Updated April 9, 2019
Collaborative Financing Pt. 2: Blockchain
“Software is eating the world”- Marc Andreesen
Blockchain technology will eat finance.
Blockchains and crypto are part of the collaborative economy because as I mentioned in the last article, many cryptocurrencies were started in an ICO or crowdsale. An ICO is a crowdfunding campaign.
They democratize the means for producing capital. Entrepreneurs get direct access to crowds that fund their creation.
Cryptocurrency is digital, decentralized money. A blockchain is a digital ledger, it performs many roles including accounting. These are the basic software components of these platforms. There’s always a blockchain and almost always a cryptocurrency.
To this you can add a layer of computing. Ethereum has added a platform for creating Turing complete programs. This expands the computing power of the applications that can be designed for Ethereum. Bitcoin does not offer a Turing complete programming language. Transactions are sent with a script.
On Ethereum, developers can make Dapps (decentralized applications) and smart contracts. A Dapp is basically an app that’s made to run on a decentralized system . Below is a great definition of a smart contract.
A smart contract is a computer protocol intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract. Smart contracts allow the performance of credible transactions without third parties.
This means any form of a contract can be executed on a blockchain. The complexity ranges from something as simple as an agreement for a monthly subscription. Or it can be as complex as a smart contract that coordinates several parties and agreements like in a Distributed Autonomous Organization. Any arbitrarily complex software application can be written for Ethereum and other platforms like it.
Smart contracts greatly expand the ability of cryptocurrencies to turn financial agreements into automated processes.
Smart contracts and blockchain-based software cut the costs of coordinating, formalizing, enforcing and recording exchanges of money and information.
This is one of the superpowers of the blockchain. It’s not just the savings from disintermediation but also the savings in the recordkeeping and processing of financial and legal data.
To illustrate, just compare how much time and money a big bank takes to do all of its recordkeeping. It’s accounting, finance, compliance, legal and taxes. Almost the entire backend of the business is busy with this. Compare this to Bitcoin where the sum total of records are on-chain, and updated automatically without a single persons input and without a single dollar's worth of expenses incurred by the platform.
The cost of money and time spent on keeping records is reduced to zero on decentralized platforms.
Blockchain platforms differ. Sometimes the currency’s primary purpose is to be a store of value like Bitcoin. Sometimes there’s a utility token that gives the holder access to computing resources like EOS, Ethereum, and Filecoin. Other popular forms for blockchain platforms are stable coins, DAO’s and of course exchanges. Sometimes a security token is issued and this gives the holder rights that are similar to equity in a company. On Siafund token holders are entitled to ‘dividends’ from the network fees paid by both renters and hosts on the Sia platform.
This is not an exhaustive list of platform types. It does, however, cover most of the top 25 blockchain platforms at this moment.
Bitcoin is the first cryptocurrency. It’s used for remittances. It’s used for investing. It’s been used to make other cryptocurrencies. And it can do much more than that. With every new successful blockchain platform, much more functionality is added to the eco-system.
This is what the software is like. It’s complex and multi-faceted. Already the existing use cases for blockchain applications are too many to list. But it’s safe to say any form of transaction, agreement or record can be automated or altered on a blockchain platform.
Payments and remittances, retail investing, and early-stage funding are the markets that have felt the impact of crypto the most.
Remittances are one of the mythic killer apps for cryptocurrencies. But as of today, they’re not always better than the normal ways of sending money. Here I’ll include payments and remittances in one category.
Western Union, Moneygram, and banks continue to lose market share to crypto in this sector. This is one of the frontlines of the battle between traditional and decentralized finance. The exact size of the crypto-remittances market isn’t known, but it’s now the fourth most popular way to send money. The ten years it took to get to this level of competitiveness is remarkable for something with this level of novelty.
The cryptocurrency has also become a competitor to retail investments. The first few years of crowd sales and ICO’s were dominated by the retail side of the market. A significant amount of money was diverted from stocks, bonds, mutual funds and other traditional forms of investing.
Traditional retail investment vehicles are going to continue to lose market share to blockchain platforms. Crypto is new. As it matures it will become more competitive.
Also, institutional investors are becoming much more active in this space. They modified their infrastructure by creating instruments like SAFT’s so they could participate in this market. This is great news for the general outlook of the industry. It moves the market closer to mass adoption.
ICO’s are still a viable way for new software projects to get funding. ICO’s dropped sharply in 2018. Still, EOS and Telegram pulled in billions of dollars. Projects will continue to draw in large amounts. Competing with startups for the funds to make software.
From the point of view of a founding team, there are many reasons why an ICO would make sense. The amount could be much larger than a VC round. It would take much less work and time to launch compared to preparing for venture capital scrutiny. And there would be no equity dilution.
