Building the Decentralized Economy

As a Chicago Booth new venture strategy professor once said:

“We model business as a race against time — those who ask the right questions first, win.”

Although the words of a crusty, industry veteran proselyting to a room of overworked MBA students could easily have slipped into the dark abyss of my mind to keep my accounting degree company, they have not. Rather, this perspective on enterprise competition has only become more relevant as I continue learning and pondering the impending effects of blockchain technology and its impact over the next decade.

Over the last few months, I went to work evaluating the decentralized space and building an understanding of what this future construction may look like alongside my colleague Jeff Franco. We wanted to identify the areas within the rising blockchain economy most prone to immediate disruption, and further, a few promising early-stage startups that need some capital to do it. If this summary doesn’t provide the level of detail you’re looking for, consider taking a deeper dive into our thesis deck.

Executive Summary

The continued proliferation of blockchain technology is creating whitespace in freshly carved markets.

• As blockchain becomes widely adopted, nearly all new consumer applications will be decentralized by 2030
• Similar to the impact of Web 2.0, we believe that over the next 10–15 years, decentralized and permissionless business models will significantly alter how economic activity is coordinated
• A rising tide will not lift all boats equally — those addressing digital asset ownership and “pick-and-shovel” approaches for widespread blockchain implementation stand the most to gain in coming years

Primer: A New Model for Transactions

Decentralized networks are meaningfully altering the way people and businesses communicate, transact and store information.

Centralized Networks

• Information/service controlled by one party
• Architecture built around a single server that handles all major processing
• Examples: Internet Service Providers (ISP), ERP systems

Pros and Cons:

🗸 Centralized networks tout the obvious benefits of being both affordable and easy to deploy.

✖ However, they’re difficult to scale due to storage and processing power limitations, have higher security risks caused by a single point for failure, and are more prone to periods of downtime.

Distributed Networks

• Data ownership and computational resources are shared across the network, but each system (or “node”) can work independently
• Solution component is maintained by a central provider
• Examples: Web 2.0 (current internet infrastructure), cloud computing

Pros and Cons:

🗸 Distributed networks have a quick response time and are extremely fault-tolerant since downed nodes are isolated locally, allowing for a high degree of scalability.

✖ Deployment costs are significant and act as a barrier to entry for innovative solutions built as a distributed network.

Decentralized Networks

• Nodes interact on a peer-to-peer basis, with the information available to every node on the network via a distributed ledger
• No single authority controls the network and information is processed by multiple parties
• Data is accessed by all participants, but can only be added through group consensus
• Blockchain technology is both distributed and decentralized

Pros and Cons:

🗸 Decentralized networks are also extremely fault-tolerant, allowing for a high degree of scalability. However, they also allow for heightened verification and data integrity through consensus-mandated additions.

✖ Their biggest strength is also a primary weakness, that is, there is no central point of control over the network.

Pain Points

Today’s business environment is riddled with inefficiencies demanding more effective consensus solutions.

Financial + Business Inefficiencies

• Currently, trillions of dollars are exchanged around the world via antiquated systems featuring exorbitant fees (e.g. cross-border transactions generated ~$225Bn in payments revenue in 2019)
• Blockchain enables untrusted counterparties to come to an agreement without the need for a middleman and allows for the use of self-executing smart contracts
• Extensive use cases exist for blockchain to bring greater efficiencies and transparency to financial services, travel & mobility, healthcare, agriculture, education, and a host of other sectors

Risks Undermining Trust Online

• Fraud and other forms of cybercrime cost businesses and individuals ~$5Tn per year
• Implementing blockchain solutions allows corporate players to securely create, store and share sensitive information surrounding: contracts, identity documents, certificates, official records, and HIPAA-compliant data

Opaque Business Supply Chains

• B2B transactions are largely executed offline and across different systems, resulting in a variety of execution errors such as inaccurate inventory, missing shipments, and duplicate payments
• With blockchain tech, organizations can digitize physical assets and track assets from production to delivery to use by end-user

Benefits of Utilizing Decentralized Networks

Adopting blockchain helps companies build trust and boost the bottom line.

Enhanced Security

• Every transaction must be agreed upon via the consensus method.
• Blockchain networks are immutable, as each node holds a copy of transactions performed.
• Personal data can be anonymized.

