(January 10th, 2022)
A well-running business needs a strong value capture mechanism. This mechanism should also be adequately defended against encroaching competitors. For example, Google’s mechanism is advertising in search, and its moat has weathered many attacks over the years.
Every application of importance in Crypto has a value capture mechanism, although it rarely reaches outside of the in-crowd audience. Some of these also have a moat. The OpenSea NFT marketplace is a centralized example where its value capture is the fee for using it. Sushiswap is a decentralized example where its value capture is similarly the fee for using the exchange. In OpenSea, artists usually get a cut of subsequent sales; In Sushiswap, the corresponding artists are farmers who stake their capital so others can swap it back and forth. They similarly get a cut of the fee.
The cry that Crypto is a pox that cannot go away fast enough is usually supported by statements that there is marginal utility for end users, and that what utility is there would be better served with a centralized service + database. While we can establish value capture mechanisms across Crypto, from Olympus to Luna to Axie, what is actually being said is that there is no utility for users who are not already in Crypto. Consequently, the value, which is largely just different forms of money, is just being sloshed around in various scams. The captured value just goes to the early holders and then later ones are left with the bags. At some point, people will wisen up to this and then the music will stop. All of this is based on a reasonable interpretation that most people are in Crypto because it’s a giant casino and they will pull back when they realize they cannot win.
I have a different thesis that addresses in broad strokes where Crypto is useful (and where it’s not). In the rest of this doc, I expand upon that thesis and then at the end talk about why blockchains are the most plausible outcome of the utility that Crypto provides. The outline of this thesis / document looks like this:
- Assets are the Product in Crypto.
- Prior infrastructure increases the value of Assets; new Assets increase the value of prior infrastructure. This has a virtuous positive feedback loop on the space.
- The majority of end users will come when their off-chain assets are put on-chain. They will do this because the value proposition is / will be very large. Because then the system will no longer be rushing to add more assets all the time, it will have less impactful positive feedbacks, concluding the rush of crypto bubbles and bringing on a more steady world of yield. We are not remotely there yet.
This thesis points a finger at the tremendous amount of value locked in off-chain Assets that can be brought on-chain. The kinetic flurry of developers and capital bubbles we see today is because of the potential energy of that value. Everything appears so murky because most of the Assets aren’t available on-chain. As that changes, the fog of war will dissipate and all the value will accrue to those Assets and corresponding infrastructure.
Crypto’s original sin was Bitcoin the Asset. Its birth was the base case, and it truly did/does have product market fit (pmf). It debuted in 2009 on the back of worldwide QE and general monetary outrage, but also in the midst of tech literacy blooming globally. Into that environment came a product that was government-free and held a trust-less consensus mechanism for whom there were plenty of true believers. This was enough to get early adoption. A brief history was that first came the cryptographers and amateur economists (to understand Bitcoin), then came the libertarians for freedom (and Bitcoin), and then the dark web because it was considered more private.
It was also enough to settle into a pmf groove as Information Age Gold (but better) after a many-year shedding of other possibilities. Because markets assign a degree of value to Gold that’s tied to its hedging stature, this then gifts Bitcoin at least that much in value capture. Of course, it will take a long time to recognize that value but we see this playing out in the successive cycles of large market participants purchasing it for similar reasons.
Everything after Bitcoin was a blossoming of engineering that in hindsight is none too surprising. Where there have been assets in the past, there has been scaffolding to support those assets, e.g. the machinery for processing and holding real estate, or the booking systems and registers for cash sales. The tech after Bitcoin’s debut either support Bitcoin, e.g. the ASIC miner rush, or tried to build something better, e.g. Ethereum. Both of those directions created demand for more Assets. This led to Ethereum, to Stablecoins, to Art NFTs, etc. Each new Asset category required new scaffolding and infrastructure. With new scaffolding, it then became easier to build new Assets.
The reason you don’t see consumer products is because Assets are where almost all of the value has accrued, and most people just don’t have use cases for valuable assets.
Bitcoin is Gold, Cryptopunks are Picasso + Monet, Stablecoin is the dollar, and Monero is black market cash. The vast majority of people don’t do anything with their dollar other than spend it on things they value, and they aren’t buying gold bars. The frenetic energy in the rest of the space has mostly been scaffolding, which aren’t user products but in-baseball products, as well as games with mostly shitty gameplay. The present users have mostly come for the small stakes art scene because they can a) afford it, b) enjoy it, c) might make money / get a gambling high, and d) it can be an expression of their personality. Another stratum of users have come for the high stakes art scene in Cryptopunks, BAYC, and a few other catalogs.
Each of these Assets hold tremendous value. Look around and you see a Gold more fit for digital infrastructure. You see derivatives of Stablecoins (e.g. Luna or Frax) whose value is commensurate with the demand for the dollar. You see ENS, a service providing NFTs representing domain names, which have long been a fantastic Asset for value accrual. And you see similar art-based status games to those we find in physical assets, which we also know has value to those participants. In this light, it’s no surprise that so much art flooded the space because Art Assets are tremendously undervalued economically relative to their cultural value. By positioning them on-chain, the Asset is more likely to have its intangible cultural value accrue its actual economic value. This follows from all of the market machinery that has been developed, which makes these markets readily available and transparent.
Each of those Assets has required a certain amount of scaffolding before they were possible. In turn, each of them then suggests more scaffolding in order to interoperate with what came before. This pattern of interleaving Asset engineering and infrastructure engineering is tremendously important because it beckons the next wave of each. But it’s also important because it magnifies the value of everything that comes later with which the Assets and the scaffolding compose.
