Electric Capital
Jun 14, 2018 · 10 min read

Electric Capital is founded by technology entrepreneurs. We have started multiple companies (five acquired), invested in 100+ technology startups with a cumulative market cap of $50+ billion, and served as executives at Facebook, Google, and Twitter. We offer our perspective on the emerging market for cryptocurrencies and crypto-enabled companies.

Disclaimer: This document is for informational purposes only, is intended to reflect the opinions of Electric Capital, and is not investment advice.

Summary: The Programmable Money Technology Stack is the Most Valuable Segment of the Cryptocurrency Market.

While a broad range of use cases have been predicted for blockchain, the most valuable use cases for cryptocurrencies are forms of “Programmable Money”. Programmable Money delivers currencies, banks, and financial instruments with new utility and potential value in the trillions of dollars.

I. Blockchain technology enables “Programmable Money.” Crypto and blockchain platforms are optimized to move slowly and never break, a uniquely good fit for use cases involving money. Programmable Money solves previously unsolved problems:

  • Seizure-Resistant Store of Value — cryptocurrencies are cryptographically secured, seizure-resistant, non-sovereign digital assets. We can now transfer $10 million in one hour between countries for a fee of $2 without a bank.
  • Privacy — new cryptographic techniques such as zk-SNARKs enable true privacy and anonymity. Private coins enable crypto equivalents to private banking ecosystems. Many banking and insurance businesses will take advantage of these privacy-preserving technologies.
  • Smart Contracts for Financial Services — smart contracts are software eating contracts. Instruments for derivatives, securitization of assets, lending, escrow, and insurance can now be expressed as software code. These smart contract platforms will often have strong regional network effects due to their interaction with regulation and regional norms.

II. “Programmable Money” is the foundation of a multi-trillion dollar new technology stack. The largest market size is for cryptocurrencies and companies in the Programmable Money category. Programmable Money tokens can earn a premium on their utility as non-sovereign, monetary stores-of-value and touch trillion dollar markets in securities, derivatives, and banking. Companies built on these tokens can transform industries yet to be disrupted by the Internet.

III. Investing in the Programmable Money stack requires an early stage technology mindset and specialized firms. The technology-driven nature of Programmable Money suggests assessing these assets via deep technology diligence (running protocol nodes, auditing code bases, meeting technical teams) and early-stage market analysis (user and network adoption, exchange utilization, etc.). “Companies” in crypto can be liquid tokens, illiquid tokens, equity, or equity-token hybrids. In addition, crypto firms must be able to self-custody a diverse set of assets and write software to participate in the market directly (staking, helping secure early stage networks).

Cryptocurrency Background / Context

The market has grown 24x since 2016, 50x the hashpower that was available in 2016 has come online, and crypto as an asset class continues to stay uncorrelated with other assets.

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Crypto continues to be uncorrelated with traditional assets

Cryptocurrency Market Segments: Programmable Money and Computation

Cryptocurrencies are a new asset class enabled by novel computer science and mathematics, such as Nakamoto consensus and zk-SNARKs. These innovations unlock use cases that were previously impractical. We classify cryptocurrencies by their use cases in order to forecast a project’s evolution and how the value that may accrue to the underlying token.

We can classify token-based projects in to the following segments:

  1. Programmable Money (Monetary Stores of Value, e.g. Bitcoin; Private Transactions, e.g. Monero; Smart Contract Platforms, e.g. Ethereum)
  2. Decentralized Computation and Infrastructure (e.g. Filecoin)
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Programmable Money is Useful Today and Trillions in Market Size

Programmable Money (Store of Value, Privacy Coins, Smart Contracts) is the most promising segment because:

  1. It is useful today with no significant technology blockers.
  2. The market sizes for Programmable Money are potentially in the trillions of dollars, so investors may still generate significant returns from today’s valuations.

The Distributed Computation market segments will likely take several years of investment in scalability and security before they are useful.

Programmable Money is Useful Today

Unlike Distributed Computation, Programmable Money is useful today. For money to fulfill its functions, it needs to be durable, portable, divisible, uniform/fungible, resistant to forgery, and widely accepted. Programmable Money fulfills all key features today better than most existing money and stores of value, such as gold.

