An Investment Thesis on Blockchain Assets
Web1 was read. Web2 was read and write. Web3 is read, write and own.
- Permission-less: Irrespective of your Race, Color, National Origin, Sex, Religion, or Age, you can participate as long as you have a stable internet connection.
- Censorship resistant: A true peer-to-peer system in which no central entity can curb your right to access.
- Trustless: The consensus mechanism i.e., the rules that need to be followed are public information and have to be adhered to by all parties.
- Composable: Since all code is open-source, you can take the Legos that best fit your need and build on top of them.
Blockchain is primarily a software and an open-source movement, whereas Internet was a hardware movement. An individual can invest directly in the blockchain (e.g., Ethereum, Solana, Bitcoin) but couldn’t do that in an Internet Protocol back in the day. (e.g., in SMTP, TCP/IP). Furthermore, there is practically no cap on how many blockchains can exist, whereas only a few Internet Protocols exist due to design limitations. Essentially, a Blockchain is a ledger that can compute and commit your ownership rights.
The different theses I look at while investing in blockchain assets include:
A cryptocurrency is a digital asset that does not depend on a central authority and can be used as a medium of exchange or a store of value. I look at cryptos through the following framework:
- Remittance purposes: Bitcoin is seen as ‘Digital Gold’ because scarcity, durability, and accessibility make it a store of value. Yet, the true potential of Bitcoin as a payment mechanism is yet to be unlocked through the Bitcoin Lightning Network. Furthermore, the intermediaries’ removal by the blockchain results in cheaper, faster, and more secure remittances.
- Utility purposes: Ethereum is called ‘Digital Oil’ because the EVM (Ethereum Virtual Machine) enables the execution of smart contracts, which are rules coded in a computer language on a blockchain. Other blockchains such as Polkadot, Algorand, and Solana also provide smart contract compatibility. Even Bitcoin is exploring this possibility through its Taproot upgrade.
- As equity: In the Proof-of-Stake consensus mechanism, such as that of Ethereum, the token itself can be considered as stock. The staking reward would be similar to a dividend payment and the token burn (EIP-1559) would be similar to a cash buyback.
Decentralized Finance represents a movement through which finance on a global scale can largely become open-source and permission-less. It is a drastic improvement over Centralized Finance because of the following drawbacks present in the old systems:
- Centralized Control: The legacy systems stymie innovation and result in financial exclusivity.
- Limited Access: The big players have no incentive to cater to the un/underbanked people.
- Inefficiency: The current model has high legacy costs since it is a trust-based system. Whereas, DeFi largely reduces counterparty risks.
- Lack of Interoperability: DeFi products are modular and composable which results in low switching costs and true growth potential.
- Opacity: The present system has a closed-door policy along with high brick-and-mortar costs.
DeFi is building new financial blocks which result in novel financial applications such as DEX (Decentralized Exchange), Uncollateralized Loans (Flash loans), Yield Aggregators (Yearn Finance), Perpetual Derivatives (BitMEX), Synthetic Assets (Synthetix) and Real-World Asset Tokenization (Centrifuge). Decentralized governance structures such as DAO (Decentralized Autonomous Organization) and CO (Continuous Organization) make this possible. DeFi is different from FinTech because the latter is just a mild improvement over the existing financial primitives.
In Web2 protocols, you rent the platform and pay through your privacy or by watching irrelevant advertisements. Whereas, you own your assets in Web3. Self-sovereign user databases would crumble data monopolies like Facebook and Twitter. This would result in low switching costs and high collaboration, security, and privacy. A Social Web3 platform such as Lens protocol can truly leverage the modular properties of Web3 to create a social graph by integrating with POAP (Proof of Attendance Protocol), a platform for recording your memories on the blockchain, and Disco, a Metaverse identity platform that can be used to create your unique digital persona with full control over how much data you want to share.
A Non-Fungible Token is a unique cryptographic token that exists on a blockchain and cannot be replicated. In the present popular form, the JPEG NFTs have certain social and cultural use cases. Yet, mostly, they are only social status signals that do not hold value creation elements, whereas, utility NFTs hold a lot of potential depending on the use case. E.g., a struggling artist can release her song in the form of NFT to raise money so that she can record the song in a studio and promise to pay the NFT holders 3% of future profits in perpetuity.
A Soul Bound Token is an NFT that can’t be sold. Hence, they can be used as your digital identity to provide on-chain credentials. Whereas, Social Tokens are how content creators can monetize their content in a truly decentralized way and their followers can also monetize their time commitments by reselling their tokens or through capital appreciation if the influencer becomes popular.
The sheer market size, scalability issues, and technological specializations enable a more plausible multichain future. Therefore, investing in multiple Layer-1 with different value propositions makes more sense. This also increases the significance of Oracles such as Chainlink and UMA, and Cross-chain bridges such as Wormhole and Binance Bridge in the future.
Depending upon the type of digital asset, the valuation would change since most of the projects are open-source, and can be easily forked. Yet, the general factors that need to be considered while valuing blockchain assets include:
1. Product-Market-Founder fit
2. How will the asset gain value?
3. The competitive advantage
4. What is the utility to the wider economy?
5. Where does the promised return of the project come from?
6. Even if the project is successful, will the asset behind it gain value? And how?
7. Is there an asset parallel to this? Either digital or traditional?
8. How time tested is the asset?
9. If it is a token, how is the Tokenomics i.e., the vesting, allocation, supply/demand?
10. Is it truly decentralized? What is the Nakamoto Coefficient of the asset?
11. Is the asset inflationary or deflationary? Is there a cap on the total number of assets that can exist? A combination of these 2 points is probably the most important factor that needs to be considered and the following assets can be categorized based on these token supply factors:
a. Bitcoin →Inflationary+ Capped (Only a total of 21 million BTC will ever exist)
b. Dogecoin/Fiat Currencies →Inflationary+ No Cap
c. Binance Coin → Deflationary+ Cap
d. ETH post-merge → Deflationary+ No Cap
Therefore, purely from a supply perspective, all fiat currencies follow the same mechanisms as Dogecoin. Whereas, the best performing assets should ideally be those that fall under the third category.
- Regulatory Risks: Most of the blockchain assets still operate in certain gray areas, resulting in regulatory scrutiny from National/State Governments and Securities Exchanges.
- Smart Contract Risk: As has been seen time and again, a bug in a contract can have drastic implications on the overall ecosystem.
- Environmental Risks: The proof of work consensus mechanism adopted by Bitcoin has negative environmental consequences. Yet, going forward most of the blockchains such as Ethereum, Avalanche, and Polygon would be on the eco-friendlier Proof of Stake mechanism.
- Governance Risks: How equitable the distribution and the vesting schedule for the token is and how does it affect its overall functionality.
- Oracle Risks: Oracle provides off-chain information on-chain and can be exploited for market manipulation.
I truly believe that blockchain technology will transform the way we function as a society. The present form of the technology is analogous to what the Internet was back in the early 2000s i.e., we have only explored the tip of the iceberg till now. The technology makes me excited for the future and the positive impact that it can have on human society. Therefore, as far as investing in digital assets is concerned, I like to stay long-term and focus on asset selection rather than look at short-term strategies for trading. I believe the next crypto bull cycle would be ushered in by low-complexity Social Web3 applications, and “programmable money” that can maximize real-world utilities.