Diversification Part II: Why Crypto?
Introduction
In Part I of this series, we examined the return profiles of broad baskets (Top 50+) of cryptocurrencies vs a simple BTC/ETH or Top 10 strategy, showing that such diversified strategies have worked recently, and hold potential for the future. We also acknowledged that this premise really hinges on a diverse range of cryptocurrencies having actual value. The huge amount of outright speculation in crypto may often overshadow the real long-term value being built by many blockchain projects, but we believe it exists. In this piece we want to dig into this broad world of innovative projects, and discuss how we see the universe of investible projects growing (the “expanding cone” which we referenced in our prior piece).
Past just being enthused about blockchain-based projects, we also believe that investing via tokens will be the preferred way of participating in value accrual within the space. This is perhaps the most controversial topic in crypto these days, with many buying into the power of blockchains, but struggling to see the value of cryptocurrencies and tokens. Indeed, the traditional way of tapping value in early-stage tech would be via venture capital and later on public equity, which are the methods most understand and are still comfortable with. The blockchain presents a unique problem here, however, where decentralization means that there may not actually be a company to invest in through which to extract value. Investing via tokens is an opportunity unique to blockchain and may in some cases be the only way to get meaningful exposure to a project. With crypto-assets as the building blocks of our strategies, a fair and necessary question to ask is: “Why should any of these crypto-assets have actual value?” We discuss this consideration as well.
Both of these questions tie into our liquid token investment strategy, which can be summarized in a few points:
The opportunity set for blockchain-based projects is huge, and spans many sectors
There will be many interesting, and useful, projects
Tokens and cryptocurrencies can have real value, if useful and well-structured
For every one project that succeeds, it is likely that many fail, but there can also be more than one winner in a sector
Capturing returns is about maximizing opportunity more so than picking the winners
Why Blockchain?
Before addressing how tokens can accrue value or particular sectors where interesting stuff is happening, we do want to give a nod to our broader thesis on the world of blockchains, cryptocurrencies, and Web3; and why one might want to participate in any way at all (be it equity or token). Blockchains, cryptocurrencies, and Web3 can all be thought of in distinct terms, but it's the intersections of these spaces that we find most interesting. To help us not get bogged down in semantics, we will use the broad term “crypto” to encompass everything from blockchain technology itself, the platforms built with it, the applications those platforms power, the communities built around both, the incentivization mechanics offered by cryptocurrencies and tokens, and the melding of all this tech and digitally native community that ultimately emerges as Web3.
What we have in “crypto” is really the infrastructure and economic architecture for digital goods. This allows for products that can be a combination of: Decentralized, secure, efficient, participatory, inclusive, and accessible. While some of this may just represent the improvement of existing processes, we also see huge potential in the crypto space fundamentally redefining value and ownership in the digital age. Digital goods no longer need to be valued based on the advertising revenue extracted from the attention we give them, but could become more closely linked to the underlying benefit they provide. In turn, the ownership of digital goods, and also the ownership of the users’ data, can now be defined, tracked, and allowed to exist independently of closed, centralized systems.
While not all crypto projects will share the same grand visions or work towards the same goals, they do ultimately still coalesce around the basic concept of technology enabling groups of distinct actors to better achieve their stated purpose. This has been an investible thesis for as long as technology has existed (in its many forms), and what we call the crypto space is just one of the latest evolutions. Are blockchains, cryptocurrencies, and tokens the only way to build and enhance the digital and the “real” economy? No. But it seems that there are many encouraging situations where the tools of crypto can be instrumental.
Blockchains present themselves as one of the key tools in this arsenal, and although not the only technologies at work in the crypto space, they are arguably the most significant, with the benefits being myriad. The emergence of smart contracts on platforms like Ethereum have also vastly expanded the power and use cases of blockchains. Codefying and automating contracts and reducing the need for trust in a diverse manner of interactions is an integral part of the architecture that crypto is designing. Zero-knowledge cryptography has taken blockchains even further, inviting applications where privacy is key to take part in blockchain technology. More efficient payments between unrelated parties was perhaps the original innovation of crypto, but we see many more:
Fairer value distribution in the creator economy
Censorship resistant sharing of data
More efficient distribution and use of resources
Efficiency improvements to legacy process and systems
The creation and functioning of governance systems, sans borders, across groups of self-organized individuals.
