The Cryptoasset Taxonomy

The crypto landscape continues to evolve at incredible speed. Bitcoin is seeing rising demand and adoption from consumers, corporations, asset managers and governments. The biggest challenge facing Ethereum right now is that there is so much demand that the fees on the network are rising to new highs. Eighteen months ago, DeFi was not even a term in the lexicon and now we have fully decentralized exchanges that are processing over $1 billion of transaction volume per day. Non-fungible tokens (NFTs) are being sold for millions of dollars and completely disrupting the digital media landscape. With all of these developments it’s tough to stay current even for those of us who have tracked this industry on a daily basis for years, let alone for newcomers to the space.

For that reason, I put together a simple, easy to understand overview of the various categories of cryptoassets. Before we dive in, you will notice I use the word cryptoassets, rather than cryptocurrencies, whenever I speak or write about the industry. This is very intentional because most of the tokens in the market today are not intended to be currencies at all. Some are platforms that enable other applications to be built and accrue value the more they are used. Others are backed by real world assets and appreciate alongside the value of the asset. There are cryptoassets that accrue fees and pass those “cash flows” along to the token holders. As such cryptoassets do not fit neatly into traditional asset class categorization. My hope is this graphic and post help clarify the ever-evolving landscape.

Cryptocurrencies

Cryptocurrencies are decentralized tokens that aim to be a store of value, settlement network, or a medium of exchange. Because Bitcoin falls in this category, cryptocurrencies have historically received the majority of mainstream media coverage. In reality, there are actually very few noteworthy cryptocurrencies beyond Bitcoin.

Store of Value & Settlement Network:

Bitcoin. That’s really all you really need to know about this segment of the market. There is nothing else that can compete with Bitcoin in terms of historical value appreciation, monetary policy, or demonstrated network effects. Bitcoin’s market cap is now roughly $1 trillion and commands over 60% of the overall market size of all of cryptoassets. Bitcoin’s scarcity and transparent monetary policy makes it the ideal hedge to fiat currencies and as long as demand continues to rise, so too will Bitcoin’s value.

Bitcoin is also a superior settlement layer to our current financial system. A common misconception about Bitcoin is that it is competing as a payment layer with the likes of Visa or Mastercard. While there is technology being developed that may one day allow Bitcoin to become a mainstream medium of exchange, today Bitcoin is much better used as a settlement layer than it is a means to buy a cup of coffee with. As such, the competitive comparison should be to SWIFT and ACH, in which case Bitcoin completely outshines both. These settlement layers are designed to securely handle large transactions on a relatively infrequent cadence compared to payment layers. International bank transfers can take anywhere from 1 to 5 days because these legacy systems are not directly connected. Instead, payments have to go through intermediaries known as corresponding banks, similar to how passengers often have to take a series of connecting flights to arrive at a destination. These transactions come with a host of fees including bank fees and transfer operator fees that can become hundreds or even thousands of dollars depending on the banks involved and the size of the transfer.

In contrast, Bitcoin eliminates all middlemen and allows two parties to transact directly with each other. Last year a Bitcoin user transferred $1 billion worth of Bitcoin on the blockchain that cost the sender a grand total of $0.68 in transaction fees. Better still, these transactions can finalize in a matter of minutes rather than days. Bitcoin is simply a far superior international settlement layer than our current legacy systems.

Stablecoins

Bitcoin, for all its successes, is still too volatile on a daily basis to currently be used as a medium of exchange. In order to solve this volatility challenge, stablecoins were created. Most stablecoins are pegged 1:1 to the dollar and allow anyone to execute transactions on the blockchain without the worry of volatility. These coins are not designed to appreciate in value, in fact just the opposite, they are designed to maintain a constant price.

Privacy Coins

Although your identity isn’t necessary to transact on a blockchain the same way it’s necessary to transact with a credit card, all transactions on a blockchain are transparent for anyone to see. Thus, every transaction is pseudonymous. If the public key used in a transaction is linked back to a real-world identity, which is often easier than you might expect, it becomes pretty simple to prove who was involved in a transaction. This is why every law enforcement official would much prefer a criminal to transact in Bitcoin rather than cash. However, there may be times where one may want more privacy. This group of coins aims to provide exactly that. Today, these coins offer a niche use case but are worth monitoring as privacy concerns continue to grow.

Smart Contract Platforms

The easiest analogy for this group of protocols is a decentralized version of AWS. Much like AWS has provided the computing power to enable many other applications to be built on top of it, smart contract platforms are enabling fully decentralized applications to be built on top of these protocols.

Today, our entire financial industry is basically built on top of “dumb contracts” with humans executing the transactions. These new blockchain based platforms allow for these contracts to be completed on their own, hence becoming “smart.” Smart contracts enable automatic execution of the terms of a contract without requiring an intermediary. A simple example is if conditions x and y are met, the code automatically transfers the funds from the buyer to the seller without a third party needing to approve the transaction or be involved.

This increases efficiency and allows for new use cases that were never before possible. As a result, smart contracts have the potential to disintermediate and automate much of the financial system today. It also has the potential to turn regulation enforcement from reactive to proactive because the rules can be coded into the smart contract in advance, so the transaction only executes if it’s in compliance with the law.

Today, Ethereum is by far the leading smart contract platform. It’s the second largest cryptoasset today and has more applications built on top of its smart contract functionality than all the other platforms combined. However, due to the rapid growth, the network has experienced some scaling difficulties which a number of newer platforms are aiming to solve.

