Could the right crypto asset disrupt Facebook and Google?

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As we described when initiating our coverage of other sectors that comprise our ICOs Playlist, blockchains and cryptocurrencies — and the decentralized applications (dApps) they enable — have the potential to be disruptive. The conditions that may determine the extent of that disruption, however, require careful consideration (as does how to value the tokens). In many (or perhaps, most) cases after all the “centralized” approach to software will be better for all involved.

We have selected 8 decentralized applications that together make up our Decentralized Digital and Social Media sector. The startups have cumulatively raised $146m in venture capital and $155m to-date through initial coin offerings. 3 of the startups — Kik (via Kin), Nexus (via Social), and Steemit (via Steem) — have crypto tokens that are traded publicly at current. The combined market capitalization of the three tokens is +$288m.

One upshot so as not to bury the lede: While trading at a premium to the price implied by our intrinsic analysis, we believe Steem is currently priced in a plausible range supportable by fundamentals.

What does decentralized digital and social media even mean really?

Decentralized digital and social media applications are those that are (a) not operated by a single entity and (b) are enabled by a crypto asset (h/t Adam Ludwin).

But what does that mean in practice? At a high level, a decentralized digital / social media application looks a lot like a “traditional” social media platform where users post, share and engage around various forms of both user generated and professionally produced content. The primary difference is the platform is supported not by a company that must, for example, sell advertisements to generate profits and in turn sustain itself. Instead, every user of the service is inherently a stakeholder in the service. Different engagements between users and the platform and between users and users can be executed through and / or incentivized by the exchange of the platform’s native tokens.

For example, users of Steemit create content and interact with one another in a forum very similar to Reddit. By interacting with posts via upvoting or liking content, users allocate Steemit’s native cryptocurrency (Steem) to the content creator, comment poster, etc.

Users of these applications must therefore own and transact in the service’s tokens in order to engage in the core activities of the service. The content around which users interact may also be stored across a decentralized network of servers rather than on those owned by the platform provider itself. A nod, if not more, to the growing privacy concerns of many users.

Is a decentralized approach to digital and social media compelling?

We often phrase this in our analyses as the “why now” question. And when analyzing decentralized applications the checklist often includes questions like:

1. Does the status quo rely on a powerful, centralized authority (or group of authorities)?
2. Is the business model of those authorities dependent on their ability to mediate certain terms of engagement and act as the “toll collector”?
3. Is there a censorship component to the model that may prove unappealing to consumers either now or in the future?

It does not take someone overly familiar with the digital and social media category to feel instinctively that those criteria may apply:

1. The digital and social media market is, for all intents and purposes, a duopoly. Facebook and Google generate ~50% of all digital advertising revenue. They have aggregated a dominant share of the globe-ex-China’s attention, and…
2. They monetize that share of attention ruthlessly and often at the expense of other stakeholders, including the publishers of the very content that soaks up the attention.
3. They monitor the interactions of their users very closely, if only to help better target the advertisements they sell to fund the business model described in (2) above. The result is perhaps the purest embodiment of the concept “if you don’t pay for the product, you are the product.”

As a result, and at the highest level, the concept of a decentralized approach to social media has the seedlings of substance. Add on growing mistrust in institutions and a desire for privacy — or the perception of privacy — and the conditions may in fact be ripening.

Are there elements of any one application’s approach that seem more likely to succeed?

As the decentralized applications that comprise this sector remain in their relative infancy, isolating a winning strategy is of course challenging. Most or all of the services attempt to use a native currency to incentivize user engagement. The idea is to compensate the users that bring value to a network. If you share or publish an interesting video or post, other users can vote currency in your direction. In some ways, this is a crypto token doing one of the things it’s best suited to do: cracking the chicken-and-egg dynamics of building a network. By rewarding early participants with hard value, crypto-based networks give themselves a better chance of reaching critical mass adoption. But that dynamic is general to the sector.

Some of the dApps in the sector stress the importance of encryption and privacy of user content. Nexus, for example.