Ethereum was created on the back of Bitcoin and a recognition that we can engineer more composable experiences with Assets. Stablecoins, which relied on an Ethereum standard implementation, were created as a response to the volatility in the space to provide an Asset that could be traded without fear of loss (or gain) and to encourage more risk-adverse organizations that there will always be a quick exit to safety. Decentralized Finance, which powers a tremendous amount of the volume and liquidity in the space, was kickstarted by an experiment meant to boost the purchasing power of an Asset (COMP from Compound).
In all of these, the accumulated wealth of the prior generation enabled the next phase. And because each generation is layered on top of each other with the same open database standards, most of it is composable. I can use scaffolding from one generation to mint an Ethereum-compatible NFT on a completely different blockchain, then use scaffolding from another generation to bridge the token into Ethereum, then fractionalize it with a number of services, before selling half of the now fungible tokens on a decentralized exchange, and then storing the other half in a special multi-sig vault for a DAO I’m in. Those functions were not built with the others in mind. Later functions took advantage of earlier ones because they are fantastic composable operations on Assets.
With each additional valuable Asset, the entire space becomes more valuable because rent to use the functions flows through the whole composition. Prior infrastructure built for older Assets, most of which are worthless, proves to be useful for new Assets, some of which will be worth a lot.
Lay-people who aren’t trying to be in the Crypto Casino do not inherently care about those compositions or the existing Assets. And they shouldn’t because to them there is nothing of value in these Assets. Aside from Stablecoins, which can be backed by dollars, most every Asset today originated on-chain. Bitcoin is not actually gold and NFT art is not the actual art (99.9% of the time). My argument is that those people start caring when their valuable assets can interoperate with on-chain operations.
The user-facing products that break out to the majority of the public will be the ones that bring important off-chain Assets on (any) blockchain.
When people can put their house and their land on-chain, they’ll understand the value proposition. When people can put their loan payments on chain, they’ll understand the value proposition. When people can yield value for Assets they own that previously were not capable of being valued by the market, e.g. VitaDao in Longevity Research and Royal in Music Streaming Rights, they’ll understand the value proposition. We see an inkling of this with artists and NFTs. We also saw this with ConstitutionDao where an enormous amount of users came into Crypto for an opportunity that was unimaginable elsewhere, to collectively buy an important off-chain asset. We're all looking for a way to relate, and it can take time until the use case appears to make it personally appealing. The aforementioned adoption history of Bitcoin evolving from “cryptographers” —> “economists” —> “libertarians” —> “drug buyers” suggests as much, but so does the ensuing rush of artists and traders on Ethereum.
People will want to do this with their own Assets because a) they’ll get better yields, b) be able to fractionalize their valued goods and sell off a chunk on an open market, c) get up-front partial rewards for long-term royalties, etc. They’ll be able to interoperate with all of the scaffolding that’s been built for Assets, and that will make their holdings more valuable. Users care about that.
This will not be next year. We need to build a lot more still. We need projects like Burrata and Spruce that are providing identity services. We need off-chain loan books like Goldfinch. And we need IP licenses with legal muster like VitaDao and Royal.
What this also implicitly suggests is that Crypto / blockchain is a poor solution when there are no underlying Assets in your causal product chain. That’s why so many current efforts appear extraneous and likely to just wash away in the market aftermath. One explicit example are all the social coins that came about in the end of the last cycle spearheaded by Rally, Roll, Bitclout, etc. These were attempts to make economies out of digital reputation. Unlike art pieces, science endeavors, or music singles, that has never been an asset that has accrued market capital. Consequently, it has no grounding for its on-chain value and will dissipate in a downturn.
The argument laid out above is that we now have an engine for bringing Assets of every flavor into a space that grants them economic accrual. One question that remains is why did we need to do it with this clunky technology that has demonstrably worse characteristics as a database than the centralized ones we’ve been using for the past 25+ years (e.g. Postgres).
The simplest reason is just that the evolution of development was inspired by a different system, one which is a better fit for people’s trust. This quality is extraordinarily important when the dominant feature of the system is that it holds people’s largest valued Assets. Bitcoin provided the Big Bang that ushered in this era, and that era was built on its reliable mechanism for distributed consensus, which made it easy to find enough “true believers” to kickstart, invest in, and develop a digital currency. With that original sin in place, the ensuing snowball of kinetic energy blossomed with the mantra of decentralization and, at this point, the existing system provides so much value to new entrants that it’s challenging for a new one to supplant it.
That reason is not satisfying. It’s possible that in another world there is a centralized company that convinced everyone to host a series of Assets on its own relational database and also openly build applications on top of its service by offering monetary incentives. The closest we come to this is App Stores, which do the latter (sea of applications) but not the former (accessible Assets).
Note the genesis differences. App Stores are developed to host Applications, whereas most blockchains are built to host Assets. I struggle to think of any company whose centralized system was built to host Assets, and I see two main reasons for this:
- Regulation frowns upon building useful Assets. It labels them Securities and greatly restricts their utility.
- An Asset divorced from an Application is rarely immediately useful to anyone.
The result is that a company building an Asset is a) going to have a hard time attracting customers or funding and b) going to have a hard time fending off regulators. This all changes either if the government ordains that people use your service because they have another purpose in mind or if your technology is sufficiently obscure, advances sufficiently fast, and there is no organization to target. The former is WeChat or, more suitably, RedDate, and the latter is a decentralized blockchain “organization” which can reliably claim to have no database owners like they would in a Postgres setup.
This suggests a more satisfying reason - the solution set for Assets as Products were not visible for centralized organizations and their centralized tooling because of structural reasons tied to regulation and profit motives. After the blockchain’s debut, all the oxygen in the room for this need was directed there.
If something here hit a nerve, reach out to me on Twitter.
Thanks to Aditya, Dino, Jess, Ren, Rennick, Shazow, and Will for comments on earlier drafts.