Amara’s Law and a top down view on investing in blockchain
“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.”
In 2017 many blockchain projects raised a lot of money on a proof-of-concept and a roadmap mentioning going “live” in 2018. 2018 came, the projects went live, and the markets crashed. People were disappointed by the lack of adoption after this new technology launched. Articles like this well written one by Kai Stinchcombe were published, stating that blockchain failed to attract adoption because the idea behind blockchain is fundamentally flawed.
While that article makes some good observations about the expected hurdles of blockchain tech in some industries, it’s way too early to make the claim that blockchain failed to attract adoption. That’s like claiming the Internet failed to attract adoption months after ARPAnet adopted TCP/IP in 1983 because connecting households would be too much of a hassle. Or like claiming airplanes will never be a commercial success just after the first commercial flight in 1914, because it would be too difficult to build airports at major cities. Such claims are good examples of Amara’s Law in effect.
Major new technologies don’t change the world in a year. Or in two. Adoption of new technologies takes time, because it takes time to develop the technology to a point where it’s scalable, safe, affordable, easy to use and available for everybody. The first iteration of a technology is always expensive, slow, not user-friendly and unsafe. This applies to blockchain technology as well as for all previous technology waves.
Does this mean Stinchcombe’s article is wrong? While we think its overall verdict on blockchain tech is, it does make a valuable point: for blockchain to be adopted in some industries, the processes in those industries need to change in order to allow for blockchain tech to add value. This is comparable to the need to build airports, railways or internet cables in earlier technology waves. Whether or how existing processes will change to accommodate blockchain usage is uncertain for some industries, and might never happen in industries where benefits don’t offset the costs.
Likelihood of blockchain disruption per industry
Knowing this, how should you choose in which blockchain projects to invest? Maven 11 developed a model to assess which markets are likely to see blockchain adoption and on which timeframe. In short, this model constitutes of two axes resulting in a 4-quadrant field to plot industries in.
Y-axis: replacing existing processes vs requiring new processes.
Some industries, like the payment industry, have processes in place that closely align with the workings of blockchain. For instance, because these processes are already fully digital and companies in those industries are used to working with ledgers. We expect those industries to be highly likely to adapt blockchain technology.
Some other industries, like agriculture or supply chain, need entirely new processes to capture real world data on the blockchain. Whether this will happen and in which timeframe is more uncertain. Blockchains are often mentioned as a tool to promote transparency about sustainability in supply chains. However, if farmers in Latin America currently have no incentive to report honestly on pesticide usage, the existence of a blockchain will not suddenly change that. This is not to say blockchain tech will never be a valuable tool in supply chains, just that the road to adoption in some supply chains will be one with many failures.
We rather invest in industries where blockchain tech makes existing processes more efficient, than in industries that need new processes in order to facilitate the use of a blockchain, because in those latter industries adoption will be more uncertain.
X-axis: level of required network effect
While network effect is a factor in blockchain technology by definition (you can’t have a decentralized ledger by yourself), there is a difference between industries when it comes to the minimum amount of network effect needed for a decentralized service to be useful for an individual user in that industry. For example, the minimum network effect for some applications in the payment industry is low: even if you’re the only person that has a credit card that can be used to pay with cryptocurrencies, you can use that credit card in every store that accepts credit cards. The other end of the spectrum is for instance a social network, which only has value if a majority of your contacts use it.
Another factor we take into account when scaling industries on the network effect axis is the differentiation between required users on the network (in other words: complexity of the network effect). For instance, a corporate communication app is already useful if only users within one single organization use it. But for a decentralized ledger in supply chains to be useful, it is necessary that all kinds of different organizations and individuals in the supply chain participate.
We prefer to invest in industries with relatively low and non-complex network effect, because those industries will see real adoption earliest, which will reflect in rising valuations sooner than other industries.
Those two axes lead to the following four-quadrant model, in which we plotted 32 industries for which blockchain tech is being developed:
Please note that industries in this model should not be represented by dots, but by differently shaped clouds around a center point. Applications within those industries might differ heavily around the center point. For instance, some blockchain data management applications can already be implemented within current processes, while others require entirely new processes to measure real world events and convert those into blockchain records.
The bottom line of this model is that investing in industries that are roughly in the bottom left quadrant makes most sense. These industries will have least uncertainty of blockchain solutions being actually adopted, and will see this adoption on a relatively short timeline. Investing in riskier quadrants (top left and bottom right) makes sense only if the magnitude of the opportunity compensates for the added uncertainty or increased timeframe for reaching expected ROI. Lastly, we avoid investing for now in industries that are firmly in the top right quadrant, because there are plenty of less risky and equal magnitude investment opportunities in the other quadrants.
When to enter the market
While it will likely take several more years for mainstream blockchain adoption in most industries, we strongly believe that waiting to enter this market, especially when looking at industries in the bottom left quadrant of our model, will come at the cost of ROI. Our reasoning is that the projects that will have mainstream traction years from now, are already being built. By investing in these projects in an early stage, we maximize the potential upside of our investments.
In 2017, the market has complied with Amara’s law perfectly by totally overestimating the short term impact of blockchain technology. After the bear market of 2018, a lot of people now underestimate its long term impact, creating a perfect investment opportunity for those who don’t.
Originally published at maven11.com on December 17, 2018.