The evolving Blockchain

Blockchain organizations face accelerated evolution

Fred Ehrsam recently observed that tokenized protocols [1] have a key advantage over traditional companies. This is because these blockchain-based protocols can evolve multi-modally:

Silicon Valley itself was borne from the “forking” of Shockley Semiconductor Laboratory by the Traitorous Eight, who created Fairchild Semiconductor. Fairchild was was then “forked” into Intel, AMD, and others. Rinse, repeat.

The Traitorous Eight. Gordon Moore (far left), co-founder of Intel, author of Moore’s Law.

We (at FundersClub) have invested in over 200 top technology startups; the common trait amongst the outlier companies is their rapid evolution in growing markets. As a case in point, looking within our blockchain portfolio, Coinbase began as a wallet service. It is now a leading digital currency and token exchange, and is expanding as a platform for distributed consumer applications, tapping into a phenomenon I describe below as functional blockchains. Echoing Shockley Semiconductor and Fairchild, Coinbase has also indirectly given rise to other key players in the blockchain space, including Polychain Capital.

The above evolution has occurred at breakneck speed, but even faster organizational iteration is on the horizon. Iterating upon and even forking an entire organization and network with the efficiency of software is incredibly powerful, and the blockchain makes that possible. We are only just beginning to see this potential emerge as software developers create a new class of blockchain-based functional organizations and protocols.

We are on the cusp of a functional blockchain explosion

When we first invested in Coinbase in 2012, the global market cap for the entire blockchain space was less than $150M. Today it is over $75B [2].

This growth was originally predominantly fueled by speculation that Bitcoin and similar blockchains were a new digital currency, and later, a new digital store of value, or “digital gold”.

However, much of the recent growth is driven by an entirely different type of blockchain. These are not optimized as currencies or for store of value, but rather for efficiency as functional protocols. The bar for and potential upside of these functional blockchains and blockchain protocols is set much higher than for store of value blockchains. This is because they need to deliver differentiated and defensible functional value, which is harder than and potentially more valuable than merely replacing assets like gold.

Examples of functional blockchains and functional blockchain protocols being developed now include those coordinating and powering applications, transactions, resources (compute, data, energy, assets, etc.), and governance [3]. Speaking of gold, there are even functional blockchain protocols whose purpose is to represent and digitally transact physical gold assets [4].

The market cap of Ethereum, the pre-eminent functional blockchain, differentiated by its application and transactional features, has grown 28x since the start of this year.

Market cap of Ethereum Jan 1 2017— June 1 2017 (in USD)

Of course, everyone is a genius in a bull market. Anyone who bought nearly any type of blockchain asset in the last few years to last few months has seen their holdings grow in value, assuming they simply bought and held. I received my first Bitcoin in 2012, then worth $6. Simply laying around, it is now worth over 367x more [5].

Not all that glitters is gold, and much of this value appreciation is speculative. However, real value is being created by innovators in the blockchain space, and at an increasingly mind-boggling pace.

Fundamental dilemmas for blockchain innovators

The blockchain space saw an enormous bull-bear cycle play out in 2013–2015, demonstrated great resilience then, and is in an even stronger position to bounce back from the future pullbacks still to come. Unlike in 2013–2015, blockchain has crept into nearly every nook and cranny of technology. It’s clear that blockchain is here to stay.

Rather than be distracted by the rise and fall of speculative markets, I think blockchain innovators should think about core dilemmas innate to today’s blockchain design, and how they will address them:

• Decentralization — Decentralization of a blockchain protocol enables tapping into network effects. Yet the development of blockchain protocols is typically centralized and politicized, with key developers wielding monarchy-like power. Additionally, key decisions in many networks are gated by a specific class of users (e.g. in Bitcoin’s case, the miners). These groups may have differing incentives from the bulk of the network, which can lead to suboptimal outcomes. Further, protocols beginning their networked life through token sales are beginning to see a highly concentrated initial base of token holders, which erodes the network effect incentives of a decentralized protocol [6].
• Immutability — Some blockchains claim to derive their value from immutability, for example, store of value blockchains. Yet these are ultimately pieces of software with development teams and networked users in an ever-changing world. While the ledger needs to remain immutable, it may be unrealistic to expect the protocol itself to also remain so and yet still continue to deliver on its original promise.
• Efficiency — Current blockchains are secured through something called proof of work, which roughly means the validity of a given network node’s record of the distributed ledger is proven by their correct answer to difficult computational problems. Solving these problems takes processing power, which requires electricity. This ends up using an incredible amount of energy. A 2014 study concluded each Bitcoin mined releases over 100 kg of CO2. This is also partly why today’s blockchain transactions take more time and cost more money than non-blockchain transactions. A new approach to securing blockchain networks that does not take energy, proof of stake, is on the horizon.
• Democratization — Many blockchain proponents believe in the potential of the blockchain space to democratize opportunity. Yet we have seen a reversion to traditional capitalization models in the world of blockchain protocols. VCs and hedge funds are buying at discounts to the rest of the market at pre-sale ahead of initial token sales, and wealthier investors are paying to “cut the line” at initial token sales.
• [EDIT] Scalability — Much work remains for core blockchain infrastructure to approach the scalability required for global, mainstream use (true for both protocols and applications). The infrastructure stack — compute, storage, etc — is very nascent in 2017. Luckily, the space is heavily incentivized to address these collaboratively and quickly. Some have claimed there is a fundamental tradeoff between decentralization and transactional speed, but a balance can be struck between using the decentralized ledger for validating trust, and using direct peer connections and sideledgers for speed once validated on the chain.

Coming full circle, one reason to remain bullish on the blockchain space is that blockchain-based protocols can and are evolving multi-modally. Blockchain innovators, each developing their ideal vision, are unwitting participants in a grand experiment of natural selection favoring the most robust and efficient of protocols.

Notes

[1] If you’re not familiar with token protocols, Chris Dixon recently wrote a good background post describing some of their unique features.

[2] Covers the market cap of Bitcoin, Ethereum, all Ethereum-based protocols and distributed apps (those based on the ERC-20 standard), and other blockchains, as reported by coinmarketcap.com and coincap.io. These market caps are based on circulating supply vs. total and future supply, which means true market caps are either understated or overstated depending on what you think the market has priced in.

[3] Detailed coverage of specific blockchain protocol examples is beyond the scope of this post, but for a preview, see Ethereum (applications and transactions), Golem (compute), Filecoin (data storage), Aragon (governance), Mysterium (VPN/Internet), Blockstack (full stack decentralized web).

[4] DGX

[5] In 2012 & 2013, Brian Armstrong unknowingly took on the role of the Johnny Appleseed of Bitcoin, gifting free Bitcoin to people he met around the world as he evangelized a new industry and his new startup, Coinbase. Based on today’s price of Bitcoin, I estimate the amount he gave away to be at least a few hundred thousand dollars, and possibly millions of dollars.

[6] The recent Brave browser token sale lasted just seconds, resulting in many would-be network participants blocked out, and resulting in a heavily concentrated network base.

Thanks to the founders and teams of Coinbase, ShapeShift.io, Protocol Labs (Filecoin, IPFS), Golem Project and others whose leadership in the space has given me and many others a glimpse into the future of the blockchain. This post’s image is from the Harry Potter fan Wiki and only marginally relates to this post, but I needed something about complex networks resolving themselves and this is the state of today’s image search algorithms.