In Search of Assets
If the recent run up in crypto markets is to be sustained, some of its products will need to start delivering real end-user utility. As we go into 2018, the biggest question facing blockchain technology is that of product-market fit, or more specifically, whether these products have utility beyond speculation.
Bitcoin, the original blockchain-based product, has arguably achieved this: acting as disintermediated, digital gold. But the market is currently pricing in a bet that many more products will deliver value.
In order to understand where the industry is going, and where fundamental value might lie, it is helpful to consider the short history of crypto innovation. The market has experimented with blockchain technology in three waves: altcoins, permissioned chains, and tokens.
In examining this progression, it becomes clear that the search for product-market fit in blockchain has always been about a search for assets.
The first trend of experimentation saw the creation of altcoins in 2013 and 2014. Most of these altcoins were technically very similar to bitcoin, with a few tweaks, maybe a new feature, and some fresh branding.
Some of these altcoin protocols have survived and thrived over the last 4 years, while others have failed. Those that have gained and retained value have found product-market fit in two ways: either the asset has met an economic need or the protocol has met a technological demand.
Like bitcoin before them, the assets that have met a real economic need have done so by enabling a form of ownership or transaction that was not previously possible. Zcash and Monero, which both implement privacy as a feature of transactions, are good examples of this.
Other altcoin projects that have endured have done so because of they meet technological demands of developers and innovators. They have served as testing grounds (Litecoin) or they have become platforms for building (Ethereum).
The altcoin boom was explicit in what it was creating: new protocols, platforms, and, most fundamentally, assets.
In 2015 and 2016, as many altcoins lost momentum, the second wave of blockchain innovation took off. Rather than generating new assets, this wave focused on assets that already existed.
One lesson from the altcoin boom was that creating a new asset is hard. Not technologically, but economically. How do you endow a new asset with value? Value is a social construct. For an asset to have value, the only rule is that people must perceive the asset to have value.
In traditional finance, perception of value usually comes from the backing of institutions and legal constructs. So this second wave of blockchain innovation says, “let’s apply the blockchain innovation to the assets we already have.” Assets that already exist should not face the perception-of-value problem.
But as soon as you represent an asset in a new format, the nature of it changes — and so does the perception of its value. It is not as simple as creating a digital asset and saying it represents the US dollar. (Although, Tether seems to have achieved this, but we will leave discussion of that for another time.)
This point is intuitive but is so fundamental that it is worth spelling out. In order for an asset to represent an actual dollar, the Federal Reserve would have to be the issuer and declare that it is backed by the full faith and credit of the US government. Legal structures would have to be created around this asset to make people comfortable with the idea that the digital version was equivalent to the dollar in their pocket. Even then, there might be a spread between the value of the two, as there is between on- and off-shore versions of currencies.
This concept of porting existing assets into new formats is at the heart of what permissioned blockchain technology attempts. Operating within a closed environment helps get us part of the way there.
Let’s say there is a digital asset that is intended to represent a US dollar. Now let’s say that the only users of this digital asset — Alice, Bob, and Carol — exist within an enclosed system. If Alice, Bob, and Carol all come to consensus that this asset is equivalent to a US dollar, then they might be able to create a functioning market for transactions amongst just themselves. This is what every blockchain consortium is attempting to achieve with stocks, bonds, and syndicated loans.
The persistent problem with permissioned blockchain technology is the on- and off-ramps. How do you cash in and out of the system? A friend of minehas coined this the Porsche problem: I might have all of these cryptodollars that Alice gave me, but if I can’t go buy a Porsche with them, what good have they really done me? Maybe I can redeem them with Alice for US dollars, but then the asset is really just a claim on Alice. A claim that is redeemable for an underlying asset, as anyone who lived through 2008 can tell you, is never the same as owning the underlying asset itself.
This second wave of blockchain experimentation also tries to move physical assets onto a blockchain. This has been applied to everything from shoes, to homes, to diamonds, to pork bellies, to art. One illuminating point here is that the world has a major tracking problem. Maintaining a record of the existence and ownership and authenticity of physical goods, it turns out, is something we are very bad at.
Unfortunately, a blockchain won’t help you with this. This is a last mile problem. You can, perhaps, track digital deeds or titles on a blockchain. The real difficulty, however, lies in linking those deeds and titles to the physical good. The issue that arises in tracking provenance and ownership is not a matter of the database not being good enough. It’s a matter of having good data that actually represents the assets.
Reformatting existing assets onto a blockchain, it turns out, is just as challenging as creating new assets. Valuing digitized assets poses many of the same problems as valuing digital assets.
Which brings us to the third wave of blockchain experimentation. The market has returned to a trend of creating new assets, this time rebranded as tokens. Tokens are new natively digital assets that creators attempt to imbue with value.
Tokens differ from altcoins in that their value attempts to be derived in more traditional ways. They might, for example, represent a claim on returns of a project or set of ventures. (In traditional finance, this would be called a share or an LP interest, but never mind that.) Blockchain Capital’s token and the Ethereum DAO are obvious examples here.
Tokens might also represent an asset to be used in an application. File storage is an intuitive example. Various applications offering a decentralized version of DropBox have come to market in the last several months. The file storing system runs as a market, where users can purchase storage from each other. App-specific tokens are the medium of exchange for these markets.
This type of design begs the question, why not use bitcoin? Or ether, the asset that is native to the platform some of these apps are built upon? Just because it is a decentralized marketplace does not mean that it needs its own peer-to-peer currency: AirBnB and Uber did not need BnBCoin or UberCoin to bootstrap their networks and become successful.
Admittedly, using in-app tokens as a medium of exchange helps to solve the token’s perception-of-value problem by making it redeemable for an actual good or service.
So the token’s problem gets solved… But the token does not solve a problem for the application or the user. Indeed, it most likely harms user experience. Are people willing to use specified assets for different goods or experiences? After all, I probably want to buy my Porsche with US dollars, not with PorscheCoin.
These examples, wherein tokens act as securities or app-specific money, are the most straightforward paradigms emerging. In fact, many tokens being pitched to the market today do not fall squarely in either category — meaning the perception of their value remains pure ideology. It has become a trend for entrepreneurs to find a way to wrap their app in a token in order to fundraise. Really, however, these entrepreneurs are encumbering their business models, corrupting their cap tables, and creating a user experience of their app rife with friction. Only the tokens that can justify their existence as independent assets will have staying power.