Envisioning the Stacks of a Decentralized Financial System & a Decentralized Internet

TL;DR. In this piece we focus on the directional vision (as we understand it today) of the developing digital asset ecosystem and explore this vision from a decentralized financial perspective and a decentralized internet perspective, both of which are evolving from their centralized predecessor establishments. The current global financial system, or “money stack” as we refer to it herein, is estimated to be worth approximately $90 trillion dollars. [Source: http://money.visualcapitalist.com/worlds-money-markets-one-visualization-2017] We explore how bitcoin and other money protocol contenders could potentially re-architect part of, if not all of, this money stack in a decentralized fashion, and what such a decentralized money stack could potentially look like. We do the same for the internet stack that also accrued many hundreds of billions of dollars in aggregated market capitalization over the last two decades. We explore how the emerging decentralized internet stack could co-exist alongside the existing (centralized) internet stack, and what this could look like. What marketplaces will these new digital economies unlock? What problems are they solving? What we hope to accomplish here, is not about being “right” or “wrong” with our vision, but rather to share this vision with readers of all backgrounds (technical and non-technical) in hopes of making the contemporary cryptoasset revolution appear more comprehensible. It is our goal to continue to produce similar content going forward in hopes of increasing the quality of education for the community and facilitating the adoption of this new digital world. Let’s begin.

The Money Stack: Envisioning a Decentralized Financial System

One of the so-called “killer apps” of blockchain technology is the growing consensus around decentralized money. Those that read “The Bitcoin Standard” by Saifedean Ammous are aware that there is a case to be made that people’s choices for money are subjective, and so there is no “right” or “wrong” choice of money, but that there are, however, consequences to choices. In his work, Ammous demonstrated that if one explores the history of money, there is a long history of technologies performing the functions of money, from primitive systems of trading limestones and seashells, to metals, to coins, to the gold standard and to present-day where we have modern government debt. As a result, the choice of what makes the best money has historically been determined by the technological realities of societies shaping the salability of different goods. It should also be noted that cryptoassets like bitcoin represent defensive technologies, whereby the cost of defending property and information secured by the underlying blockchain technology is far lower than the cost of attacking them. As a result, users can protect their holdings in a censorship resistant manner without having to trust others to protect their wealth for them. This is particularly valued in regions like Venezuela, Turkey, Iran and Zimbabwe, where these countries are facing ongoing economic crises and are suffering from high levels of inflation. Many are paying attention to these currency crises in case they continue to spread across the globe.

To understand how this decentralized financial system may develop, we believe it’s important to first understand our current financial system and then compare the two. An infographic of the current system (left) and the envisioned decentralized system (right), using bitcoin as an example, is presented below:

Starting with the traditional financial system (left side), the system essentially starts with the central banks that work directly with the governments. These central banks work with investment banks, commercial banks and retail banks, which in turn serve a variety of markets. The investment banks and commercial banks, for instance, facilitate various capital markets (equity markets, debt markets, etc.). These banks also provide custody services, clearance and settlement and other services such as the ability to transfer value from one party to another. On the retail banking side, the retail banks serve end-customers with a variety of products (checking/savings account, mortgages/loans, etc.). As illustrated above, the estimated money supply in the world when you consider all of these categories (across the M1, M2 and M3 money supplies) is approximately $90 trillion dollars. [Source: http://money.visualcapitalist.com/worlds-money-markets-one-visualization-2017]

In consideration of the foregoing, we acknowledge there is a case being made that bitcoin and other money protocol contenders (e.g., ETH, ZEC, XMR, and others) can potentially re-architect our existing financial system, in whole or in part, in a decentralized, peer-to-peer fashion outside of a government’s control. As a result, many people believe the money stack as it exists today is poised for significant disruption, either by a sound money (something like bitcoin, that many believe is designed to be able to retain value across time, across space and across scale), or a programmable money (where users can program how, when and where money moves, essentially automating how things like wills, trusts, escrow agreements and more are governed). It should be noted that these features may also coverage, creating a programmable, sound money.