Traceability & Transparency

• Transactions can be tracked in real-time with an audit trail.
• Network helps reduce risk of counterfeits and fraud.
• PwC estimates using blockchain to prove provenance could generate $962Bn for global GDP over the next decade.

Reduced Transaction Costs

• No vendor costs required.
• Less interaction associated with facilitating a transaction.
• Smart contracts also result in the automation of key services.

Speed & Efficiency

• Documentation and transaction details can be stored on chain.
• No need to reconcile multiple ledgers, so clearing and settlement are fast.

Adoption of Decentralized Networks Over Time

While corporate acceptance of distributed systems began slowly, usage by major businesses has surged in recent years.

Adoption of Decentralized Networks Over Time, 1991–2021

Factors Accelerating Adoption

Rising financial relevance and an increasing emphasis on consumer privacy are acting as exogenous market drivers.

(1) Shifting Generational Preferences

• Millennials and Gen-Z are seeking mobile, anonymous, and secure methods for transactions
• This has driven Bitcoin adoption growth faster than the PC and internet, averaging ~1M new crypto users per month in recent years
• High-profile data abuse by big tech and recent consumer privacy legislation are further fueling this shift

(2) Privacy Risks Eroding Trust

• Data breaches and other cybercrime are not only costing businesses trillions of dollars annually but also furthering mistrust between enterprise services and end-users
• Implementing blockchain solutions allows corporate players to securely create, store and share sensitive information: contracts, identity documents, certificates, official records, and HIPAA-compliant data, among others.

(3) Political and Economic Volatility

• Market dynamics are pressuring financial institutions to support and build instruments for digital assets
• The uncorrelated nature of crypto is attracting investors, hedging against anticipated fiscal and monetary expansion threatening an increasingly inflationary environment
• Political unrest and escalations in uncertainty entice blockchain adoption as consumers seek a flight-to-safety in ‘‘digital gold’

Market Opportunity for Decentralized Networks

The Blockchain market is poised for strong growth, with ~40% of businesses expected to implement the technology in the coming years.

In 2020, the global blockchain market revenue was estimated at $3.7Bn. From 2021 to 2028, the market is expected to grow at a CAGR of ~82% to ~$400Bn in 2028.

Companies are beginning to take note of the benefits associated with blockchain, and we expect, on average, ~40% of businesses are planning to implement the technology before 2023.

Investment Landscape & Funding

Blockchain private funding is still in the beginning stages…but investment in the space has been accelerating rapidly.

Blockchain private funding still accounts for <1% of the global VC market. While most investments in the blockchain space have historically happened with little to no VC involvement (~80% of all investments before 2020), only 22% of investments in 2020 had no venture-backing. Cryptocurrency and blockchain-related companies have raised more money in 1Q 2021 ($2.6Bn) than in all of 2020 ($2.3Bn).

Venture Funds Targeting Decentralized Technologies

A number of VC funds have been active in the blockchain space, with investment predominantly focused on the Seed round within the US and Europe.

Sector Leaders: Numerous venture teams have devoted their focus to blockchain-related deals, with several more quickly making a transition into dealflow that represents a proportionally larger allocation to the decentralized field. TRGC, Alameda Research, and Coinbase Ventures are just a few of the leaders in the space, clocking in 20+ blockchain deals annually in recent years.

Historical Focus & Return Profile: Out of the 676 registered blockchain VC deals completed in 2020, the majority of investments were both made at the Seed stage and focused on blockchain infrastructure. Another 100+ projects under this umbrella were related to decentralized finance (“DeFi”). While the diversifying effects of private investments are well known, investments in the decentralized space have recently been seen to extend this effect even further.

Geographic Distribution: Asia ranks 3rd in blockchain VC investment worldwide, but trends may begin to see a reversal over the next 3-5 years.

Other Funding Considerations: Venture capital is not the only source of funding for blockchain-related companies, as the technology itself democratizes access to investment opportunities, opening other funding channels previously inaccessible to most (as seen by BitClout).

Segmenting the Decentralized Network Market

To begin assessing the decentralized space, we first need to identify attributes among the constituents by which to group them. After significant market mapping of the current, visible blockchain startup universe, we can see six not-so-distinct categorizations of offerings to begin building an evaluative framework.

The Decentralized Network Ecosystem

Significant offering gaps within blockchain-enablement and digital ownership applications will be filled by innovative startups in the near term.

