[5 minute read] by Tony Faccenda
Hey folks! Another encouraging week in crypto with BTC and ETH sitting relatively stable while alts showed healthy growth. As sentiment rises, more commentators are suggesting we’re starting the transition from the markdown to accumulation phases. If you’d like another hit of optimism, I’d recommend watching Willy Woo’s appearance on Tone Vays’ channel (skip to the 48 min mark), where he discusses on-chain activity and says he’s now 66% confident we’ve established a bottom.
On to this week’s article recommendations, I’ve tried to tidy up the structure to make it easier to read. Always keen to hear feedback on how these summaries can be improved.
Here are my top articles for this week…
Title: The Convergence Stack
Author: Lawrence Lundy-Bryan
Organisation/affiliation: Outlier Ventures
I’ve shared a lot of OV’s work in the past as the quality is always high. This particular piece is an update on the firm’s 2016 investment thesis. It focuses on the ‘convergence stack’ which is defined as “a set of interlinked and open-source technologies spanning hardware, software, networking and applications that support a more secure, private, accessible and ultimately what we hope to be equitable digital infrastructure.” The article sets out to define this stack, starting from the physical layer and working up to the application layer (known in IT networking as the OSI model). It identifies 18 separate functions within the stack, including storage, compute, bridging between chains and UX.
Key takeaways & quotes:
- My main takeaway from this piece is around how an ecosystem of inter-dependent apps and services is forming. It’s tempting to try and assess crypto projects in isolation, but the reality is that for individual projects to succeed the whole space needs to develop in tandem, e.g. for a dapp to be ready for mainstream consumption it needs solutions in UX, authentication, scaling, etc. to be in place. This piece is useful for thinking about how the various projects mentioned fit in at different layers of the stack.
- “As the market matures and consolidates, projects will look to vertically and horizontally integrate and aim to have multiple products across the stack.”
- Compare with Multicoin Capital’s work on defining the Web3 stack: https://multicoin.capital/2018/07/10/the-web3-stack/
- Find other Outlier Venture research here: https://outlierventures.io/research/. See particularly the recent work on Token ecosystem creation and stake of blockchains 2019
Title: On value capture at layers 1 and 2
Author: Kyle Samani
Organisation/affiliation: Multicoin Capital
Maintaining a similar theme, this second piece focuses on blockchain protocol layers and how they fit into an investment framework. Before reading this piece, it’s important to understand the difference between layers 1 and 2. The first layer is the base protocol that governs the network, while the second layer is the projects, platforms, and protocols that sit on top of base blockchains and try to make the technology, and the user experience, better. The piece begins by explaining why ‘protocol’ is a nebulous concept as the protocol is simply a set of rules, and it’s the tokens that power the protocols that capture the value. He proceeds to discuss Layer 1, which he says exists only to secure the chain, i.e. to prevent attacks that interfere with consensus. He explains why security and value are mutually-reinforcing: investors feel safe in storing money in Bitcoin because it’s the most secure chain, this increases the value and incentivises miners to maintain security (what Kyle refers to as a ‘natural network effect’). In the longer term, this makes some chains more likely to succeed as money will flow to secure chains and away from less secure alternatives. At layer 2, a protocol can only capture value if ‘it stores some sort of external and valuable state’, i.e. memory of events and interactions. Kyle expands on this by comparing value capture in four assets: ZRX, BAT, REP and LPT. ZRX and BAT, he argues, do not capture state and thus have dubious value capture, while the later two (required for, respectively, market creation and network security) have value capture potential.
- The main thrust of the piece is that value comes from network effects, i.e. a token needs to incentivize valuable activity in order for it to itself capture value.
- “While there are many ways to bootstrap network effects for layer 1 assets, in the long run, we will see consolidation as price volatility between chains is ultimately value-destructive. Layer 2 assets, on the other hand, don’t need to defend themselves against 51% attacks. Instead, they build network effects through the value of the state they contain.”