So why is this important? Why is this considered a revolution?

For starters, bitcoin sparked a socioeconomic, paradoxical disintermediation movement on a global scale as a response to the 2008 global financial crisis. Bitcoin is arguably one of the biggest leaps in technological innovation since the creation of the internet and has created a new era of digital money. This paradigm has proceeded to disrupt industries and financial institutions as well as introduce a new value proposition focused on transparency and decentralized trust. Bitcoin is also the first practical solution to the longstanding problem in computer science called the Byzantine Generals Problem (“BGP”). To quote from the original paper [Source: https://people.eecs.berkeley.edu/~luca/cs174/byzantine.pdf] defining BGP: “[We] imagine that several divisions of the Byzantine army are camped outside an enemy city, each division commanded by its own general. The generals can communicate with one another only be messenger. After observing the enemy, they must decide upon a common place of action. However, some of the generals may be traitors, trying to prevent the loyal generals from reaching agreement. The generals must have an algorithm to guarantee that.” Bitcoin presented a solution of how to establish trust between otherwise unrelated parties over an untrusted network like the internet, which many argue is a tremendous, technological breakthrough.

In consideration of the foregoing, we spent some time considering what a decentralized financial system could look like, with the bitcoin blockchain network as an example. In our view, we view the bitcoin main chain serving as the settlement layer, similar to the London Bullion Market Association (LBMA) for the gold markets. On top of this base layer come the “Layer 2” protocols. Examples of these Layer 2 protocols include the Lightning Network, where “smart contracts” keep tabs (in an extremely speedy way) of what the balance is of particular “contracts”, that are then ultimately settled on the main chain. Other examples of Layer 2 solutions we see emerging are channel factories/hubs, exchanges, payment processors, bitcoin banks and other scaling solutions. In the case of sidechains, such as Blockstream’s Liquid federated sidechain, the smart contracts essentially mimic a blockchain-like environment via multi-signature wallets with a limited number of participants. The idea is that this can enhance processing speed and flexibility while essentially retaining many of the security properties of the main chain. It is important to note that ultimate settlements will still happen on the main chain. Finally, “Layer 3” is envisioned to emerge as a decentralized application layer, with applications built on top of the Lightning Network (“Lapps”) along with several compatible apps built on Eclair and c-lightning. [Source: https://dev.lightning.community/lapps/index.html] Other envisioned examples of Layer 3 decentralized applications include uncensorable value transfer solutions, peer-to-peer finance, merchant services and collateral and digital collectibles (e.g., Rare Pepes exist today, but we believe there will be future sophisticated evolutions of digital collectibles). [Source: http://rarepepedirectory.com/]

The Internet Stack: Envisioning Web 3.0 & a Decentralized Internet

Switching gears to the internet, similar to how we analyzed the money stack, we believe it’s important to first understand the current internet stack and then compare it to the developing decentralized internet stack.

If we begin by observing the internet revolution over the last two decades, we’ve seen physical internet infrastructure serve as a base with protocols such as TCP/IP, SMTP, FTP, HTTP, etc. built above it. TCP/IP and the other internet protocols control the routing of web traffic, video streaming and more. The creators of these protocols in the early days of the internet didn’t make money for their innovation aside from consulting fees and other supplemental income, because while those protocols created a ton of value, they didn’t capture that value. Instead, we witnessed tremendous value creation and value capture (in the form of many hundreds of billions of dollars in market-caps in many cases) across many platforms built on top of those protocols (e.g., “Layer 2” solutions), including (but not limited to):

· Mobile solutions (iOS & Android operating systems by Apple and Google, respectively);

· Carrier services (e.g., Verizon, AT&T, Sprint, etc.);

· E-commerce (e.g., Amazon, Ebay, Groupon, Jet.com, etc.); and

· Internet service providers (Verizon Fios, Comcast Xfinity, Spectrum, Warner Media, etc.).

