they're fully responsible for augmenting an artist’s popularity.” - Justin Blau
But the upside to taste has thus far been purely social. Royal enables audiophiles to be overture capitalists, profiting directly from their ears. With millions of listeners expressing their tastes via the tokens they invest in, quality is rewarded and perpetuated, bringing us better music than ever before.
The collective feedback of an entire market of passionate users is wiser than that of a few eminent arbiters. Crypto encodes this axiom into a practical and guiding reality. Entrepreneurs, in a race to build a minimum viable product and collect feedback from their users, can now garner feedback from either VCs or their impassioned user base, or both. Fundraising, like any economic activity, changes shape as the predominant tech does.
Gaming: How a Community Ownership Transforms the Sector
Star Atlas aims to be the first AAA strategy and political domination game built on a blockchain. Unreal Engine 5 and the Solana blockchain are used to enrich gameplay and support an open economy, respectively. The developers have raised small seed rounds but have mainly funded via non-fungible and fungible token sales directly to the community. NFTs sold include posters and future in-game assets, like ships, characters, and access passes.
Source: Star Atlas, Advanced Mining Town: A new day in the deep space mining town. It’s a new world, a new life of prosperity for yourself. Deep underneath the surface, you are on the hunt for the precious minerals powering galactic trade.
The fungible tokens sold, $ATLAS and $POLIS, are the utility and governance tokens of the Star Atlas universe, respectively. Instead of issuing additional interests to VCs, Star Atlas has distributed ownership of its universe to the community most likely to actually play the game. This allows for a very organic and symbiotic interplay between developers and user-funders. Further, if the development team has a lengthy token vesting schedule and the community of token holders have skin in the game, everyone in the Star Atlas ecosystem is incentivized to build value over the long term.
Star Atlas and Royal unleash a novel dynamic on us gamers and listeners. We might be power-players of Fortnite or Roblox, but both games leave community ownership largely unexplored. Star Atlas, Royal and the succession that will follow allow us to own our passions. We will fund and help build features that we like, pursue profit, and liberate creators to produce with fewer shackles.
Thus far we’ve focused primarily on how crypto will affect consumers, but have not discussed how businesses stand to benefit.
What Stalled the IoT Revolution? (And How Crypto-Economics Is Jump-Starting It)
Within the graveyard of much-anticipated technological revolutions that failed to materialize, the Internet of Things rests in a cavernous mausoleum. Crypto-economic networks provide precisely the incentives needed to revive IoT’s initial promise. The logic presuming the significance of that transformation was sound: if we can equip things with intelligence, we can translate the data these things generate to save time, energy, or other resources.
Imagine a marine wind farm off the east coast of Scotland, with thousands of turbines accessible by boat. The farm generates heaps of clean energy but is relatively inefficient to maintain. At any given time, no one knows which of the turbines is depreciating or to what extent, so operators must check them all routinely. If only the turbines were equipped with sensors that detected which turbines were damaged and the nature of the damage. Instead of sending an entire fleet out every three months, then, the wind farm operator could send single boats with replacement parts to precisely the turbine in need of repair. The through-line: if rolled out successfully, an Internet of Things would make wind farms and a bevy of other business activities significantly more efficient, which would in turn shift us to renewable energy sooner, would make goods more affordable, and would reduce waste in the system.
Sensors like the wind turbine ones already exist, and they are affordable. They provide granular and actionable information on environmental conditions and the statuses of machinery and equipment. So why aren’t businesses reaping the benefits?
The answer lies largely in connectivity, or a lack thereof. A network of sensors is only as valuable as its connection to those who can act on the data generated. 5G connectivity is accessible only in high-density areas because it’s unprofitable to create 5G hotspots in low-density areas. 5G hotspots also require a lot of power. Bringing in enough requires either a grid connection, which is impossible in very low-density locations, or a large battery. For a remote sensor to be useful, then, companies in low-density areas–-like the Scottish wind farm–-need to build an expensive hotspot and manually recharge, and occasionally replace, its battery. We have a classic chicken-or-egg problem: incumbent telecoms have no incentive to expand their coverage into low-density areas because there aren’t yet enough IoT devices to amortize the costs. And there is no incentive to equip things with IoT sensors because there is no infrastructure to transmit the data.
As we’ve suggested already, crypto-economic systems might solve this problem. Beyond the obvious value of immutable public ledgers and cryptography, crypto-economic systems will actually unlock new incentives and monetary policies to re-start the IoT engine.
As one example, Helium Network, or the People’s Network, is a decentralized wireless network composed of LoRaWan (Low Power Wide Area) hotspots. These hotspots are deployed by independent agents seeking to earn HNT, the network’s native crypto token. “Mining” rewards are earned via proof-of-coverage.
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Helium remunerates early providers handsomely in order to shift the network out of neutral into first gear. As the network provides more and more value, users will more and more readily adopt it. And as paying users enter the fray, the profit incentive to coverage providers increases, ensuring the supply of coverage. As the network scales, $HNT rewards to providers taper because (a) the risk inherent in providing coverage to the network declines and (b) IoT users will begin to spend data credits on coverage. (c) as the network grows in value, presumably so will the token
Helium currently provides connectivity across 171,000 hotspots and on most continents. A cascade of economic activity will follow. Companies will, en masse, equip their supply chains, equipment, and vehicles with sensors connected to Helium. CFOs will more accurately estimate costs and more efficiently manage working capital. Insurance companies will have access to better data and can more efficiently and broadly underwrite policies.
Decentralized services, made possible via crypto-economic incentives, will fill the gap left by institutions trapped in the Innovator’s Dilemma. (Why take risks on new initiatives when existing business lines are quite profitable?) People and businesses are not irrationally failing to create opportunity, they are just responding to the predominant economic incentives of today. But incentives are changing. Compared to traditional business and capital markets models, crypto-economic systems can more effectively jumpstart network effects. By subsidizing early providers of a network’s services with a token that may increase in value, protocols like Helium solve the chicken-or-egg problem. Networks, aligned on shared tokens, will catalyze a technological revolution of a magnitude greater than that of the Internet.
New Rules Change the Premise of the Game
Zoom out. What looks like a series of new toys is actually a larger, more dynamic sandbox. A public ledger is the omniscient chaperone, demanding that everyone play nice. Instead of stealing each other’s blocks, the kids are impelled to build together.
Consumers and businesses are invited to play a completely new game. Crypto might scare you, or it may interest you, or maybe you’ve already started playing. Either way, a rubicon has been crossed. Applications on blockchains will only continue to proliferate. They’ll start esoteric and clunky, but grow approachable and convenient.
In the next decade, I believe crypto will touch each and every one of our lives. First gradually, then all at once.
Disclosures: I contribute to MakerDAO and own Centrifuge (CFG), Aave (AAVE), Synthetix (SNX), SushiSwap (SUSHI) and Helium (HNT) tokens.