Building upon our market mapping above, we can then dice these categories into a cross-section based on their respective positioning in the tech stack. Although the visual below is absolutely not entirely inclusive, areas of opportunity can be seen at particular intersections of function and positioning.

Emerging Opportunities

Demand for independent, digital asset custody and services that support blockchain scaling will draw meaningful attention.

After careful analysis of the empty spaces where each market intersects delivery, two specific trends become obvious as whitespace for startup candidates to compete:

1) Creator Economy + Digital Ownership Channels

2) Functionality + Scalability Enablers

Startups to Watch

Now we know (or at least think we know) what niches should be tracked closely. But what use comes from this analysis?

Below is a curated selection of startups making waves in the blockchain community, spanning the creator economy, digital ownership, and scalability enablers.

S!ng | Creator Economy > Channels

What They Do: Provide content creators an Ethereum-linked platform to easily create, store, share and sell digital assets.

What They Fix: Protection from insecure and poorly validated content channels currently available for artists and publishers.

Why We Like It

• Emphasizes Digital Ownership: Utilizes NFT base secured by Ethereum blockchain, supported by generational demand shifts for content distribution that benefits artists over hosting platforms.
• Growing Tides: Fills creator economy decentralized application market opportunity, poised to grow over time despite criticisms regarding volatility and intrinsic value concerns as NFTs evolve.

Potential Risks

• Untested Assets: NFTs are still very young and the landscape is changing rapidly, exposed to swings in consumer appetite + regulatory restrictions.
• Minimal Corporate Traction: Although businesses have begun implementing blockchain technology to remove inefficiencies, there are few demonstrable indications incumbent enterprises will accept NFTs.

UpShot | NFTs, Gaming + Metaverse > Apps

What They Do: Blockchain protocol that creates real-time price feeds for NFTs through crowdsourced appraisals.

What They Fix: “Professionalize” blockchain marketplaces by establishing a reliable, metrics-based system for transacting, helping bring confidence into a market that has largely been illiquid and inefficient.

Why We Like It

• Crypto Angle: Individuals participating in Upshot’s peer prediction platform receive incentive currency atop its blockchain, allowing the company to play in the burgeoning cryptocurrency space.
• Product Development Pipeline: The Upshot team recognizes the efficient discovery of NFTs is only one use case for this technology. Throughout 2021, the team is focused on building additional decentralized products in insurance, government and content curation.

Potential Risks

• Scalability: The Upshot protocol lives on the Ethereum blockchain, so questions remain on how this technology would scale to other blockchains (e.g. Solana) where future projects may be concentrated.
• User and Expert Acquisition: While the technology has a variety of use cases, the onramp of both users and experts may take a long time to develop, therefore limiting growth of the company.

Crucible | Developer Tools / NFTs, Gaming & Metaverse > Apps

What They Do: Software development kit (“SDK”) allowing for a secured, portable digital identity across the metaverse.

What They Fix: Provide a simple solution to enable metaverse-compatible experiences and scale in-game economies.

Why We Like It

• Agnostic Application Layer: Technology is compliant with both Unreal and Unity game engines, which represent the majority of the gaming market worldwide, especially in the VR and AR end markets.
• “Plug and Play” Offering Enabling Rapid Development: Crucible provides modular control so companies can access multiple components of Web 3.0 without the challenging and expensive learning curve. Development options include identity solutions, secure payment system, marketplace creation and automated royalty systems.

Potential Risks

• Scalability: The success of Crucible ultimately depends on the adoption of the metaverse, which is still in the nascent stages of development.
• Customer Acquisition: It’s still too early to determine how CAC may develop over time.

Gauntlet | Developer Tools > Scalability

What They Do: Simulation platform for blockchain protocols and applications.

What They Fix: Identify and reduce risks for startups and project teams implementing Web 3.0 technologies.

Why We Like It

• Robust Product Offering: Gauntlet has a wealth of data included in its library of agents and attacks, allowing it to achieve broad coverage of testing scenarios. Despite initial industry projects being built across a variety of blockchains, Gauntlet can customize testing for each customer and is chain agnostic.
• Strong Founding Team: The management team has extensive experience in the fields of high-frequency trading and bitcoin mining, and most of the initial team members have worked at tech unicorns. The CTO was involved with the self-driving market simulation technology at Uber.