Further reading: See previous content the fund has developed on network effects; https://multicoin.capital/2018/05/09/on-the-network-effects-of-stores-of-value/
Title: Considering liquidity flows and sector rotations for the next crypto market cycle
Author: Andrew Gillick
Organisation/affiliation: Brave New Coin
Brave New Coin researcher Andrew Gillick takes on the topic of liquidity – an important, yet often overlooked, aspect of crypto investing and trading – in this highly detailed article. He borrows Oaktree Capital’s definition of liquidity as being ‘the ability to buy or sell assets without moving the price substantially,’ and talks about how it correlates with market cycles:
“Liquidity is transitory, there is lots of it when times are good and there are more buyers than sellers, which can trick investor’s into thinking liquidity will always be that good — until the market reverses and everyone is running for the doors.”
Over the course of the article Andrew explains the different phases of liquidity, as demand expands during bull phases and sharply contracts once the bear has set in. He talks about the 2017/18 crypto bubble, where the immature state of the market meant that all tokens experienced a liquidity boost regardless of the nature of the project, stage of development, etc. Moving to our current stage of market recovery, liquidity is still low but with signs of ‘early recovery’. Using 2017 for comparison, he analyses potential patterns of liquidity inflows during the next market cycle, which ‘sectors’ or types of tokens are likely to benefit and in which order.
- Crypto is likely still in the ‘early majority’ phase of adoption. Liquidity will come with the entry of the ‘late majority’ into the market.
- Liquidity means different things for traders and investors; traders want high liquidity as they want to know they’ll be able to exit their position when they need to. Investors ideally want low liquidity as they will seek to ultimately gain a ‘liquidity premium’ on their investment.
- BNC anticipates that the next crypto market cycle will last 1,158 days (more than three years) and during which we’ll see less correlation between assets compared with the current market.
- Liquidity is likely to start with infrastructure-based projects, with novel and speculative assets last to receive a liquidity boost.
Further reading: On understand crypto market cycles, read https://medium.com/paradigma-capital/5-crypto-native-indicators-to-enrich-your-market-cycle-analysis-205b8b8e7314
Title: Why open source finance will win
Author: Ric Burton
Description: This article centres around an ambitious prediction that ‘50% of all assets will live on an open source financial protocol in 50 years.’ The author explains that while we’ve seen substantial innovation in the fintech space (through apps such as Stripe and Monzo), such advancements required a substantial amount of human and financial capital to bring to market. He argues that the next wave of innovation in financial services will come in decentralised / open source finance as it removes the barriers to entry and allows entrepreneurship within a permissionless system. He uses projects such as MakerDAO, Uniswap and WalletConnect as current examples of open finance applications.
Key takeaways & quotes:
- “The best teams will stop starting startups and start growing communities.”
- “The internet did not kill many companies. It enabled lots of new ones to grow. [DeFi] will not kill many banks. It will enable lots of new ones to grow.”
Further reading: Fred Wilson also published a good article this week on DeFi: https://avc.com/2019/03/decentralized-finance/
Title: The impossible balance between usability & security
Author: Taylor Monahan
Our final piece is repurposed content from a presentation Taylor, CEO of Ethereum wallet MyCrypto, gave at the recent ETHDenver conference. It’s a simple piece drawing on an important concept: mainstream consumers are used to a simple, safe and reliable app experience and may struggle with the realities of owning crypto and using crypto-based apps and services. Specifically, features such as self-sovereignty, self-custody and immutability/irreversibility are alien to most. Her talk focuses on how ‘builders’ (developers, marketers, operations, etc.) can find the balance between good UX and strong security. Her main argument is that there’s no one size fits all solution (there rarely is) and so projects must battle test their products by getting them into the hands of users so that they can find the unexpected issues and flaws before they become security risks. I enjoyed some of the quotes in this piece that highlighted the challenges in making crypto accessible to the masses.
Key takeaways & quotes:
- “As we build products with the best possible user experience, we have to keep in mind that the worst user experience is when people lose their money. It doesn’t matter if it is lost because of user error, accident, fraud, or outright theft: your user experience sucks when people lose their money.”
- “We should also keep in mind that most people don’t start 100% decentralized. People can ease their way in and work from a centralized, custodial solution to a non-custodial solution as they become more and more familiar with this ecosystem.”
- “Security is about preventing bad things from happening and preventing the unknown from occurring. Good security is simply the absence of bad things happening. It’s far less tangible.”
Further reading: Nothing comes to mind.