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The Programmable Money Tech Stack Will Transform Industries Worth Trillions

At the base layer of this stack, digitized “cash” disrupts global store of values. The potential market sizes for a monetary store of value is in the trillions of dollars. Similar stores of value include gold with a market cap of $7.5 Trillion, $20T in offshore accounts, and global broad money supply (M3) at $97.5T. These markets will be served better by cryptocurrencies.

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Programmable Money is New Technology Driving Novel Utility

Programmable Money Winners Will Be Rooted in Unique Utility

Though market prices for stores of value are reflexive and reach an equilibrium over time, they are rooted in utility. Gold is inert, has industrial applications, is used as ornamentation and ceremonially, and historically had signaling value. When gold was established as a store of value, few alternatives existed with the same utilities. Similarly, to understand which Programmable Monies emerge as winners, we start by analyzing their foundational utility.

We classify Programmable Money via three novel utilities over other forms of money:

A. Store of Value — cryptocurrencies may offer a novel, non-sovereign store-of-value

B. Privacy — a better way to do offshore banking and store assets

C. Smart Contracts — code that can own, transfer, and manipulate money will result in better derivatives, lending, escrow, securities, REITs, insurance, and other instruments

A. Store of Value

Potential stores of value such as Bitcoin, Chia, and Coda are decentralized, uniquely seizure-resistant and non-sovereign, and exhibit many of the other requisite properties of stores of value. The initial utilities are cross-border payments, transferring assets out of the reach of a government, and transferring wealth in large sums. The use cases are distinct from payment networks such as Visa, which are efficient today in the developed world.

B. Privacy

Modern cryptography allows for confidential transactions (a third party cannot deduce how much was transacted) and anonymity (a third party cannot determine the participants in a transaction). These techniques work for currencies and smart contracts that hold private currencies. Private coins are bootstrapping off of the dark markets and private smart contracts will bootstrap off of international private banking. These ecosystems are actually representative of how the existing financial infrastructure operates. Today, money flows in to your possession, others cannot inspect these transactions without your permission, and all entities have an obligation to pay taxes. Privacy coins offer similar features, wherein a user could grant a third party such as the IRS a view-only perspective in to an account. The combination of modeling existing behaviors and enabling new digital use cases makes privacy coins and smart contracts a compelling starting point for the adoption of a new currency which could evolve into a store of value.

C. Smart Contracts

Smart contracts dramatically drop the cost of performing countless high-value transactions such as raising financing, borrowing money, or purchasing insurance. However, smart contracts are the most misunderstood aspect of the cryptocurrency ecosystem. Analysis often conflates smart contracts with distributed computation, but smart contracts should be seen as software “eating” financial contracts that wrap money. For example, Initial Coin Offerings are simple escrow agreements to raise funding and release funds according to rules laid out in code. Developers are building smart contract-based derivatives, lending, fundraising, and banking. By allowing code to control money, smart contracts enable novel use cases and lower barriers to creating financial infrastructure. If these transactions are backed by a single currency such as Ethereum, this currency could become a dominant reserve currency for a new crypto economy.

Programmable Money is the Foundation of a New Technology Stack

Crypto and Blockchain Are Optimized to Move Slowly and Never Break — a Uniquely Good Fit for Use Cases Involving Money

Crypto platforms sacrifice throughput and proceed carefully in pursuit of platform independence, immutability, seizure-resistance, and privacy. Crypto platforms are the opposite of the “move fast and break things” that drove Internet, social, and mobile platforms. Technology platforms that evolve slowly and never break are a uniquely good fit for use cases that touch money.

Companies built on programmable money are more transparent, trustworthy, and efficient. New banks, brokerages, insurance companies, and more, will be built on crypto and blockchain platforms. True digital “cash” that preserves privacy and anonymity will replace the $1.6 trillion USD in circulation and smart contracts will replace legal contracts for more efficient securities.

