Borsalino Test #38: On the future of crypto
On the future of crypto
This document lists a running collection of important takeaways and insights that help me reflect on the future of crypto. My goal is to create a repository of high-quality content that could guide my understanding and inform my expectations of crypto over the next few years. It should be noted that the term “crypto” means different things to different people (and yet we all refer to this one word as a catchall). This has been a boon for a budding interdisciplinary community but also much miscommunication among blind men describing an elephant. In a great blog post, Jon Choi greatly articulates his three crypto theses, which I like to paraphrase as 1) trustless money, free from central banks (Bitcoin > USD); 2) trustless Internet, free from FAANG monopolies (DAOs > corporations); 3) and trustless financial system, free from traditional financial primitives (Tokens > equities). I will organize my reflections around this framework.
These insights come from some of the best thinkers and analysts in the space and are corroborated by my personal knowledge and experience. This repository is not intended to be a MECE synthesis nor does it lead to any specific scenario projection (for now). Later, I will prune redundancies and converge towards conclusions. For now, I am focused on handpicking evidence and connecting dots.
No returns beyond price increase The crypto investment structure is fundamentally one-dimensional. Large returns are based on constant price rises and new inflows of cash. There is no secondary return for investors that provides some cash flow or incentive to look more closely at the protocol they are investing in. This structure is totally reliant on a continuous stream of new cash to drive up prices, and returns can only be gained through a continuous rise in prices, requiring the influx of new cash into the market. However, the fundamental operating tenant of any economy is a return to its investors. For the vast majority of tokens, there is no return for the investor beyond the price of the token. Crypto ballooned in a moment when free capital was available: most retail investors were benefitting from an especially risk-prone investment environment. Some are young, with high-risk tolerance and some extra investment capital available (e.g., Covid stimulus check, …). Some others are baby boomers transitioning towards retirement, with the highest investment capital and risk tolerance of their life, looking for the last bit of yield before switching to a way more conservative financial management philosophy. Historically, whenever capital was cheaply available and accessible to source a lot of strange things happened (e.g. Enron, subprime, …).
Decentralization is not a better way to run a business. The appeal of the DAO movement is fueled by
the sense that most democratic processes are broken. People are seeking new forms of organization where hierarchies are failing: public health (e.g., pandemic management), climate change, inequality, etc. However, DAOs are insufficient solutions to complex problems. They failed to achieve product-market fit and provided instead a little more than voting and funds allocation mechanisms. Legal, traditional contracts are both idiosyncratic and complex. Smart contract rigidities can’t capture the nuances of most organizational decisions, which are often outsourced to off-chain governance tools (e.g., Telegram, Discord DMs, …). For example, DAOs tried to innovate employee compensation mechanisms through measures of perceived “value” of the work done (e.g., Coordinape). As a consequence, technical skills are better rewarded as easier to define, and less precise tasks are either grossly misestimated compared to market prices. There are now dozens of ‘zombie’ DAOs, created but no longer active. These failures contribute to the outside perception that DAOs are just a fad or scam. DAOs are addressing a very small segment of the decision-making spectrum in organizations, and the lack of deeper tools to manage complex decision-making makes it harder to envision a replacement of centralized foundations.
Crypto is all about flows, not stocks. In his classic 1945 essay, As We May Think, Vannevar Bush shaped 70 years of tech development with the idea of a future device capable of storing all books, records and communications, as a supplement to individuals’ memory. Venkatesh Rao argues that this does not fit crypto, which entails a radical subversion of the original vision of the internet, which is stock-centric. The fundamental behavior in crypto is not following a trail of links from stock to stock, but following a stock as it flows from address to address. The coin metaphor is going to prove to be severe baggage for crypto, just as the document metaphor was baggage for Web1 and Web2. Voting and staking mechanisms look like flows > stocks. Multisig wallets are flow control valves. “Balances” (not coins) are levels of fungible stocks in flow buffers. Burning tokens is flow.