Centralized applications eventually emerged on top of these platforms, many of which also accrued hundreds of billions in market caps, such as:

· Social media (Facebook, Instagram, Twitter, Snapchat, etc.);

· Transportation (Uber, Lyft, etc.);

· App Store (iTunes, iOS App Store, Microsoft App Store, etc.);

· Email applications (Gmail, Outlook, Yahoo, etc.);

· File storage solutions (iCloud, Google Drive, Dropbox, etc.);

· P2P payment solutions (Venmo, Apply Pay, PayPal, etc.);

· Messaging platforms (WhatsApp, Telegram, etc.);

· SaaS businesses (Salesforce, AWS, Slack, Adobe, Box, Google Apps, Shopify, Mailchimp, WordPress, etc.); and

· Steaming content (Spotify, Hulu, Netflix, HBO, etc., enabled by internet service providers).

We realize the foregoing examples are not all-encompassing, and we do not intend to list out every platform and application on the internet in this piece. Rather, we wanted to illustrate this internet evolution from “Web 1.0” to “Web 2.0”, and where value was captured. In consideration of the foregoing, what we have in the present-day is the evolution of a so-called “Web 3.0” paradigm (aka, a decentralized internet). On top of the existing physical internet infrastructure and internet protocols/mesh networks, we foresee a nascent decentralized network stack developing (a “Layer 2”) that begins with middleware protocols that provision functionality for things like financial contracts, decentralized exchanges, curation markets, and more. Alongside these middleware protocols, we have a resource marketplace that essentially enables the exchange of digital commodities (e.g., storage, compute power, network bandwidth, memory, etc.). Finally, on top these Layer 2 platforms, we have a Layer 3 platform, which constitutes a decentralized application layer. [Sidenote: With the helpful feedback of Davison Avery (@otoburb), we acknowledge internet purists coming from a “legacy” worldview may view the internet in the context of the OSI model that is already categorized into Layers 1 to 7. They may present the case that these new decentralized internet stacks should be “layer 8+”. For this research piece, we intentionally elected to keep the illustrations more basic in hopes of reaching a more general audience]. We envision interoperable networks to co-exist alongside this, with the following examples (also not all-encompassing) expected to reach the end-consumer:

· Finance 2.0 products;

· Decentralized autonomous organizations;

· Prediction marketplaces;

· Decentralized social media;

· Decentralized browsers/DNS;

· P2P marketplaces;

· Gaming and digital collectibles (non-fungible tokens);

· Uncensorable value transfer solutions;

· Decentralized insurance networks; and

· Decentralized key storage solutions.

In sum, we hope these infographics provide color into the potential marketplaces these new digital economies will unlock. What we hope to accomplish here, is not about being “right” or “wrong” with our vision, but rather to share this vision with readers of all backgrounds (technical and non-technical) in hopes of making the contemporary cryptoasset revolution appear more comprehensible. We understand many projects working on building within these decentralized stacks have yet to deliver on their promises and acknowledge the non-zero probability that some may never fulfill those promises.

We will continue to monitor this developing ecosystem and update these infographics accordingly as trends continue to develop. It is our goal to continue to produce similar content going forward in hopes of increasing the quality of education for the community and facilitating the adoption of this new digital world.

Special thanks to Tuur Demeester, Nic Carter, Matt Odell, Ria Bhutoria, Dan Held and Jake Franek for their feedback.

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Vision Hill Advisors is a crypto asset and blockchain focused fund of funds. Through a proprietary fund manager selection process and institutional level due diligence, Vision Hill aims to lead investors into the future of digital assets. Vision Hill brings together a team with extensive experience in traditional financial markets, a deep passion and understanding of crypto and digital asset markets, and a history of risk and portfolio management.

The content provided herein should not be considered investment advice, and is not a recommendation of, or an offer to sell or solicitation of an offer to buy, any particular security, strategy, or investment product.