These, and others, are all major ideals that crypto strives towards, which can arguably result in value creation and accrual to investors and participants. To us, however, it is critical to find a careful balance between the idealism that provides the energy on which the sector thrives, and the realism necessary to evaluate the concrete improvements offered by the technology. To this end, it is important to remember that blockchains are not new technology. Blockchains are really “just” another type of database, and the underlying idea of distributed ledger technology (DLT) has been around since the early 1990s1. But, the technology is being applied and advanced in innovative ways to capture the benefits of trust, security, transparency, and traceability. There are also many issues yet to be solved, such as solving for the right mix of security, decentralization, and speed.
Despite the admirable vision many crypto projects have with regards to these benefits, not everything needs a blockchain. In some cases, the blockchain structure can be advantageous, and in other cases not. It’s a technology that can be applied with great effect, but need not be applied to everything, and is no panacea for all problems. It is also a technology that can both improve existing products and services, and also allow for the creation of entirely new products. So, even though blockchain is not always the answer, the addressable, disruptable market for the technology is huge, and as such, we think value can and will materialize in many different sectors.
Why Tokens?
Broader thesis on blockchain technology aside, why do we believe that tokens capture the value being created on blockchains? That is, supposing an investor believes that blockchain as a concept can add value to existing enterprises and inspire the creation of new ones, how does any of that get reflected in the price appreciation of a token? As we mentioned before, this is a topic of significant debate.Thinking about the value of crypto-assets is very much still an evolving area of study, and we can’t purport to have found the ultimate solution.
But, let’s not forget that this isn’t the first time an asset class has had growing pains. To be fair, we need just look to the early days of the public equities market (which, one can argue, lasted for hundreds of years), where stocks were also largely an object of pure speculation. Investors may have attempted to predict price moves, but information was scarce and there was no agreed upon framework for how to compare valuations of companies. The revolution in “valuation” did not really come about until after the Great Depression, when Benjamin Graham and David Dodd came up with their seminal methodology for valuing securities2,3.
Crypto has not yet seen such a revolution, but that does not mean tokens will continue to exist purely as a speculative fun house. Nor do we think that irrationality will persist for hundreds of years this time. After all, crypto, if anything, moves fast. Already, we see several ways in which value can theoretically accrue to tokens and help us parse through our expectations of which may perform better or worse in the long run.
The reason all of this is difficult though, is that, unlike securities (and their digital counterparts, security tokens4), which can be related back to an expected stream of cash flows or an asset for which a robust valuation framework already exists, crypto-assets generally do not have built-in cash flows accruing to a central operator. What’s more, the speculative “value” of many crypto-assets means that prices in the secondary markets, while often quite liquid, may not at all represent the fundamental value of an asset.
So where do we start? We take it back to money fundamentals.
Indeed, many tokens can be reduced to some idea of money (perhaps for highly specific purposes, but a medium of some exchange nonetheless), which allows us to enter the Quantity Theory of Money into conversation. The theory posits that the exchange value of a currency is determined by supply and demand, as expressed in the Fisher Equation relating the size of the money supply (M), the velocity of circulation (V), the cost of the goods (P) and the volume of transactions (Q, or T):
(M)(V)=(P)(Q, or T)
The application of this theory is controversial, to say the least, and has been widely discussed and debated5,6,7,8. We leave the reader to explore these arguments separately. For us, we are less interested in the specifics of the valuation than in thinking about how the inputs can relate to the fundamental use cases and adoption of cryptocurrencies.
Per the theory, the value of a token is linked to both how much and how often it is utilized, as well as the amount in circulation. This is most straight-forward for payment and money tokens because the utility is well defined: they are meant to act as a medium of exchange. As such, the question of whether such a token has value comes down to whether or not it will actually be used to transact. This depends on a host of external factors such as integration into existing payment infrastructure and actual mainstream adoption. However, we would argue that the use of crypto-assets as money replacements is a viable proposition, and that there could well be more than one coin that captures market share, given particular competitive advantages of different approaches.
But payments, as we know, are far from the only application of blockchains, and applying the QTM ignores many of the nuances of different token structures. So, it might help here to distinguish between some types of tokens, because their structures can and do impact how, and how often, they are used.
