Blockchain VC @ Sustany Capital
The largest opportunities for profits are frequently found at the introduction of new disruptive technologies. An often-cited example of this observation is the emergence of the internet and consequent emergence of the World Wide Web, which created some of the most notable investment opportunities in recent decades. Companies such as Google, Amazon and Facebook turned hundreds of their employees into millionaires and made billionaires of some of their founders and early investors.
While entrepreneurs and analysts will frequently point to parallels between blockchain and internet solutions — and might even refer to blockchain as “Web 3.0” — these references are often limited to the aforementioned standout examples. Or, conversely, they might quote then-Federal Reserve Board chairman Alan Greenspan’s statement on the “irrational exuberance” displayed by investors allocating to internet companies. The following analysis aims to provide a more nuanced perspective for discerning capital allocators.
At its core, the internet is a network of distributed computers connected by open-source technologies. A standard set of programmatic rules — protocols — enables electronic devices to nearly instantly exchange data. Email protocols drastically curtailed the need for printed communication and stamp fees. New audio protocols enabled free communication, all but ending minute-metered phone communication. And internet protocols allowed new entrants to disrupt the business of newspapers and publishers, heretofore limited to the distribution of information in print or through costly broadcasting equipment.
As the capacities for digital distribution over internet protocols grew, so did their use cases: Video distribution followed music sales over the web in pure digital form. This first caused record stores to close and, as bandwidth increased further, led to the demise of video-lending storefronts, such as Blockbuster.
While blockchain-, and graph based solutions, in principal, work in much the same way as internet protocols, the former provide additional security features that, when properly implemented, make transactions recorded on a decentralized ledger next to impossible to reverse or alter. This characteristic, often referred to as “transaction immutability,” allows developers to create “smart contracts.” Metaphorically, smart contracts can be thought of as digital vending machines: If fed the right input - such as a coin or token - the code will deliver the desired product or service without the need for human interaction or validation. Similar to internet protocols, standardized smart contracts enable any client applications implementing the protocol to transact directly with each other peer to peer.
And, since these blockchain-recorded transactions cannot be reversed without significant expenditure of resources, they can replace the need for an intermediary — and associated fees — entrusted with the transfer of an asset or right.
Fintech, short for “financial technology,” has been a popular term in the investment community for some time. However, it is important for investors to recognize that fintech companies are still largely relying on legacy banking services, such as the automated clearing house (ACH) and the Society for Worldwide Interbank Financial Telecommunication (SWIFT). The effects of these legacy solutions can include delayed or even uncompleted transfer of funds for consumers. And, integration with systems of financial service providers, caused fintech companies by extension to inherit the technology debt of these companies.
Blockchain-based protocols enable the transfer of value stored purely in digital form in significantly less time. Unlike transaction costs charged by most legacy financial systems, which assess a percentage fee based on transaction value, fees for blockchain-based platforms are usually based on transaction speed and demand.
While banks and other financial service providers announced the use of blockchain in their own operations, it is important to understand that these efforts are hampered by the legacy implementations central banks such as the US Federal Reserve. As such, settlement of value transfer - including fiat- will be hamstrung until these systems adopt Central Bank Digital Currency (as discussed by the Federal Reserve).
For investment purposes, blockchains are best understood as the building blocks for new open-source value transfer protocols and “digital vending machines” dispensing services previously only offered by finance industry professionals. Unlike the preexisting internet protocols, which were limited to the transfer of information, blockchain-based protocols enable the peer-to-peer transfer of value. The latter can drastically reduce the need for intermediaries and middle-ware.
As in the early days of the internet, current blockchain-based protocols are hampered by interfaces designed by engineers for engineers. However, as these protocols are being applied to user-friendly interfaces, the utility of these protocols will be accessible to a wider population.
Investors should look for startups that embrace the fundamental innovations that blockchain poses — specifically the utilization of a digital bearer instrument to reduce cost and friction for users. At this state of the technology, this might only be visible in a company’s road map. Savvy entrepreneurs do not bank on disrupting the business model of incumbents, but proactively seek opportunities that provide solutions and even more value to end users.
As a rule of thumb, it is a red flag if the main value proposition of a startup is merely a cost reduction, while replacing the previous intermediary or middle-ware with their own offer.
Further reading: Cryptocurrencies
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