A professional investor’s attempt to demystify blockchain and crypto investments

Lessons learned comparing blockchain to earlier technologies and bubbles

When I was a wide-eye, world-is-my-oyster 28 year-old CEO of a fast-growing Internet telephony startup in the 90’s dotcom, I visited Sand Hill to pitch legendary Silicon Valley VC (now legendary early blockchain investor), Bill Tai.

We were the leading Asia-focused VOIP firm at the time and had multiple offers from VCs. Bill stood out. Bill showed me a map of the VOIP ecosystem. Like today’s blockchain, it was early in the Internet telephony days and no one had mapped out the ecosystem, not even us, the entrepreneurs. Bill color coded the segments his firm had invested, the segments they shunned, as well as their target segments. My firm’s logo sat nicely in one of the targets boxes, along with our top 3 competitors. Bill explained how they can help us with suppliers, customers and partners through their portfolio ecosystem. He also made it clear that if they didn’t invest in us, it’d be one of the other logos in the box. That 15 minutes and Bill’s term sheet that followed won me over. Regrettably, our Board voted to take our Series A from an Asia investor at materially higher valuations. We went on to raise multiple rounds (Series B, C, D, E and F in 2.5 years!) totaling $60m plus with Lehman Brothers pre-marketing our dual NASDAQ and HKSE IPO before the market came crashing down.

A student of history can learn many lessons from the first internet bubble. First, bubbles normaly form for the right reasons: smart entrepreneurs and the best VCs get in early, seeing the transformative nature of the tech and future. When everyone else smells blood and piles in, the bubble forms; cheap capital fuels a spiral, until inevitably, the majority die and the best — those with perseverance, sincerity and execution ability — prosper.

This is what happened in the Internet of Information driven by TCP/IP and what is happening now (in pockets, not overall) in the Internet of Value driven by blockchain.

Technologies are useless, well, unless they are used.

In the first Internet, we had chat, email, and voice-over-IP as useful applications. Then we had e-commerce, social media and the rest of Internet consuming our daily lives. In blockchain, some call web 3.0, the action has been at the infrastructure and protocol levels, and we are seeing emergence of real use cases.

We will explain below.

When I shifted my career to investing, including setting up my own private equity firm in China, I kept Bill’s strategic and analytical approach close to heart. We try to learn the underlying tech and visualize the future ecosystem as early as possible. Here, we share our Eureka moments in learning blockchain and our attempts to map out the ecosystem. We believe seeing how it all fits together makes us better investors.

My first “aha” moment was reading Satoshi Nakamoto’s whitepaper on Bitcoin. Arising out of the Lehman crisis (including my own VOIP startup, which missed the IPO window), Satoshi made a compelling case for decentralized digital currency not beholden to any politician or government, brilliantly made possible on blockchain, including unbreakable security and elimination of middlemen and double spend problem. It was an easy read, even for non-techs, yet brilliant.

Next was Joel Monegro’s insightful article on the ‘Fat Protocol’. Our team has modified it to include the key players in both the Internet and the blockchain stacks:

A stack is a set of components or layers in a software offering that provides broad functionalities. In the Internet world, “thin” protocols such as TCP/IP did not capture any value — monetization was at the “fat” application level, captured in the form of stocks (equities) by the FAANGs and BATs of the world. In blockchain, to date, not much value has been captured in the applications (DAPPs or decentralized apps); instead value has been created at the protocol and platform layers and captured not in companies or stocks, but rather in the form of tokens.

In short, for blockchain, the value creation so far has been in protocols and tokens, less in equities and apps.

That statement has huge implications for investors, particularly professional investors. Fund managers must not only mentally wrap around investing in tokens without entities or management teams, but also must amend their fund legal mandates to do so. This is a conversation many partners of institutional funds are having today.

Yet, what’s a protocol vs a platform? What are applications in the blockchain? How does this all fit with the ‘real world’? Bitcoin is the first blockchain, created initially for digital payments. There are now many blockchains, serving (or proposing to serve) many functions. Today, the most popular blockchain for development with most use cases is Ethereum. We will try to map out the Ethereum ecosystem and compare it to its ‘predecessor’: MS-DOS. The analogy is far from perfect, but may serve helpful for us older folks ;o)

Source: dAlchemy & Ameer Rosic of Blockgeeks

We can view MS-DOS and Ethereum both as Platforms or environments which software can be executed. The former is built on programming languages such as FORTRAN and CP/M-86; the latter on Go, C++, and Rust. Sitting on top, the Frameworks (.Net vs OpenZeppelin) provide the software environments to build and deploy applications. Protocols provide a set of rules to transmit data. So Sharepoint, Exchange and Windows Server vs. 0x, Swap, Bancor and Kyber — open to debate. On top of protocols we have the various Applications and Widgets, designed for the front end user.

There are key differences in the two worlds, of course:

In MS-DOS world, Microsoft captures much value in the Platform, Framework, Protocol, System Software and Applications layers. Other companies such as Adobe, create value with their applications such as Illustrator, as well as Widget makers such as Hulu, Spotify. The value here has been in information sharing and development of front-end applications and services. Information is centralized and value owned by companies and their stockholders. In the Ethereum world, the value to date has been created from processing information at the Platform and Protocol layers (the back-end Fat Protocol). No company or persons owns Ethereum, information is decentralized across the the network, with value captured in its token. The layers built on top of the Ethereum Platform, certainly the major ones to date, are also issued as tokens, not stocks. Whether Protocols, DAPPs or Widgets, the ones with the real use cases, manifested in tokens, will survive and prosper, making the token holders (entrepreneurs and investors) wealthy.

The above analogy is overly simplistic. The are many blockchains. Bitcoin is the first blockchain, created initially for digital payments (and now maybe store of value — depends on perspective). Ethereum is the most used, with most developers and applications, and often viewed as a decentralized “world computer.” Other major blockchains and their use cases include EOS (decentralized operating system), NEO (Chinese Ethereum), Steem (decentralized social media), Monero and Zcash (privacy coins), Lisk (mobile applications), Cardano (security and scalability) and Litecoin (high volume transactions).

As investors, though, we need to think beyond just blockchains and tokens. There are opportunities in infrastructure and service providers across the ecosystem. Many, like digital wallets and exchanges, are highly profitable today. One digital asset exchange company for example, Binance, we named the fastest profitable unicorn in history ( article here). Like everyone else, we are learning which tokens are long-term winners, but we are also seeking opportunities in companies across the ecosystem. The diagram below, another work-in-progress, shows segments we have invested and those we like:

Sources: dAlchemy & Virtual Capital Ventures

Today we live in a world with the widest, deepest, and fastest technological innovation in human history. We are truly lucky to be alive and witness the simultaneous emergence of not just blockchain, but also artificial intelligence, data science, robotics, autonomous driving, bio/health-tech, agri/foodtech, nanotechnology and so on. We won’t argue that blockchain is the most disruptive, but, to us, it is certainly the most exciting and developing at the fastest pace. Not only does blockchain attract the best talent and traditional investors, it is also championed by its impassioned early adopters: crypto-geeks turned crypto-whales — believers in blockchain technology’s potential to democratize information, to make the world a fairer place. Many ‘whales’ have been eager to invest their billions in blockchain innovators.

The hype for this future blockchain infused utopia, of course, far overstrips today’s reality.

We agree that perhaps just 1 out of every 100 blockchain ventures (tokens or equities) will survive and prosper.

That’s why we love investing in the space.

If it were 99 out of 100, everyone would be doing it.

What fun would that be?

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