ethereum and the cryptocurrency opportunity

(Big thanks to Nicolas, the guru)

I have spent some time in recent months thinking and learning about cryptographic tokens and blockchain, specifically Ethereum. This included time at the Ethereum Developers Conference, conversations with thoughtful folks in the space, and a wheat beer at Room77 in Berlin. After these conversations, I feel strongly for various reasons that it is a space we all should be on top of, and where tech investors should be looking to put capital to work, sometimes in unfamiliar ways.

1. Top Down. Cryptocurrencies (mostly Bitcoin and Ethereum) are emerging as an entirely new
asset class with returns we, as technology investors, shouldn’t ignore

In 2010 all the world’s cryptocurrencies were worth virtually nothing, today they are worth between $20-25B. In a world where the existing 5 macro asset classes (currencies, commodities, rates, equities, fixed income) are largely influenced by policymakers, central bankers, and increasingly unpredictable democratic outcomes, cryptocurrencies are providing a relatively uncorrelated asset class that can potentially reduce portfolio volatility and increase risk-adjusted returns.

Not to mention, the returns have been fantastic. In the last 12 months BTC has grown from a market cap of $6.3B to $17.8B. In the last 12 months ETH has grown from a market cap of $850M to $4B. While it’s true that these asset classes have also historically been extremely volatile, it’s also clear from the data that they have thus far delivered consistently handsome returns to early investors. Losses were posted two of the 9 years, with annual average returns of in the ballpark of 350% and 500% respectively for Bitcoin and Ethereum.

We may argue that, as impressive as these numbers may be, we are equity investors into technology companies, and as such these and related asset classes are clearly inappropriate investments. That would be a mistake. These tokens are fundamentally new technologies first, and financial assets second.

2. Tokens are becoming a new funding paradigm. It behooves us to think about how as VCs we can
operate here if we see compelling cases.

Previously, protocol layers (like HTTP or TCP/IP) were largely provided by researchers who didn’t (at scale) monetize their protocols directly. It took entities who built software on top of those protocols, and then either sold that software directly, or built networks large enough to be attractive to advertisers, before the
protocol could be meaningfully monetized.

Networks like Ethereum are entirely different. Through cryptographic token sales, a for-profit entity can issue tokens to would-be participants in the network while retaining some portion of the tokens for themselves. As network participation increases, so does the value of the withheld tokens, which they can use to fund operations, incentivize employees, etc.

As such, as technology investors I think we need to think about how we can gain exposure to these tokens
in the event that we see a company that is attractive to us and meets our investment criteria.

3. It is very early days for Ethereum (genesis block in July 2015), and yet the flexibility of its
scripting language (Solidity) means that it has already garnered lots of developer attention, with the
promise of a much richer and diverse application layer of decentralized applications (DApps) built on
top of it

Big validation points for Ethereum include:

• $4B market cap less than two year after creation
• Coinbase’s adoption (July 2016)
• The formation of an Enterprise Ethereum Alliance including Microsoft and JPMorgan (Feb 2017)
• Leaders in the space abandoning Bitcoin in favor of Ethereum

You already have an entire ecosystem of developers using Solidity to build DApps
A full list of DApps maintained by ethereum.org

Some examples:

Status – A mobile browser, OS and messaging platform for Ethereum & Dapps
Oraclize – Data carrier for decentralized apps
Ujo Music, Musicoin – Blockchain-enabled digital rights mgmt. for musicians
Etherisc – p2p Social insurance, flight delay insurance, crop insurance
Gnosis – Prediction market platform including automatic payouts
Ethernote – Legal contracts and templates
uPort - Identity Management
KYC Chain – KYC solutions for finance and law
Augur – Forecasting Tool

Risks

To be fair, this space is fraught with risk, of which here are some:

1. Security
   There have been numerous cases of security breaches at high-profile stores of currencies, most notably Mt. Gox and the DAO. Security needs to be #1 DD item for any investment involved with storing or transferring a high volume of keys
2. Volatility
   Tokens have been tremendously volatile, which is a direct risk for us as investors but also a risk to mass-market adoption.
3. Reputational risk
   Ask your friends what they buy with their Bitcoin
4. Scale
   Both Bitcoin and Ethereum have issues at scale involving block-size, and transaction speeds/costs. Ethereum has an active community and is willing to evolve via hard forks, which suggests it will be the more flexible solution
5. Is this just batshit crazy?
   I don’t know. Is this so out there? I don’t think so. At this point, there have been billionaires created by investing in these tokens, building companies in the space, and building next generation protocol layers. The value of these networks is increasing exponentially as more and more smart people dedicate their careers and lives to the space.