2020 Has Been a Breakthrough Year For Blockchain & Crypto
By Brooke Pollack of Hutt Capital
2020 has been a breakthrough year for blockchain and crypto. There have been a number of developments this year which have led me to this conclusion and have me more excited than ever for the future of this market. I know that others in the industry share the sentiment. These are listed below and described further in this piece.
· Bitcoin Goes Mainstream
· Financial Infrastructure & Market Structure Becoming More Institutional
· Decentralized Finance (DeFi) Emergence
· Stablecoins Experience Significant Growth
· Governance Token Success Paves the Way For Community Owned Networks
· Tokens Prove Ability to Bootstrap Growth & Build Financially Aligned Communities
· NFT & Digital Art Growth is the Start of a Bright Future
Bitcoin Goes Mainstream
The federal reserve has significantly expanded its balance sheet by ~75% this year as a result of the economic slowdown driven by covid-19. The fed purchases assets by “printing” dollars causing an increase in the money supply and leading to more investor interest in store of value assets.
Bitcoin has increasingly been part of this public conversation as its fixed supply cap offers a compelling store of value proposition similar to how gold has traditionally been utilized in portfolios. Bitcoin, which is up 78% YTD to $12,800 with a market cap of $237 billion, has outperformed both Gold and the S&P 500 by significant margins year-to-date, proving its ability to perform well during turbulent periods.
One item which gained significant attention was famed hedge fund manager Paul Tudor Jones’ letter in May 2020, The Great Monetary Inflation, which discussed the current environment and advocated for Bitcoin as a compelling store of value investment and due to the broader digitization of currencies. Paul disclosed that his Tudor BVI funded adjusted its mandate to allow a low single digits % exposure in bitcoin futures. An excerpt from this letter:
“[bitcoin] falls into the category of a store of value and it has the added bonus of being semi-transactional in nature. The average Bitcoin transaction takes around 60 minutes to complete which makes it “near money.” It must compete with other stores of value such as financial assets, gold and fiat currency, and less liquid ones such as art, precious stones and land. The question facing every investor is, “What will be the winner in ten years’ time?” At the end of the day, the best profit-maximizing strategy is to own the fastest horse. Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be Bitcoin.”
Tudor is not alone. Renaissance Technologies, for example, one of the largest hedge funds in the world led by renowned quant investor Jim Simons, received SEC approval to trade bitcoin futures in March.
More recently, we have seen large corporates and financial firms announced large bitcoin positions as a core part of their holdings. MicroStrategy (NASDAQ:MSTR) bought $425 million of bitcoin from its balance sheet, Square purchased $50 million of bitcoin from its balance sheet, UK-listed Mode is putting up to 10% of its cash into bitcoin and Stone Ridge, a $10 billion asset management firm, disclosed a $115 million position in bitcoin managed by its partially-owned subsidiary NYDIG.
PayPal (which also owns Venmo) just announced a new feature allowing its 346 million users to buy, hold and sell cryptocurrencies, and by early 2021 will allow them to use crypto to shop at its 26 million retailers.
I expect the type of mainstream activity around bitcoin described above to accelerate over the next 2–3 years.
Financial Infrastructure & Market Structure Becoming More Institutional
After years of serving primarily retail and industry-focused clients, the financial infrastructure around bitcoin and crypto has matured and is increasingly of institutional quality. Key market functions have been built by talented teams with significant financial services experience, replicating systems and processes from the traditional finance world that large investors and institutions are comfortable with. Many of these startups have seen incredible growth this year.
New products are thriving such as options, futures and other derivatives which are important pieces of mature financial markets. Other areas such as prime brokerage and market making continue to scale, offering improved services, pricing, and execution. Asset management firms are growing and offering higher quality products. For example, as shown below, BTC options have seen strong growth this year, with new entrants such as CME finally taking some market share from Derebit, as have Grayscale’s listed single asset Bitcoin and Ethereum trusts (tickers GBTC and ETHE, respectively).
The low hanging fruit of unregulated crypto trading is now being closely scrutinized or prosecuted by the SEC. Notably, BitMEX, an offshore spot and derivatives exchange which is known for offering up to 100x leverage and has been particularly cavalier about skirting U.S. regulations, was recently charged by the SEC for not properly enforcing anti-money laundering (AML) procedures for U.S. customers and the executives are being criminally charged personally.
Activity on BitMEX has historically led to higher volatility for crypto prices, including being blamed for the 40%+ single day decline in March 2020, and was cited by the SEC as one reason why they were concerned about approving a bitcoin ETF. Accordingly, this move will help crypto to build more trust among regulators and institutions, and improve the chances of a bitcoin ETF approval, especially once Jay Clayton is soon no longer SEC Chairman given his strong negative bias.