The ideas of a decentralized future have captured the imaginations of software engineers everywhere. The competition between decentralized and centralized software is not just about competing for funding but it’s also a competition for talent. More software developers are devoting more of their time to working on blockchain platforms.
On the investing side, we may start seeing later rounds raised as ICO’s. Further disintermediating venture capital. One form of a DAO operates very much like a VC firm. Other forms of venture capital on the blockchain will probably be invented. Some may be unmanaged, crowdfunded and distributed.
Venture capital, remittances and retail investing will define the bulk of the competitive landscapes between DeFi and traditional finance for the foreseeable future. With most of the impact being felt on the investing side.
Two factors will influence this market the most. The legislative environment and the competition between DeFi and traditional tech and finance. Current uses of blockchain technology include DAO’s and stablecoins. The software in this sector is advanced and will probably have a disproportionate amount of influence on finance.
The single biggest factor influencing the future of crypto is legalization. There are four trends indicating this will increase.
- The rate at which governments are allowing or using blockchain or crypto.
- The rate at which institutional investors are investing in this space.
3. The number of Fortune 100 companies that are using blockchain technology.
4. The increased number of merchants including mainstream businesses that accept Bitcoin and other cryptocurrencies.
A positive legislative environment could make a very big difference.
Over 82% of the Fortune 100 companies have either implemented, invested or at least explored the use case of Blockchain in their businesses.
Some of the most important features of blockchain software come from the fact that it’s trustless. Trustlessness and decentralization allow cryptocurrencies to operate without a central authority.
The nodes that use the system also host the system. This is what allows you to send Bitcoin peer to peer. The consensus algorithm allows it to update automatically.
Because it’s trustless it’s partially autonomous. Meaning it operates without management or employees. Bitcoin has over 300,000 transactions per day and over 30 million wallets and growing and $100 billion dollar market cap with no board of directors or executives.
Blockchain platforms cut the cost of labor to zero. It’s trust as the goal of computation that makes this possible.
A specialized use of blockchain technology is a DAO. A DAO is a distributed autonomous organization.
Buying a token gives the owner the right to vote for the funding of projects that will further the cause of the platform. Projects are funded and sometimes people are hired to perform specific tasks. The DAO has a governance structure that allows this.
Owning the coin makes you an investor and a custodian of the interest of the project. So your incentive would be to vote on projects that will better the community.
DAO’s shows us that there are alternative methods of coordinating inputs to create economic value.
And because DAO’s are in direct competition with venture capital.
One of the unique and confusing parts of this asset class is the extreme fluctuations in price. if you make a purchase at the wrong time a $5 cup of coffee could cost you $500 at the exchange because of a sudden price change.
This is one of the reasons why some platforms are made to stabilize the price of crypto by pegging their currency to the USD like MakerDao or to gold like Digix.
These cryptocurrencies are called stablecoins and they are going to make crypto behave more like normal money. Making it much less risky to use it for things like daily purchases.
Volatility makes it difficult to estimate the future value of money. This mundane aspect of fiat is missing from cryptocurrencies. Solving this problem would attract increased investment to this sector.
Trustlesness, DAO’s and stablecoins are an indicator that this market will continue to be one marked by extreme innovation.
How the architecture and governance of blockchain platforms coordinates inputs on the human layer is what makes the software remarkable. Code organizes something that’s almost like labor, but not exactly. Add to this the fact most of the software is open source and labor as a factor of production is called into question.
Trying to predict exactly what these markets will look like in the future is difficult. The technology and the landscape changes quickly. There’s a lot of legislation coming that will have a variety of influences. This will be the most influential factor. Until the laws are written there’s no way to tell exactly how coming legislation will affect the market. The past isn’t always repeated. But history does give us two clues to help us estimate what’s to come. The dot com bubble, and open-source software's climb to ubiquity.
The tech bubble showed us that no matter how new the business model is at some point it has to monetize. Platform monetization varies from network to network. But token appreciation is the dominant business model for cryptocurrencies. Fees are the main business model of exchanges. The fees model has been tried and tested. But we don’t know as much about perpetual token appreciation as a business model.
Either way, better-monetized platforms are more likely to survive. Looking at the example of open-source it looks like traditional centralized businesses were much better at extracting value from open source software than open-source companies were. In the case of cryptocurrencies, there are scenarios where traditional centralized tech companies out-competes the crypto-native networks. But it won’t be the case every time. So there will be fat protocols and fat applications.
The growth of open-source showed us that this type of software can spread virally. No matter what happens to the individual platforms, the use of the software is going to skyrocket. Further consolidating the supremacy of open source.
The near elimination of labor and record-keeping expenses is what will make this software irresistible to businesses. More sectors of finance and commerce are going to use blockchain platforms. Fundraising and remittances are today. Tomorrow any corner of the economy could end up decentralized, digitized and automated. This change is expected to be one of the most important movements in the history of computing.