Understanding The Endgame Helps Investors Make Sense Of Seemingly Random Developments In Cryptocurrencies And Blockchain
Over the past few weeks, we have been talking about the core principles behind the unfolding cryptocurrency1 and blockchain2 revolution. And while understanding this big picture is essential for its own sake, it’s also important because it helps us put today’s developments in perspective. It gives us a framework for interpreting headlines and making sense of the barrage of news—good, bad, and in between—coming at us every day.
Let’s consider three key issues, and related headlines, and then we can address how to interpret the headlines in a larger context:
1) Institutionalization: The endgame for this whole Internet of Money, and Money of the Internet, is for an emerging asset class to become mainstream—to become integral to the functioning of the global economy. That cannot happen, however, if large global financial institutions cannot participate in these markets.
Why is institutional participation important? First, because such institutions hold the majority of global financial assets. Second, because institutional participation could bring trillions of dollars of liquidity into the crypto ecosystem, helping to address a range of adoption issues, not the least of which is market volatility. Third, solving key problems faced by institutions (trade-ability, security, transparency, speed, efficiency, etc.) should also help solve some of the challenges to broader retail adoption.
In particular, one of the biggest stumbling blocks for institutions has been custody—i.e., a lack of vehicles that highly regulated institutional investors can use to hold blockchain-based digital assets. That is changing, and very quickly.
We got earth-shaking news last week when Intercontinental Exchange (ICE), the world’s largest stock exchange operator (owner of the New York Stock Exchange) announced the launch of Bakkt, a subsidiary aimed at creating “an open and regulated, global ecosystem for digital assets.” The offering will include federally regulated markets and warehousing along with merchant and consumer applications, according to the company.
This combination of a licensed exchange and licensed custody solves two of the major hurdles to institutional investment. And it drastically increases the possibility, in my view, that we will soon see a bitcoin ETF—a long-elusive goal of many investors and fund managers.
In fact, there are myriad custody solutions coming to market: from the crypto exchange Coinbase; from the crypto wallet firm, Blockchain; from the French crypto-wallet and custody start-up, Ledger; and from the Goldman Sachs-backed start-up Circle.
2) Interoperability: Think back to the early days of the internet. Before open public networks, we had a series of closed networks. If I had an email account on one network (say, AOL), and you had an email on a different network (say, CompuServe), I couldn’t send you an email. These independent networks had an “interoperability” problem.
But then in 1980, a brilliant computer scientist by the name of Jonathan Postel proposed something called Simple Mail Transfer Protocol (SMTP), which solved the interoperability issue and allowed users of different networks to send data to each other.
Just shy of 30 years later, in 2017, the Palo Alto-based technology research firm Radicati Group estimated global email traffic at 269 billion emails per day, among more than 3.7 billion email users. That’s an example of the kind of the rapid growth that can be unleashed when interoperability problems are solved effectively.
Today, interoperability solutions for cryptocurrencies are on the horizon—pointing to a day, perhaps soon, when you may be able to spend and convert them however you wish.
I said the news from ICE was earth shaking because its reverberations will be enormous, immediate and far-reaching. Case in point: Just hours after the ICE announcement, Starbucks announced that it had signed on to the Bakkt initiative, with a goal of advancing digital currency technology and the convertibility of cryptocurrency into fiat currency.
3) Scaling: A third obstacle to wide-scale adoption has been the speed of crypto networks. But transaction speeds, measured in transactions per second, are rising. The market is also seeing new approaches to solving the scalability problem. One approach, moves data among multiple blockchains. In theory, using such a system you would ramp up transaction speeds by having an infinite number of blockchains all operating in parallel, rather than a few giant blockchains running independently.
Again, it’s too soon to know which technical solution is going be the winner, or if there is even one killer app that solves the scaling problem—it may be many killer apps working in harmony.
And it’s jumping the gun to assume any of the approaches in development today will solve the problem, because none of them have been tested in the real world. And history tells us that the best tech doesn’t always win. Sometimes the better user interface prevails—e.g., there are plenty of phone with better tech than the iPhone, but the iPhone solves a range of challenges in unique user-friendly ways.
But computer scientists and engineers are working all due haste to get the scalability issue worked out. And I believe we will see major leaps in this area in the next year or two.
What does my 2Cents add up to?
When trying to make sense of an avalanche of daily headlines, it helps to keep in mind the overall journey—where it’s taking us, and where we are in that process. I believe we are headed toward a full-scale Internet of Money ((IoM)), toward a “sound” Money of the Internet ((MoI)), and toward a user-controlled global Databank. But…
- You cannot have a global databank unless you have a way to hold your fungible digital assets: that is, custody.
- You cannot expect trillions of dollars of regulated capital to flow into these digital assets, and reap the liquidity benefits, unless you have a secure way to store that value: again, custody.
- You cannot have an IoM if you don’t have a way to measure and translate value from one owner to another: that is, interoperability.
- You cannot have a MoI if you don’t have scalability: i.e., you need to be able to support billions of people conducting possibly trillions of transactions as they go about their daily lives.
What do we see in the headlines? On the custody front, we see a range of workable solutions being put in place, with many more coming. I believe that institutionalization, the first plank in wide scale adoption, is very close to being a solved problem as new blockchain-based systems come on line to address the regulatory, risk, and compliance constraints placed on institutional fiduciaries.
As headlines unfold over the next six months to a year, I am also keeping my eye on the other two main roadblocks: interoperability and scalability. But rather than looking at each new headline as a disconnected news items, I will be viewing them as singular pieces of a larger puzzle.
Over the past few weeks, I have tried to explain how all those puzzle pieces come together, and where we may eventually end up once they form a more complete picture. As an investor, I believe that such a macro perspective is essential to understanding what drives investment opportunity in the cryptocurrency and blockchain space.
It’s something to keep in mind as we parse the headlines week by week, with an eye on measuring progress toward the endgame.
Source that inspired this entry:
Kate Rooney, CNBC, 6/25/2018. Goldman Sachs-backed Circle sees boom in crypto demand from institutional investors, despite bear market
Olga Kharif and Sonali Basak, Bloomberg, Regulated Crypto Custody Is (Almost) Here. It’s a Game Changer. 6/18/18.
Lubomir Tassev Bitcoin.com The Daily: Crypto Vault in Hong Kong, ‘Herd of Institutional Investors’ in Crypto 7/24/18
Radicati Group press release 4/20/2018