How To Understand The First Principles Of Crypto
The reasons blockchain will change the game.
This the real world, homie school finished, they done stole your dreams, you don’t know who did it. — Kanye West, Gorgeous.
It’s undeniable there’s a huge amount of speculation in crypto. Fledging founding teams are sourcing huge amounts of capital via ICO’s (Initial Coin Offerings), valuations of the largest, more mature cryptocurrency projects are in the tens to hundreds of billions. Undoubtedly there is a lot of mania, and undoubtedly a lot of people are going to get rekt.
Contrary to popular belief, crypto is not a get rich quick scheme, and, as is always the case with capital allocation, it will be the patient and the educated who end up winning in the long run. Just like the dot com bubble, we will have the pets.coms, and the webvans, spawned from nothing but a speculative frenzie, but we will also have the next Amazon’s, and the Google’s — world-changing companies underpinned by a crystal clear vision and game-changing technology.
So how can you have success in crypto? Unfortunately, patience probably can’t be taught, and definitely not through a blog post, but the fundamentals of crypto, which may help you differentiate the wheat from the chaff — can.
In this article, I’ll break down what I believe to be the fundamental first principles of the value crypto creates and the real game-changing innovations it brings to the world. These are the principles I look at, that when combined with a genuine problem solved, can weight the odds in our favour.
Principle 1: A Completely New System of Ownership
What excites me most about defi (decentralised finance) projects is the completely new system of ownership they offer. In the current nation-state model of ownership, you generally have shareholders, directors, employees and customers — all with completely different rights, roles and responsibilities. Let's break this down by looking at the example of one of the largest web 2.0 successes — Uber.
Uber’s initial shareholders were the founders, angel investors and venture capitalists. In order to invest in Uber at this stage, you’d need to be a) very well connected, and b) regulated, deemed to understand the ‘risks’ of your investment (a security). This regulation keeps the poor, poor, blocking them from high growth startups. The average joe couldn’t invest in Uber — or any private company. The best he could do was 8% per annum via the public markets.
The employees at Uber are employed via an employment contract and are pretty much entirely paid in $USD. On this income, they’d be taxed over 30%. The first employees may get some meaningful stock options, anyone joining after a few years, wouldn’t get much. Not a great deal.
As for the customers (and in this case we refer to the drivers as well, as they are not technically employees), they get the real raw end of the deal. If you are an early-adopter of uber, you may get a few hundred dollars worth of credits for free rides. As a driver, you may also get some cash payment for referring other drivers, but apart from that, you aren’t really any better off than someone who started using the platform once it was in its mass adoption phase. This is pretty terrible. It’s the initial customers who make the product, they should see a portion of the upside.
“It’s not hard to imagine a decentralised version of Uber in the future, in which every driver has a choice between collecting dollars or the equivalent $ amount for the work they do in tokens of the project. Likewise, customers could pay in these native tokens, creating an ecosystem where the currency of the service is also ownership of the company…. early customers would have as much exposure to the upside of the platform as early investors.”
Crypto completely flips this model of ownership on its head. Tokenisation means that incentives can be drawn up which gives early users of the product tokens for their participation. This means that as a customer, you can gain ownership of the project, simply for participating. An example of this is the BRAVE browser, which rewards customers with $BAT, the BRAVE token, for each ad they are exposed to.
It’s not hard to imagine a decentralised version of Uber in the future, in which every driver has a choice between collecting dollars or the equivalent $ amount for the work they do in tokens of the project. Likewise, customers could pay in these native tokens, creating an ecosystem where the currency of the service is also ownership of the company. As the popularity of the startup increases, the utility and TVL (total value locked — basically investors holding) of the token would drive the price higher, but service rates would be set at the rates of a stablecoin ensuring stability. A ride that used to cost 5000 tokens, would now only cost 100 tokens.
The result — early customers would have as much exposure to the upside of the platform as early investors. Dreams stolen no more.
Principle 2: Radically Different Incentive Structures
If you like astrology and healing crystals study macroeconomics. If you like the scientific process, study micro-economics. One of the fundamental pillars of microeconomics, in fact arguably the only pillar, is that of incentives. Incentives drive everything we do, and are responsible for the obesity pandemic, to the 2008 financial crash, to ‘Keeping up with the Kardashians’ being such a hit.
If we look at the cause of the 2008 recession, you’ll find it was the doing of greedy bankers, fearful (of losing business) regulators, and incompetent auditing firms. There’s nothing inherently evil about the traits of greed, fear or incompetence. A pig is greedy, but if incentivised to eat cheap grain, will profit its farmers. An army recruit is incompetent, but if given minimal free will and rigid instruction, can make a great soldier.
“the fact that most economic problems comes down to incentives doesn’t make things easy, but the blockchain does make it solveable.”
Now I’m not saying the fact that most economic problems comes down to incentives makes things easy — far from it, I’m just saying incentives are solvable, and the blockchain makes the creation of incentives that serve a wider-reaching perspective, a lot easier.
Blockchain making constructing incentives simpler is a combination of a few different factors. The first is the transparency that the blockchain provides, getting rid of double-entry bookkeeping means that the consensus of a transaction achieved on-chain is an immutable source of truth. If regulators, bankers, and executives were mandated to keep records on a public ledger, for anyone to see, perhaps this would make doctoring the books a lot less attractive.
The second reason the blockchain makes incentives easier to structure is through the idea of a DAO (decentralised autonomous organisation), which I covered in detail in this article. Effectively DAOs allow voting for certain decisions on-chain. One token can equal one vote, one human can equal one vote, or quadratic voting can be employed to find somewhere in between.
Voting can also be weighted to allow participants who have contributed more to the project to have more impact. Interoperability (the interaction of various blockchains) can also help to form dependencies between organisations, for example, a decision on whether to mine a local resource could be run through a number of different protocols that would represent the local community, regional businesses, and the resource needs of a larger scale. DAOs then, allow decisions to take a wider, systems thinking perspective, and shape incentives accordingly.
Finally, tokenomics can be used to incentivise long-term results over short term gains. People rightly kicked off at bankers bagging huge bonuses after causing the collapse of their company, and the economy, if instead tokens in a firm, vested over a suitably long period were used as a reward, you may encourage longer-term thinking.
Principle 3: Disintermediation as a Service
Probably the simplest benefit of blockchain to explain is that of disintermediation. Everyone hates middlemen taking a piece of the pie, the blockchain invalidates the need for them. Let’s use the OG protocol of Bitcoin to make the point.
Say you make a payment online. First, you debit the amount from your Visa card, which then gets sent to Stripe, or whatever payments processor the platform uses. If it's an international payment, it might be sent to a transfer service, before settling in the account of the company you are paying. All of these services have to keep a separate account of the transactions, and then reconcile that transaction with each service used. It may seem that this payment has gone through instantly, but the whole process takes around 3 days.
On Bitcoin, your payment is pushed as a transaction ID to the blockchain, where miners then validate this transaction. That’s it. 1 step, and no intermediaries to keep separate books. This whole process takes around 30 minutes, but Bitcoin is old and slow, on the 3rd generation protocols such as Fantom, transactions are resolved in seconds.
I can’t see an industry in which blockchain won’t have some impact in killing the middle man. From real estate, to supply chains, to manufacturing to transport, if you can cut out middlemen, and multiple sources of truth, by having a single immutable source of on-chain truth, any savvy businessman would do that every time.
Hopefully, this article has shed a bit of light as to why the technology of blockchain can be so revolutionary, I have a few points I want to discuss that I didn’t get a chance to in this piece, so if you’re interested in hearing them, make sure to sign up to my newsletter to hear them first.