Cryptocurrencies
One of the simplest dichotomies to introduce is between true “cryptocurrencies” and other “tokens”. In a strict sense, “cryptocurrencies” are the native asset of a blockchain network. “Tokens” on the other hand can be thought of as anything built on top of specific blockchain protocols, generally tied to specific projects or organizations separate from the underlying blockchain.
It helps to draw this distinction because these true “cryptocurrencies” have a somewhat more well-defined value proposition because they must be used to interface with the blockchain. Cryptocurrencies are generally used to pay transaction fees (i.e. “gas”) and/or incentivize users to secure the network (via staking or mining) - which are critical functions to the blockchain ecosystem. If an investor believes that a blockchain serves a useful and productive purpose, and if said blockchain is functional and secure due to the incentivization structure for participants to secure it, then it should be fair to assume that the token used to realize that incentive structure has some actual value proportional to how much the whole system is used.
Ethereum is a useful example. As a Layer 1 blockchain with smart contract functionality, it serves as the platform for a multitude of other apps to accomplish disparate goals. While Ether (the native cryptocurrency of Ethereum) has also become viewed as a type of digital “money”, its real utility is the ability to build contracts and applications on top of it and rely on it for transaction verification. Ethereum, and other Layer 1s, accrue some value from all the projects built on top of it (even those with their own tokens), because they increase the total transactions and usage of the network. That in turn makes Ether valuable as a means of exchange, which further increases its value. Regardless of what the cryptocurrency’s ultimate use is, however, it is inexorably linked to the blockchain and can’t be removed without breaking the entire functionality. So, the question of value for cryptocurrencies native to a blockchain remains one of how much and how often the network and the token are used.
Another support for the value of cryptocurrencies is the fact that blockchains make use of scarce resources that have real-world costs. These are largely network-based, such as processing power, memory, bandwidth, etc. Miners / operators that provide these resources must ultimately be compensated for the cost of doing so, which puts a sort of “floor” on the value of a cryptocurrency. At values below this floor, it is no longer economically viable to serve the network, and functioning could stop.
Everything Else
Moving outside the context of cryptocurrencies that serve as the backbone to blockchain networks, and those that serve as a form of money, most tokens serve as parts of distributed applications, or Dapps, and exist to create incentive structures within those ecosystems. Whatever the use case, determining whether a particular token does have, or can accrue, value is critically linked to the underlying utility provided by, and demand captured by, the project.
In this regard, we assert that tokens may have value because the underlying project has value, but the underlying project is not by default valuable because it has a token or operates on the blockchain. So, there are situations where a blockchain-based product or service is useful, but the associated token is not; situations where the product is useful and the token does capture this value; and situations where neither the product nor the token have any long-term value. We cannot, however, rationalize, on fundamentals, any situations where a project provides no utility or value while the token does. Of course, anything can have speculative value, which may be enough of a reason for some to invest, but we are more interested in the fundamental, long-term value, which we do believe is how the market will ultimately value tokens.
In our view, tokens can capture value when they are an inexorable part of the project’s ecosystem or incentive structure, and said project is actually novel and useful. Tokens ultimately serve as a socio-economic tool to achieve coordination on a network towards a particular goal. As a tool, they should be judged with regard to how well they incentivize working towards the goal in the long-run. Incentives should align goals of the protocol and token holders, creating a virtuous cycle that both promotes ecosystem growth and token appreciation. We believe that this, in turn, is a justifiable source of value for the token, which links the system together.
Tokenomics
On top of the fundamental need for a project to be useful (that is, solve a problem that users want solved), we also see a number of factors that can help value accrue to a token - many of them relating back to the size of the money supply in the QTM and the sources of demand. The crypto community likes to broadly call these “tokenomics”. Ultimately it is a balance of these different factors that can make a token valuable, and none provides the final word in determining how well a token accrues value.
Multiple Functionalities: Tokens that are purely designed as “proprietary currencies” for their own ecosystem could fall victim to the “velocity problem”9 of the QTM. If users have absolutely no incentive to hold a token past spending it, then value will actually decrease as volume and frequency of activity increases. This can also be seen through the lens of opportunity cost: what are holders gaining by holding on to the token vs what are they missing out on by not holding a different token or asset. Becoming “accepted” as a store of value, like Ether, is an improbable solution, and likely only to work for the most successful tokens given the level of collective “belief” necessary. As such, serving purely as a proprietary currency is insufficient to drive sustainable value. This is the main reason why the incentivization structure of a token is so important, and why most tokens build functions into their protocols that incentivize the lock-up of assets for longer periods of time (such as staking).