Web3

Web 1.0 consisted mostly of the early internet and was characterized by static webpages people could visit. Web 2.0 brought interactive, social, and communication capabilities to the web but also saw the centralization of much that data and power into a small handful of companies. Web3 aims to build on much of the functionality the web has provided but with the added benefit of being fully decentralized. Not only would this reduce our reliance on large corporations, but this new infrastructure could also prevent data hacks, deplatforming, and allow users to control and profit off their data rather than giving it away to centralized corporations. The projects in this category are basically rebuilding much of the webs centralized infrastructure in a fully decentralized manner.

One example is Helium which is creating a fully decentralized wifi network, outside the purview of traditional internet providers. Helium sells hotspots to users that create a mesh network by connecting with all other Helium hotspots. Users earn HNT (the underlying token for the Helium network) in exchange for providing wifi capabilities to the network from the hotspot they own. It’s easy to envision a not-too-distant future where crypto-based phones, VPN’s, decentralized storage are all powering an internet without the need of network and cellular providers.

Web3 has the potential to provide end users with complete control of their personal data along with the security of cryptographic encryption. Information can then be shared, potentially even profited from, on a case-by-case and permissioned basis. Because data will be decentralized and distributed, much of the hacks we have seen in recent years would be rendered obsolete. Also, because there would be no single point of failure, service disruption will theoretically occur far less often than today. Applications will be easy to customize and device-agnostic, capable of running on smartphones, TVs, automobiles, microwaves and smart sensors. Furthermore, they will be able to carry out machine to machine transactions without the need of humans opening up whole new business models and use cases.

Decentralized Finance (DeFi)

DeFi projects are building fully decentralized, non-custodial financial products aimed at replacing centralized middlemen in financial applications. Most of these projects are built on top of the Ethereum platform and are leveraging the smart contract functionality to build many of today’s existing financial products but in a fully decentralized manner. A key metric for this sector is Total Volume Locked (TVL), which represents the dollar value of assets in DeFi protocols. 2020 was a breakout year for DeFi as TVL grew 2,000% and closed out the year above $13 billion. The top Decentralized Exchange (DEX), Uniswap, grew 15,000% in 2020 and is now regularly processing over $1 billion in daily transactional volume.

The potential of DeFi is enormous as it provides the ability to digitize and financialize (aka tokenize) every asset in the world. This could be real estate, cars, art, jewelry, media, or any other asset you can think of. NBA all-star Spencer Dinwiddie even tokenized his most recent 3-year contract allowing fans to invest directly in him and earn a portion of his future earnings. In essence, he IPO’d himself using DeFi technology.

DeFi has the potential to not only make existing markets far more efficient but more importantly, create brand new markets for assets that have never previously existed. In doing so, we will be able to trade these assets, borrow against them, fractionalize them, pull forward future value into today and monetize them in a way that was never before possible. We will trade them globally, borderlessly, and frictionlessly. All of this without middlemen extracting value from the process.

NFTs

One of the core breakthroughs of blockchain technology is for the first time ever, we now have digital scarcity. Prior to blockchains, if I sent a picture to someone over the internet, what I really was doing was sending a copy of that picture and thus the file now existed in two places. If that person forwards that same picture to five other people, there were now seven identical copies of that file in existence. However, with blockchain technology, Satoshi solved this “Double Spend” problem so that a digital asset can be scarce, and ownership can be proven.

In the physical world, there is only one Mona Lisa and its incredibly valuable. Sure, people can take photographs of it and you can see the image online by doing a Google search, but would anyone deny that the original, one-of-a-kind painting is far more valuable? We now have this same capability in the digital world with NFTs. Anyone can create a digital file that is one of a kind, or limited edition, and transfer ownership of that digital file to someone else.

What NFTs are really doing is inverting the ownership model of digital media. Today, creators upload their files to platforms such as YouTube, Spotify, Instagram, TikTok, etc.. and when they do so, they give away ownership of those files to these respective platforms because the terms of service of these platforms allow these corporations to own and monetize whatever is uploaded as they see fit. NFTs are allowing creators to retain ownership of their work, bypass these middlemen and sell directly to their fan base thus capturing far more value themselves. Furthermore, because these tokens are programable, artists can track any future sale of a piece of work and be paid a commission every time their work is resold.

Non-Fungible Tokens (NFTs) are not necessarily new, they have been around since 2017, but they have exploded in popularity in the last six months thanks to better user experiences and the launch of NBA Top Shot. NBA Top Shots are blockchain based trading cards that have now done over $300 million in gross sales since their launch last October and daily trading volume of these NFTs has peaked at $32 million. But it’s not just the NBA that is taking advantage of NFT technology. One of the premier digital artists, Beeple, recently sold a piece of digital art as an NFT for $69 million and Jack Dorsey recently converted the first ever tweet on Twitter to an NFT which sold for $2.9 million. The NFT space is rapidly evolving and I expect to see far more innovation in this space in the coming years.

The cryptoasset landscape is not only rapidly evolving but the distinctions between each of these sectors is not always cut and dry. However, the key takeaway is that there are cryptoassets in each of these sectors that have real users and immense growth. There are a number of cryptoassets that are finding product market fit and there are opportunities to invest across all these sectors within cryptoassets.

Note: The projects listed in this post are some of the most notable projects to date but by no means is it an exhaustive list.