Most retail crypto activity is outside the U.S., with the market dominated by Asian exchanges. In contrast, institutional capital is much more U.S.-centric. As the infrastructure and market structure continue to mature and the more legally dubious activity goes away, this should drive institutional investment activity via U.S. regulated venues and strong growth for this segment of the market. This is further supported by the more mainstream attention being received by bitcoin as discussed earlier.
We can see this starting to emerge in the futures market, for example, where institutionally-oriented CME and Bakkt (an ICE subsidiary with external funding) have seen strong growth in the volume over the past 18 months.
The blockchain and crypto industry has been waiting since 2017 for “the institutions to come”, but 2020 may be looked back on as the year where this finally started to play out.
Decentralized Finance (“DeFi”) Emergence
Decentralized Finance, or DeFi, is best thought of as automated finance. Financial services in the form of code built on smart contract platforms (blockchains) such as Ethereum. DeFi is based on system parameters, offering services without intermediation or bias.
DeFi protocols have been focused primarily on lending, borrowing, savings, trading, asset management, and synthetic assets, with a flourishing ecosystem of companies being built around them. Many DeFi products and services are far superior to their traditional finance counterparts which has driven strong demand. DeFi products and assets built on a common blockchain can interact with and build on each other in a way that is leading to compounding innovation and would be impossible in traditional financial markets.
DeFi’s user base and traction exploded this year with year-over-year growth in total value locked (“TVL”) in DeFi protocols of over 20x, to $11.3 billion, as shown below.
The largest DeFi project by TVL is Uniswap, a decentralized crypto exchange (“DEX”). In September, Uniswap saw more trading volume than Coinbase, the most well-known crypto exchange/platform in the U.S. last valued by VCs at over $8 billion.
The user base for DeFi has exhibited a hockey stick growth trajectory over the past couple of years.
The incredible growth of DeFi has led to very strong returns & performance for DeFi crypto assets and companies, and created a number of highly valuable decentralized finance protocols, including 18 unique DeFi crypto tokens with a market cap of over $100M and quite a few more above this level on a fully-diluted basis.
DeFi has massive potential and we believe that growth experienced this year is only the beginning, the first serious iteration and a precursor what is to come in the years ahead.
Stablecoins Experience Significant Growth
Stablecoins are digital dollars, crypto assets that are worth $1 USD rather than having some other market-based value. They offer all the advantages of crypto in moving value around the world fast and cheap, but without the fluctuation of price.
Stablecoins have experienced significant growth, with total supply surpassing $20 billion for ~300% growth year-over-year.
Today, the market is dominated by crypto companies who have created stablecoins as a product. There are different ways to maintain the $1 peg but most are backed 1:1 with USD. We expect to see significant further growth for stablecoins in the coming years and believe the supply will eventually be measured in trillions. As a notable recent positive development, the U.S. Office Of The Comptroller Of The Currency (OCC) announced in September that regulated banks and thrifts could hold reserves for stablecoin issuers, an important step towards moving stablecoins in the mainstream.
Another boost for this market could be the potential launch of Libra in 2021, the digital currency project created by Facebook but which is now managed by the Libra Association. If Libra launches successfully, not only would this serve to massively increase the “stablecoin” market size, but it would be an exciting global catalyst for adoption and awareness for the entire crypto industry.
Governments are also moving towards issuing their own digital currencies, aka Central Bank Digital Currencies (CBDCs), a fiat currency they control but in digital form. Recently, we have seen the European Union state that by mid-2021 it will announce if it will launch a digital Euro project. U.S. Fed Chairman Jay Powell recently said that “there are a number of ways a CBDC might improve the payment system” and that ~80% of central banks are exploring CBDC concepts but also that in the U.S. “there’s a great deal of work yet to be done as well as extensive public consultation to be had with all stakeholders before making such a decision.”
China is reportedly far along with its digital currency project, called Digital Currency Electronic Payment (DCEP). Earlier this month, China gave away $1.5 million of its digital currency to 50,000 citizens in Shenzhen, among 2 million who registered for a chance to win, as a trial to test out the governments mobile app which can be used to spend the currency at 3,000 approved local stores.
Governance Token Success Paves the Way For Community Owned Networks
We have seen the emergence of governance tokens as a compelling new way to govern protocols and create value for stakeholders of a network. The general concept is you start as a normal company that builds a protocol with a compelling “product” for users, then once it has sufficient traction and scale the protocol issues a governance token. Thereafter, the company no longer controls the direction of the protocol, and a new governance model is put in place whereby token holders can submit and vote on proposals for the future direction of the protocol. This is called “progressive decentralization” where it starts as a centralized company and methodically transitions over time to a decentralized network governed by the community.
From a VC perspective, a company will typically raise equity with rights to any future token, and when a governance token is launched the VCs get their pro rata of the portion allocated to investors. VCs continue to retain their equity in the company but it will no longer have material value unless the company decides to build another protocol or new products.
Not all governance tokens follow the above equity-to-token conversation path though, as some governance tokens are a part of the protocol from day one and have instead raised capital through token sales or in some cases have raised no capital and entirely reserved to be earned by community members (or later bought by investors on secondary markets).