Distribution of Protocol Revenues: Probably the most direct way of driving value to a token is by distributing a share of protocol revenues to holders - particularly those “staking” their holdings to help secure the network. Many protocols have implemented such a system, particularly in the DeFi and DeX space. This leads to a stream of cash flows, the estimated present value of which should correspond to the token’s value. Such a system is of course not possible if the protocol supported by the cryptocurrency or token does not directly generate revenues.
Natural, Sustainable Sources of Demand: In order for a token to have value, there needs to be a credible framework for why the token exists. This framework needs to be fundamental to the project and relevant for its entire lifetime. In other words, the token should be spendable, or have credible future spendability, on the network, alongside other functions that will slow the velocity of the token. It is important that sources of demand should also persist throughout the life of the project in a sustainable manner, and, for example, not only at inception to incentivize onboarding or liquidity (i.e. liquidity mining).
Scarcity: The idea that scarcity creates value is a core principle of modern economics, and as such, supply is a critical factor in tokenomics. Oversupply or constant sell pressure can negate demand. In general, inflationary mechanics are a cause for concern as they automatically dilute the value of the token, unless demand expands at a higher rate than supply. Scarcity must be managed, however. A token launched with artificially low supply may soar to a high market cap on initial demand, but then fall as circulating supply is steadily inflated, even if the total amount of tokens is capped.
Deflationary Mechanisms: In line with the previous point, a token with a deflationary mechanism can help support long-term value as it increases scarcity of the token. These mechanisms are often called “burning”, and can be thought of as somewhat like the stock buybacks that public companies do. For example, in addition to burning a portion of gas fees in real time, the popular centralized cryptocurrency exchange Binance uses a percentage of their quarterly profits to buy and burn BNB, which leads to both buying pressure on the token and a reduction in the outstanding supply10.
However, relying on reducing the supply of a token to achieve price gains is also not sustainable, and can result in an illiquid, volatile market. Some protocols have implemented functions around the concept of a burn-mint equilibrium11. In such an application, the number of tokens minted in each time period theoretically equals the number of tokens used over the same period of time (which are, in turn, destroyed). Higher usage levels lead to deflation, and lower lead to inflation. This can be a useful way to create a sustainable economic system, where demand essentially regulates the overall levels of supply.
Allocation and Distribution: Tokens need to be put in the hands of users, but should also exist to incentivize developers and investors. This needs to be considered from the inception of the token. The two most common ways that tokens are generated is via pre-mining or a fair launch. If the project pre-mines and allocates tokens to specific groups of holders, there should be vesting periods that ensure tokens are not flipped for a quick profit. Holders should have a long-term interest in the success of the project, and vesting periods should reflect this.
As a part of the allocation and distribution process, projects often retain treasuries of tokens that they can use to incentivize developers to build on their network or app, in hopes of driving value to the network. This can be thought of as a customer acquisition cost, similar to that incurred by many growth-oriented startups, and, if done well, those customer acquisition investments will have a positive ROI via the traffic and subsequent transaction volumes they create. However, the execution of this is sometimes done poorly, particularly in cases where projects essentially give away free tokens to retail investors who have no further incentive to hold them and, as such, sell quickly.
Governance: We’ve left the elephant in the room to last, which is: Whether or not governance alone adds value to a token. This has been a popular topic of discussion recently, with Vitalik Buterin recently tweeting:
“The notion of ‘governance rights’ as a narrative for why a token should be valuable is pathological. You're literally saying, ‘I'm buying $X because later on someone might buy it from me and a bunch of other people to twist the protocol toward their special interests.’”
In our view, it’s less black-and-white than this. For one, many tokens that have governance rights also have other functionalities that could be driving value. But we’re not so sure that even governance as a stand-alone concept for value accrual should be thrown out. The structure of the governance rights could be an interesting incentive mechanism if designed correctly. This depends on what exactly the governing body has control over, and also the future utility of the project and its business model. Ultimately the value probably comes from how well systems can promote maximum participation (even of smaller holders), and how well the system stays decentralized. Whatever that ends up looking like, it’s clear that existing models need work, but these concepts are still in their infancy and can evolve significantly. And as before, a successful governance token still relies on a successful project to govern.