Sound money is here to stay. Money is simply a ledger of who owns how much of something. And weirdly enough what it fundamentally requires is that others are willing to exchange goods/services with it and hold it. More importantly, we’ve built incredibly efficient and borderless information sharing and consumption platforms over the past two decades (such as search, social media and instant messaging). Those two points combined have made now a uniquely compelling time to experiment with the concept of decentralized digital money. Unlike web3 or open finance, the money use case only requires belief and reasonable scalability to succeed. As such, the ingredients for success are already within reach. The rest is up to what consumers decide, what regulators decide and how the community decides to communicate the product. The concept of non-sovereign digital money is here to stay (whether that is Bitcoin, Ethereum or something else entirely). The hurdles here around scalability, awareness, wealth distribution, regulations and framework seem reasonable compared to the demand of the expanding core customer base. Crypto-enabled businesses that support adjacent services for the decentralized store of value will be highly valuable (insurance, custody, security and any other UIs and managed services on top of the core protocol). Wealth distribution is one of the largest sources of long-term fragility for any monetary system. The converse is also true: when guided correctly, it is a source of unstoppable growth and antifragility.
Web3 faces a high bar for adoption. While the social need for an Internet without abuse of centralized control must absolutely be recognized, the customer-focused framework paints a challenging view of the adoption path today. It has a small customer base with a strong need, trying to reach an audience that is already satisfied by incumbent platforms. At feature parity, people will choose trust, but most people are not likely to sacrifice the convenience they have today for “trust insurance” (unless there’s a high-profile event that eventually turns the public narrative). The fundamental challenge here is the asymmetric cost/benefit for the censored vs their target audience. The broader audience is used to the benefits of a smooth, quick, and managed experience that delivers the information that they enjoy quickly and effortlessly.
Promiscuous nationalism DAOs allow contributors to work on different projects simultaneously. Mario Gabriele argues that this "promiscuous nationalism" would represent a significant departure from today’s corporate nationalism. You can be an employee of multiple companies or a citizen of different nations, but legal and cultural norms discourage it. DAOs may have a different relationship to fealty. Because the internet allows for spatial simultaneity, we can "occupy" multiple DAOs at once. You could be a citizen in one, actively working on some task while passively existing, earning, and contributing to hundreds of others. Presumably, you will still have some sense of loyalty, prioritizing one DAO over another. But rather than being immutable, a fact of birth, our "nationality" may shift along with our opinions, making you a "conditional citizen." Such promiscuity may not last forever, particularly should conflict arise. Over time, DAOs will establish firmer borders, cultures, and services. Stronger allegiance may be required.
Minimally extractive coordinators. Crypto projects provide structure for businesses, but are not businesses themselves; they are systems of logic that coordinate exchange between suppliers (businesses) and consumers of a service. As coordinators of exchange, protocols are minimally extractive, whereas businesses are incentivized to be maximally extractive (that’s profit, and a business is valued as a multiple of its profit). Minimal extraction doesn’t mean crypto assets that capitalize protocols will capture minimal value. If something is minimally extractive, but globally produced and consumed, the coordinating asset can capture a significant amount of value. From this angle, protocols can be seen as routers of economic activity. Just as the routers of the Internet are as lean and efficient as possible, so too should crypto’s protocols trend. The less extractive a protocol is in coordinating exchange, the more that form of exchange will happen. Matt Ridley argued that the emergence of exchange is what allowed humans to unlock the magic of competitive advantage, and its associated innovation and progress. If that’s the case, facilitating exchange is a sacred position in society.
Incentives are towards more centralization, not less People don’t want to run their own servers, and never will. The premise for web1 was that everyone on the internet would be both a publisher and consumer of content as well as a publisher and consumer of infrastructure. A protocol moves much more slowly than a platform. After 30+ years, email is still unencrypted; meanwhile WhatsApp went from unencrypted to full e2e in a year. If something is truly decentralized, it becomes very difficult to change, and often remains stuck in time. That is a problem for technology, because the rest of the ecosystem is moving very quickly, and if you don’t keep up you will fail. When the technology itself is more conducive to stasis than movement, that’s a problem. From the very beginning, crypto immediately tended towards centralization through platforms (e.g., Coinbase, Discord, …) in order for them to be realized. This has ~zero negatively felt the effect on the velocity of the ecosystem, and most participants don’t even know or care it’s happening. This might suggest that decentralization itself is not actually of immediate practical or pressing importance to the majority of people downstream. Moreover, given the fact that so many crypto projects depend on ever more people entering the ecosystem, such that earlier users can see the value of their holdings increase, the incentives of both existing users and new users are aligned in favor of more convenience and easier onboarding, which is to say that the incentives are towards more centralization, not less.