Tokens Prove Ability to Bootstrap Growth & Build Financially Aligned Communities
One of the most exciting promises of crypto tokens has long been the idea of bootstrapping growth and accelerating community building through financial incentives. An oft-used example is “what if Uber could have provided equity to its drivers and riders from the early days so they could financially benefit from the growth of the network since they are crucial to its success?”. This is exactly what crypto enables, the ability for users and other community members of a protocol to “earn” the native token, creating a positive feedback loop where you make money by using a protocol, and then as a holder of the token are incentivized to promote and help the network grow which then brings more users, and so on, all organically.
Compound, an on-chain interest rate protocol primarily used for borrowing/lending, issued its governance token this year at which point protocol users earned tokens based on their activity. Can you guess when this happened?
As soon as the COMP token launched in June, value locked in Compound increased 6x almost overnight and in total has grown over 8x since the launch just four months ago. Today, COMP has a fully diluted valuation of ~$1 billion.
Likewise for Uniswap, an automated market maker better known for being the largest decentralized crypto exchange. Uniswap launched its governance token UNI September 16 and has seen its TVL grow by 264% in just over a month, from $748 million to $2.7 billion. UNI, Uniswap’s native token, trades at a fully-diluted market cap of ~$3 billion.
With the success of COMP, UNI and others in recent months, there is significant interest in this model not just from other DeFi projects but from blockchain projects across a broad range of sub-sectors who understand crypto’s power to create novel incentive mechanisms which help to bootstrap and build dedicated, financially aligned communities in a way that has never been possible before. Recent notable non-finance examples include Audius, focused on the music industry and streaming, Braintrust, an online talent marketplace and Helium, a decentralized wireless network.
For users, being able to earn tokens (the primary value creation mechanism for these networks) from the early days by using a service is a game changer. This model offers a world with a more equitable model for ownership and wealth creation spread across the community, who have always been so crucial to success but have never been able to financially benefit.
As an example, 60% of UNI tokens were reserved for community members based on usage and participation in Uniswap. 45% to be distributed based on future use and 15% retroactively to those who used or participated in Uniswap prior to the token launch. At current prices, that 15% provided retroactively means early Uniswap community members, over 250,000 of them, were eligible to receive a total of >$450 million as a reward for their early involvement in Uniswap.
The next step is for these and other projects to prove that community owned networks
NFT & Digital Art Growth is the Start of a Bright Future
Non-Fungible Tokens (NFTs) are crypto tokens that represent something unique and which is not interchangeable with any other crypto token. For example, digital art or a digital collectible, where you own that specific item represented by a unique crypto token. Bitcoin, on the other hand is fungible, because any bitcoin is the same and equal in value to other bitcoin as far as the owner is concerned.
The NFT market is still very small but growing fast. For example, NFT sales in the past week were over $2 million, an annual rate of $113 million. This was up ~4x from a similar period in 2019. We are seeing more attention and capital flowing into this sub-sector which should serve to fuel continued growth and innovation in the coming years, and we are very bullish on the long-term opportunity for NFTs.
NFTs are an exciting application of blockchain which enables the creation of scarce digital items where ownership can be proven and authenticated. Similar to how blockchain enables digital scarcity for bitcoin and other digital currencies, but applied to new types of assets. Further, because they are crypto token sitting on a blockchain, they can seamlessly interact with other blockchain-based applications which is going to drive immense creativity by entrepreneurs for how NFTs can be used.
To date, the market has been dominated by digital art, collectibles, trading cards and in-game items (for video games or virtual worlds). These are very large existing markets that are finally going to go digital via blockchain and NFTs, presenting a very attractive opportunity for early stage venture investors.
NFTs for digital art are also exciting for creators, who have the opportunity to benefit financially from their work in ways not possible historically. For example, digital art can be created with a provision saying that the creator gets 10% of all future sales, and since its all tracked on a blockchain the artist would automatically receive proceeds every time their work is resold. This is just a single example of how blockchain has the opportunity to significant alter how artists benefit from their work in the future. For a deeper dive on crypto art specifically, check out “You’re Sleeping on Crypto Art” from Steve McKeon and Derek Schloss at Collab+Currency.
The opportunity for creators to utilize blockchain and crypto to build community and take more financial ownership of their work extends beyond NFTs to music and other forms of art and entertainment, and we are starting to see some very exciting innovation around these ideas as well.
Conclusion
There is so much exciting activity and innovation occurring in blockchain and crypto across a breadth of underlying themes and sub-sectors. 2020 has already been a landmark year for blockchain and crypto yet its clear that we are only getting started and taking a sneak peak of what the future holds.
About Hutt Capital
Hutt Capital is a blockchain venture capital fund of funds and direct investment firm, offering diversified exposure to blockchain innovation globally. To learn more about Hutt Capital, please visit our website and feel free to reach out.