Make no mistake, however: Crypto-economic design is extremely complex. It is difficult to model and fully understand the sorts of decentralized, self-organizing systems that have become the norm in the crypto space. Any sort of design will rely on assumptions that may ultimately turn out to be entirely different in practice. But this is not unique to blockchains, and is a problem experienced by essentially every study in traditional economics. Complexity alone is not a reason to dismiss the value of tokens, and, as the space evolves, we are likely to develop much better understandings of how to model and optimize the unique economies created in the crypto realm.
The Exciting Stuff (Use Cases)
Now that we’ve discussed how tokens can actually have value, we want to dig into the actual problems being solved, or capable of being solved, by blockchains. In our first piece, we discussed how we saw an “expanding cone” of opportunity in the crypto space. While still quite young, the space is maturing. Builders and users of technology are learning from past mistakes. Initial use cases are being proven, and new use cases are being tested. Adoption is rising. Markets are becoming more efficient. Excitement remains high. There are MANY opportunities for investors to get involved. This bodes well for our strategies, which seek exposure across many tokens, in diverse sectors.
Our diversified approach to investing in liquid tokens borrows from the well-documented phenomenon in other asset classes that shows that “picking” winners is actually a losing proposition12,13. While the crypto markets are perhaps still less efficient than equity markets in pricing in all available information, we remain convinced that it will be more profitable in the long-run to spread bets over a broad array of projects with potential, rather than placing concentrated wagers on a select few. To be clear, this is not a new or unique proposition even in the fast world of tech start-ups. Venture capital investors have historically funded a wide range of projects in hopes of a handful of major successes with asymmetric outcomes.
One might argue that diversification in other assets works because the underlying companies (or sectors, or regions) are actually quite different, while crypto is either all a scam or all about replacing fiat money. We disagree. For one, even if payments were the only use case, diversification is still a good strategy within sectors. But, more importantly, payments are far from the only use-case: There are blockchain solutions being explored in multiple sectors, many of which are powered by, or rely on, credible token structures.The advent of zero-knowledge cryptography has also addressed the issue of privacy necessary in many applications, and thereby opened up further opportunities perhaps once not seen as fit for a public blockchain project. Here are some areas that excite us:
Finance
We can start with the most visible of sectors with blockchain activity (for better or for worse..): the world of finance. Let’s include here the original Bitcoin use-case as well: that of an alternative currency and new means of payment. The opportunities in this space are huge, thanks to some key characteristics of traditional finance that are ripe for disruption:
Traditional finance is exclusive and permissioned, while blockchains can be inclusive and permissionless - bringing financial services to a greater audience globally.
Traditional finance extracts huge amounts of fees via a complex array of middle men. Blockchains can reduce the need for trust and remove these intermediaries.
Much of traditional finance is still incredibly inefficient. Settlement times and transaction costs are an issue for nearly every service and in every market. Blockchains can dramatically reduce these frictions.
These opportunities span diverse sub sectors such as payments, capital markets, central bank digital currencies, DeFi, Insurance, Real Estate, and more. DeFi in particular has illustrated the value of public blockchains with smart contract functionality. Unfortunately, this space has seen some of the most high-profile mistakes in all of crypto as well. From hacks to outright fraud, finance on the blockchain is still in its infancy, and needs considerable maturation to become appropriate for a mainstream audience. However, the ideas of immutability, decentralization, and encryption are all highly relevant to financial applications, and we expect to see significant further development in this space.
Among the innovations we look forward to in the financial space are:
Tokenized private investments trading on public blockchains, enabling increased efficiency, price discovery, and access for a wider range of investors. Illiquid stakes in funds could also become more tradable and accessible to a wider audience.
Further adoption of stablecoins, already a massive market today, could enable instant payments and foreign exchange.
Synthetic, 24/7 traded assets: We expect that existing liquid assets such as stocks, commodities, and currencies will transition to blockchains. Digital-native or even just synthetic securities could enable broader access to markets and enable round-the-clock trading.