Some of the services in this sector make it possible for other decentralized applications to integrate their tokens. Kin (from Kik) and Props (from YouNow), for example. This may ultimately make the currencies more valuable, by increasing the size of the “economy” running over the currency’s “rails”.

Steem meanwhile is the highest capitalized of the group (the market cap of Steem is +$220m), was the first to market, and with a focus on the relatively simple posting and upvoting dynamics of a Reddit-like experience may appeal most to the early adopters of this kind of experience, who have tended to spend time in the less designed, “deeper” parts of the Internet previously. There are an estimated 257,000 registered accounts on Steemit with 23,700 daily active users. That said, the full Steemit system is complicated to understand, as it actually includes multiple inter-related currencies. And we are not completely convinced that Reddit’ers are disgruntled (or at least not as much as YouTube stars).

What case for distributed social media are investors underwriting by buying Steem (for example) at current prices?

Among the unique dynamics of decentralized apps is that their tokens are traded and that that trading sets a price. That price, in turn, can be evaluated. If we take Steem, for example, which is the primary token of Steemit, we can ask questions like:

1. What according to an analysis of the fundamentals is the price at which Steem should trade in the intermediate future?
2. Or inversely, what do current trading levels suggest are the expectations of investors buying Steem?

To assess this, we use the “quantity value of money” theory, which was advanced originally by, among others, Milton Friedman and has returned to mainstream dialogue with the rise of crypto assets.

Applied here, the theory states that the fundamental value of a crypto asset is equal to T(t) / (S(t) x V(t)) where T is an estimate of potential future Steem transaction volume derived, in this case, from an estimate of the serviceable addressable market (SAM) for decentralized digital and social media, V is the velocity, and S is the supply of tokens.

• We estimate the SAM in 5 years for decentralized digital and social media at ~$2.5b and include the full detail later in this report. As a point of reference, the overall digital advertising market is expected to reach $335b by 2020, so our estimate is fairly conservative as to the traction of decentralized apps in penetrating this category over the next 4–5 years. For illustrative purposes, we also present our analysis with the assumption that the relevant token / platform achieves ~50% share of the serviceable addressable market (SAM). Current market share dynamics (see the duopoly described above) support the perspective that this is likely to be a winner take most market.
• We assume Velocity of 10. The velocity of the M1 US Dollar money supply at its peak was 10. Crypto tokens are easy to trade and will likely change hands at a higher velocity than basic US currency. For context, a single Bitcoin could be utilized as much as once every ~10 minutes and more realistically at ~ once every hour (or 8,760 annually). Our analysis is highly sensitive to this assumption. And an assumption of V=10 ends up being on the “aggressive” end when it comes to the implied price of the underlying token. So, in this case, we offset the conservativeness of our T assumption in part with our V assumption.
• We use the ultimate supply of a given cryptocurrency (in this case Steem), rather than the supply of currency that is currently released. A central component of most cryptocurrencies is the ability for more currency to be mined / released over time. Seeing as we are thinking about a market in the future, we believe the future supply of currency is a better estimate than current.

This framework allows us to consider current Steem trading prices in two ways:

• SAM => Price: First, we can use our own market sizing analysis to imply an intrinsic value of each currency. Using our $2.5b future SAM estimate, the implied intrinsic value of one Steem token, assuming velocity of 10 and 50% market share, would be $0.48. It is currently trading at $0.98 (as of 25-Oct), or a 105% premium to the intrinsic value estimate.
• Price => SAM: Second, if we flip the analysis on its head, we can also use the current market price of one Steem token to consider what investors buying the currency at current levels are implicitly underwriting as the size of the decentralized digital and social media market in the future. The current Steem token price of $98 implies a SAM of $5.1bn. To put that in context, and as mentioned above, estimates suggest that the overall digital advertising market will reach $335b by 2021, and we estimate the SAM for decentralized social media in ~2020 at $2.5b.

While our fundamental analysis at current may imply a discount to current Steem trading levels, the reason for running this analysis in two directions is to try to triangulate what case investors might be underwriting. And in the case of current Steem trading levels, the concept of a ~$5b market for decentralized social media strikes us completely plausible.