Potential Risks

• High Level of Customization: Each project is highly customized to serve a customer’s needs, so commercial scalability may be sacrificed.
• Market Uncertainty: It is still unclear what market demand looks like, as initial projects have been with several public chains and applications (e.g. Stellar, Computable, Kadena).

Potential Industry Headwinds

Despite the clear benefits associated with blockchain technology, a number of headwinds exist that could delay adoption by businesses and governments.

Before we start throwing money at prospects in the decentralized space, we need to be aware of the things our confirmation bias wants us to miss.

1. Lack of standardization. Over 6,500 projects are leveraging a variety of blockchain platforms, each comprising different protocols, privacy measures, and coding languages. Future projects will need to offer interoperability amongst the various blockchain networks to enable efficient sharing of information, execution of smart contracts, and a better user experience.
2. Scalability concerns. The two largest blockchain networks — Bitcoin and Ethereum — handle under 20 transactions per second with long latency times. While newer blockchains (Ethereum 2.0, Solana, Polkadot), protocols (proof of stake), and techniques (sharding) are all being developed, it remains to be seen if these solutions can meaningfully address the scalability issue.
3. Regulatory uncertainty. Blockchain technology removes the traditional institutional mechanisms that help ensure market stability, fair practices, and reduction in fraud. As such, governments and agencies will undoubtedly introduce new regulations that will impact all companies utilizing this new technology. When and what these regulations look like remains to be seen, making it difficult for entrepreneurs and managers to commit to business plans and projects.
4. High energy usage and transaction costs. One of the larger concerns surrounding blockchain technology is the immense environmental impact associated with miners adding new transactions to the network. According to Digiconomist, a single bitcoin transaction uses ~700 kilowatt-hours of electrical energy, equivalent to the power consumed by an average U.S. household over 24 days. High gas fees from this process lead to steep transaction costs for end-users and further accelerate the need for clean and renewable energy solutions.

Conclusion

Recent surges in adoption are not temporary and will continue redefining the enterprise and consumer landscape of tomorrow.

In our minds, there’s no denying that decentralization is on the horizon. Anywhere there is a centralized registry, including licenses, property titles, account ledgers, and so on, there is potential to replace those registries with trustless, decentralized transactions via smart contracts and other blockchain protocols. Blockchain tech will continue to be rapidly adopted, likely decentralizing nearly all new consumer applications after its implementation by over half of US businesses by 2030. While we see immediate opportunity in the creator economy, digital ownership, and those enabling blockchain scalability and functionality, there are undoubtedly a plethora of other trends where decentralization will find a profitable new home.

Soon, decentralized models will be applied across the majority of the existing centralized universe and will no longer be represented as an independent vertical, but rather a part of everyday life.

If you’re a founder creating something that accelerates blockchain adoption, or an investor looking to exchange thoughts, I’d love to connect. Reach me on LinkedIn and share your ideas. If you’re interested in seeing more theses, Startups to Watch Airtables, or any of my other published content, check out my LinkTree here. Happy hunting.

About the Author

Cai Greeff, CFA, CAIA is a venture investor, CFO for the digital healthcare startup ModoScript, and an Army National Guard engineer officer. In his past, Cai led early-stage VC for Origin Ventures across the US and Canada, managed global VC and PE portfolios for a US-based private pension, and graduated from the University of Chicago Booth School of Business, but will never forget where he started: making video games.

References

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[2] Blockchain Engineer, “Centralized vs Decentralized vs Distributed”, January 2021, https://blockchainengineer.com/centralized-vs-decentralized-vs-distributed-network/

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[9] Deloitte Insights, “Many paths lead to blockchain adoption, and no two are alike”, December 2019, https://www2.deloitte.com/content/dam/insights/us/articles/6358_2019-global-blockchain-study/DI_2019-global-blockchain-study.pdf

[10] Helen Partz, “Crypto industry got more funding in Q1 2021 than all of last year: Report”, April 2021, https://cointelegraph.com/news/crypto-industry-got-more-funding-in-q1-2021-than-all-of-last-year-report

[11] COINTELEGRAPH CONSULTING, “Venture capitalists invest over $16B in blockchain equity since 2012”, April 2021, https://cointelegraph.com/news/venture-capitalists-invest-over-16b-in-blockchain-equity-since-2012

[12] Finextra, “Remaining challenges of blockchain adoption and possible solutions”, February 2020, https://www.finextra.com/blogposting/18496/remaining-challenges-of-blockchain-adoption-and-possible-solutions