Further growth in lending: Permissionless, overcollateralized loans are one of the most useful use cases in DeFi right now. Being able to borrow against crypto without selling it and using the loan for real world purchases could enable substantial flexibility and help port crypto into the “real world”. On-chain, undercollateralized lending could also give companies without access to traditional banking services an avenue to tap borrowing markets and expand their businesses. Alongside these innovations, we could also see growth in crypto credit scores based on on-chain behavior. Such credit scores could ultimately be more objective and less discriminatory than traditional credit scores.
Media & the Creative Economy
In our view, one of the most unique and exciting spaces for blockchain development is in the media industry, or, more broadly, the “creative economy”. We see this as the whole media value chain from content production, to aggregation, distribution, and ultimately consumption. It is no secret that many believe the business model of the media industry to be broken, especially with regards to how content and content creators are valued and compensated. Consumers of media today have largely gotten used to a model that distributes content for free and makes up the revenue via advertising. These days, content is ubiquitous to the point of commoditization - largely to the detriment of content creators, who end up being rewarded minimally for their fundamental role in a multi-billion dollar creative industry. That industry has become, almost purely, fuel for the advertising industry, where the consumer becomes the product, and the creator becomes detached from any upside participation in the fruits of their labor. However, as privacy concerns grow, even the model of “free product for personal data” has come under scrutiny, further complicating value transfer and accrual in the industry.
As we stated earlier in the piece, one of the greatest promises of the blockchain and crypto-asset revolution is the wholescale creation of an economy and infrastructure that is built for the digital world. Content, and particularly the associated rights, that was once largely an intangible concept can now be represented and tracked as tangible, defined assets in a digital ecosystem. NFTs, smart contracts, cryptocurrencies, and tokens can all serve to better define and deliver value in the creative economy, ensuring that musicians, artists, writers, publishers, and others in the value chain are all credited and compensated appropriately. We could see this implemented via new pricing options (via tokens or cryptocurrencies), more robust royalty payment structures (via smart contracts), definition and tracking of ownership (via NFTs), and a host of other blockchain-enabled opportunities.
Social media, another bastion of the “free product for personal data” model, could also be a huge beneficiary from blockchain technology. Once again, privacy and censorship concerns have made it more important to users that they “own” their data and know exactly how it is used. While centralized platforms hold all the power today, and wield it in a dubious, opaque fashion, a future of blockchain-enabled social media could see: new monetization strategies, greater portability of user data across platforms and products, more genuine engagement and collaboration, and both more local and more global venues for interaction.
Gaming
Gaming is arguably a subsector of the media industry, but the potential for blockchain in gaming is significant enough to warrant its own category. Both fungible and non-fungible tokens could become major elements in existing games and inspire entirely new games built for a blockchain-native future. While the early play-to-earn titles have perhaps focused too much on the “earn” rather than on the “play” (assuming that “play” should mean an enjoyable activity), they have at least served as useful proof-of-concepts for blockchain integration in gaming and have inspired considerable investment of talent in the sector.
Theoretically, gamers could be the largest and most natural audience to port into Web3, but their willingness to adopt new blockchain-based technologies will hinge on the quality of the content they are paired with. As such, an area of particular opportunity could be infrastructure projects that make it easier for established AAA gaming studios to integrate Web3 elements into new and existing titles. Past just being fun to play, gaming experiences in Web3 need to be as seamless as the experiences currently offered in traditional gaming, whether on mobile, console, or PC.
Education
Another critical but oft-underserved industry is education. Blockchain technology has the potential to revolutionize this industry in a number of ways: From how it is delivered, to how it is accessed, and how it can be shared and verified. For example, blockchain-based technology could be used to create secure and immutable records of educational qualifications and achievements, which could make it easier for students to prove their qualifications to potential employers and other educational institutions. These provable qualifications could also expand past centralized teaching authorities like public schools and universities, and include education independently pursued by students via other avenues, such as the internet (particularly in Web3 style).
Blockchain technology could also be used to create decentralized platforms for the creation, sharing, and distribution of educational content. A major issue with traditional forms of education is that their availability is largely dictated by geography. That is, students residing in a particular area are often limited to the education available at local schools or organizations - an issue exacerbated in countries like the USA where education is often funded by local property taxes, creating inescapable poverty for many. Decentralized education platforms could make it easier for students to access a wide range of educational materials and resources, regardless of their location. These materials could also be more personalized to the learning needs of individual students. For educators, decentralized platforms would also enable them to share their knowledge and expertise with a larger, or more tailored, audience.