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Farther up the Programmable Money stack, centralized institutions like banks, brokerages, and derivatives all have crypto-enabled counterparts. Bank of America ($110B in revenue) has counterparts such as Anchorage. Charles Schwab ($9B in revenue) has analogs such as Coinbase, a crypto exchange currently valued at $8B, and Bakkt, a crypto exchange created by the parent company of the New York Stock Exchange. We believe these crypto-enabled counterparts to traditional financial institutions can extend the utilities of Programmable Money.

Crypto Requires an Early Stage Technology Mindset

Predicting Winners In Early Stage Markets Is Challenging

Even with known starting points, predicting eventual winners in early-stage markets is extremely challenging. There are technology, team, market, and timing risks. For token investments, economics and incentive structures for miners, validators, and users are paramount. There are potential pitfalls in execution and subtle product decisions that can take many years to play out. There are real-world network effects, language barriers, cultural barriers, and regulatory barriers.

Early Feature Decisions Can Have Dramatic Downstream Consequences

The history of technology is the history of small decisions made early in the history of a product that have dramatic, unforeseen consequences. Facebook and MySpace took dramatically different forms because of subtle differences such as a policy requiring users to use their real names. The importance of this early decision became apparent only after many years. Ethereum uses a Javascript-like programming language and Tezos using OCaml as its programming language. These trade off between the security of a smart contract and how many developers can develop in the ecosystem. It is unclear which tradeoff will be more successful long term, and there are hundreds of tradeoffs being made across dozens of crypto platforms.

Geography and Culture Have Dramatic Downstream Consequences

Culture, language, regulation, customer acquisition, and other factors are significant influences on adoption. The Chinese government, for example, has shown a keen ability to understand technology, king-make a domestic winner, inhibit non-Chinese competitors, and prop up the Chinese winner as a regional (and potentially global) winner. Baidu, Didi, Tencent, and Alibaba are all examples. Similarly, Korea, Japan, South-East Asia, and Russia have had winners independent of the rest of the world, e.g. LINE in Messaging or Naver in Search. The Programmable Money tech stack will be influenced by geographic and cultural factors, which makes picking a single winner at each level of the stack significantly more challenging.

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Investing in the Programmable Money Stack Requires Specialized Firms

Early-stage judgement and company-building support that traditional VCs offer are table stakes. The crypto platform shift redefines the operator-investor relationship, placing new requirements on investors.

Firms Must Handle a Diverse Set of Asset Types

The Programmable Money tech stack will require flexibility to participate. Crypto unlocks innovations in capital formation, new instruments for value capture (tokens), and requires active network participation. A firm needs to invest in equity, equity/token hybrid investments, and token-only opportunities. For instance, collateralized lending products manifest as companies such as BlockFi (equity), hybrid companies such as Dharma and Compound (equity + tokens), and decentralized organizations such as MakerDAO (tokens). These diverse value capture mechanisms require firms to operate in new ways.

Specifically, investing in tokens or token+equity hybrids requires new strategies such as holding a probability-weighted basket of liquid and illiquid tokens and accruing a position via exchanges outside a structured round of funding.

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Crypto Requires Custom Infrastructure and Technical Depth

The best crypto firms need data infrastructure tools to make real-time decisions, in-house custody for new or long tail assets, and active participation in networks to generate yield. Additionally, entrepreneurs need partners who have the operational know-how to participate as infrastructure providers, stake tokens for network security, and participate in governance.

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Programmable Money is useful today with a potential market size in the trillions of dollars. Programmable Money offers unique utility in the form of low fee payments, smart contracts, and privacy. It will form the base layer of a new technology stack that will disrupt finance, supply chains, and other industries untouched by the Internet. To participate, the Programmable Money tech stack requires an early stage, venture mindset. Like other early technology networks, it will be shaped by market factors including culture and regulation whose downstream effects will not be seen for years. Furthermore, investing will take many different forms across the stack — from tokens, to equity, to a hybrid of the two. Predicting winners is extremely challenging and identifying potential winners requires significant technological and market diligence. Given the potential for significant returns, actively identifying potential winners across market segments, geographies, and project stages is the preferred strategy.

Electric Capital is focused on Programmable Money. You can follow Avichal, Curtis, and Electric Capital on Twitter.

Electric Capital

Crypto Research and Insights

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