Improving existing systems or working with new ones, blockchains could enable financial access to education by creating more transparent and secure systems for the management of educational funding and scholarships. This could help to ensure that educational funds are distributed fairly and efficiently, and could also make it easier for students to access the financial support they need to pursue an education.
Going a step further, blockchains and token-based economies together could help incentivize learning in particular fields that are critical to certain industries, but underserved by traditional education. For example, companies or organizations could sponsor education in niche areas of mathematics, sciences, or computer programming, that would directly prepare students for employment. Completing such courses could again be reflected and verified via detailed records of individuals’ educational accomplishments. This approach would also have a greater chance of reaching underserved communities, for whom such skills could be instrumental in pursuing higher-paying careers.
Supply Chains
The transparency, traceability, and security of blockchains make them a very interesting technology to explore in the context of supply chains. A blockchain-based system could track the movement of a product from the manufacturer to the retailer in real-time, allowing all stakeholders in the supply chain to have a clear and accurate view of where the product is at any given moment. Such traceability would be valuable past the delivery stage as well, as the provenance of any product could be traced and verified back to original sources. This could be incorporated into enhanced product certifications - an application that could be particularly useful in the agriculture and food industries to add legitimacy to labels like “organic” or “fair-trade”.
The immutable nature of blockchains can also help to reduce the risk of fraud and counterfeiting, as it becomes much more difficult for bad actors to alter or manipulate the information that has already been recorded. Companies involved in luxury goods are natural customers for such a service, given how much value is driven by authenticity and brand value. However, this is equally valuable in other industries, such as high-tech, where the quality of components is critical.
Supply chains might be an area where private inter-company blockchains serve as the initial proof of concept, especially as large-scale global shipping and logistics is carried out by a relatively small number of centralized entities. However, applications could move to public blockchains to capture the trust of those protocols that could be more valuable to consumers.
Healthcare
Applications for blockchains in the healthcare industry could be significant. At present, the industry is characterized by an inefficient mix of public and private providers (country-dependent), none of which necessarily have the same patient data. Blockchains could be used to create secure and immutable records of patients' medical histories, which could make it easier for healthcare providers to access and share information about their patients' health. This could improve the accuracy and efficiency of healthcare services, and could also enable healthcare providers to deliver more personalized and effective care to their patients.
Patient information could be stored in a secure and decentralized manner, with privacy protected by zero-knowledge cryptography. Such platforms, with rich, anonymized user data could prove invaluable for the purposes of medical research and discovery. This could accelerate the pace of medical innovation and the development of new treatments for a wide range of medical conditions.
Blockchains could also be helpful in the production and distribution of medications, helping to prevent the proliferation of counterfeit or substandard medications. Pharmacies, patients, and medical professionals could all explore blockchain records that verify the manufacturer and creator of the medical products. This could also help disintermediate middlemen in the medical supply chain, and streamline processing and delivery without excessive and costly involvement by third parties.
Digital Infrastructure and Identity
As blockchains proliferate, the infrastructure around them will also need to grow and evolve. Blockchains themselves are of course infrastructure, particularly the Layer 1 protocols that power varied digital applications. Some of the most important tools will likely relate to interoperability between blockchains. There are already projects addressing the need for inter-blockchain communication, but this should remain fertile ground for innovation.
Wallets are a major piece of blockchain infrastructure that will need to be refined for mainstream consumption. Wallets will also need to evolve to support the various applications we’ve talked about. Particularly, wallets could come to incorporate more digital identity technology - passports for the digital world as it were.
The decentralized and immutable natures of blockchains are particularly valuable for digital identity solutions, helping to address issues such as lack of access, lack of security, and outright fraud or identity theft. Again, zero-knowledge cryptography is a potential boon to the space, enabling essential levels of privacy without the need for centrally maintained databases.
In the current state of Web2.0, centralized entities have been able to build enormously detailed profiles of users and in turn profit off of the sale of this information to advertisers, often without knowledge or consent of the user. A blockchain-enabled future for digital personal data and identities would help individuals control their data and who has access to it. Furthermore, rich digital profiles curated by users could be portable to a variety of platforms, enabling richer, more customized experiences. For example, a “sign in with Web3” concept where a user can sign into their various social media accounts, email accounts, and other web services with a single wallet, porting details and preferences to each platform.
Already, work is underway to revolutionize concepts of digital identity. Soulbound tokens, for example14 can be useful as a “proof of personhood” method for voting in any governance system, or act as non-transferable NFT’s with a variety of use cases (such as diplomas or proof of attendance for a particular event). Many identity efforts overlap with the increasing desire of individuals to stay anonymous, or at least control what information about themselves is in circulation on the internet. Blockchain-based identification could help retain anonymity and freedom from censorship, while still providing some proof of reputation. For example, Digital Reputation Attestations15 is a resume-like concept that also helps users remain anonymous.
Indeed, the need to maintain security digital identities overlaps with nearly every “real-world” application of blockchain technology. Healthcare, finance, ownership of assets, travel, KYC, voting, education, hiring, and a multitude of other applications, will all be profoundly impacted by technology that enables a fairer, more secure, approach to verifying identity.
Conclusion
Tokens provide an interesting opportunity to gain exposure to the broader thematics of blockchain technology. These tokens can have real value if they are well-structured and useful, and the opportunity set for blockchain-based projects is vast, spanning many sectors. Blockchains, alongside the other technology and communities that surround them, offer the potential to redefine value and ownership in the digital age - a critical element of “Web3”. However, not every problem needs blockchain as a solution, and the industry is still in relatively early stages of finding product-market-fit for potential applications. We prefer to take a broader bet on blockchains, and the products they enable, by pursuing diversified strategies across liquid tokens. Such a strategy has been proven to work in other asset classes, and our own work in Part I of this series shows that the strategy holds potential for cryptocurrencies and tokens as well.
Appendix: Security Tokens
We have mainly discussed tokens with structures unique to the blockchain, but there are also tokens that are, from the start, structured and treated as securities. Security tokens are essentially the digital equivalents of TradFi investment products like stocks, bonds, or other structured or securitized assets, although they can include more innovative structures as well. As such, their value relates directly to the legal rights or ownership they represent, whether that be in a singular asset (for example, a company) or multiple (an investment fund). Models from TradFi, such as discounted cash flow analysis, are portable to this realm of tokens, and the value of the token is linked to well-understood concepts such as fractionalized equity ownership in a company.
Thematically, we think of this space as more of an improvement, or extension, of traditional financial assets - and less so an innovative blockchain-native experiment. Arguably, an investor seeking exposure to blockchain-native projects would look more to the tokens described in the previous sections. However, the benefit of tokenized securities, and why one might want to hold them vs other formats, is largely in the operational efficiencies captured by digitizing the assets. Greater liquidity, faster settlement times, lower trading costs, and reduced counterparty risk are all goals of tokenizing assets.
We see great opportunity in the security token space, which could help reinvent capital markets for the digital era. This growth in the security token space could also lead to value accrual at the cryptocurrency level, depending on what blockchains become utilized as the rails for these assets. Indeed, if even small portions of the multi-trillion-dollar global securities market end up flowing through public blockchains, they could drive significant value accrual.
Footnotes
“How to time-stamp a digital document”, Stuart Haber & W. Scott Stornetta, 1991, PDF
“Security Analysis”, Benjamin Graham and David Dodd, 1934
“The Intelligent Investor”, Benjamin Graham, 1949
“The valuation of crypto-assets”, Ernst & Young, 2019, PDF
“Cryptoasset valuations”, Chris Burniske, 2017, Medium
“The Quantity Theory of Money for Tokens”, Warren Weber, 2018, Medium
“On Medium-of-Exchange Token Valuations”, Vitalik Buterin, 2017, vitalik.ca
“Understanding Token Velocity”, Kyle Samani, 2017, multicoin.capital
“Binance BNB Burn Explained: How Much is Burnt and When?”, Jordan Lyanchev, 2022, CryptoPotato
“New Models for Utility Tokens”, Kyle Samani, 2018, multicoin.capital
“U.S. Persistence Scorecard Mid-Year 2022”, S&P Global, 2022, spglobal.com
“The efficient market hypothesis and its critics”, Burton Malkiel, Journal of economic perspectives, 2003, aeaweb.org
“Soulbound”, Vitalik Buterin, 2022, vitalik.ca
“What is Sismo | Part 1: Zk Badges”, Sismo, 2021, blog.sismo.io
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