Author: Will Peets, CIO of Passport Digital Holdings, @WillPeets
Despite Bitcoin being introduced >10 years ago, we are still in the very early innings of the development and adoption of digital currencies (perhaps the first half of the first inning). We expect the technology to develop, evolve, and be adopted more quickly than is perceived by the broader market. While we expect this to happen quickly, we acknowledge and have identified key fulcrum points in the broader adoption and development of digital assets which play a significant role in our investment thesis. These include:
Infrastructure (custody, trading, etc.)
Legislation & Regulatory Clarity
Refinement of crypto economic models (design, governance, valuation, etc.) and reconciliation of those models and existing business and ownership models
Obfuscation of cryptocurrencies in consumer applications
Mainstream media has, unfortunately but understandably, been focused on the price, value, and volatility of bitcoin and the larger digital asset ecosystem.
The objective of the next few posts is to address fulcrum point #1 (education/understanding): provide an overview of the digital asset landscape, simplify certain of the more technical concepts, and lay out a broad investment case for investing in the digital asset ecosystem. This draws upon the work of several groups and individuals as cited throughout and will be periodically updated as our investment view and the underlying technology evolves. We also expect to publish more detailed pieces that focus on specific topics introduced at only a high level here.
Where did it come from?
Before presenting the investment case for the asset class, it’s important to demystify the technology and core concepts that underpin digital assets and crypto economic systems - the most important of which is the blockchain construct. The main point is that blockchain technology, similar to the internet, is the product of research and innovation progressed by individuals, academia and the private sector over several decades. For a more in depth review - click here.
With blockchain technology now well established having been invented ~10yrs ago and battle tested with the release and the success of the Bitcoin protocol, it has set the stage for an incredible amount of innovation - innovations on blockchain design, contemplation of different use cases, which have the ability to create a step function change for many industries.
What does it provide?
At the most primitive level, blockchain technology enables trustless distributed systems and removes the need of a trusted third party or intermediary. Blockchains and their associated cryptocurrencies have the potential to enable several applications such as the transfer of value and the “internet of money”, trustless execution of code/programs and “smart contracts”, trustless sharing of information and storage of data, digital scarcity that can underpin art and collectibles, a shared immutable database that can act as a “store of state” of public records, and other innovations - many of which have not likely not yet been identified.
Trusted third parties and intermediaries add both a cost and a security risk to existing systems. As stated by Nick Szabo, “trusted third parties are security holes”. Blockchain technology has the ability to remove the need for trusted third parties at the protocol layer (removes the need for an intermediary by design) and thus has the potential to remove a lot of cost and friction in existing systems.
For purpose of discussion, I”ll define nomenclature in the context of Bitcoin but this is generally applicable to the digital asset ecosystem.
Protocols & Currencies: The word protocol refers to a set of rules. Software enables a set of rules (defined in the code of the software). The Bitcoin (capital B) protocol is software that defines the rules of the Bitcoin network. Given that blockchain protocols like Bitcoin are peer to peer networks, protocols define the rules of the “network” (i.e. how information is propagated across the network, how peers/participants interact, etc.). This is analogous to TCP/IP, HTTPS, FTP, and other protocols that dictate the operating rules of the internet. The unit of account on the Bitcoin network is bitcoin (lower case b), it’s native “currency”. It’s important to note that a protocol doesn’t need to have a native token (like HTTPS). A native token however is the incentive mechanism for peers to provide a scarce resource to the network (compute resources in the case of Bitcoin).
Permissionless (Pubic) vs. Permissioned (Private) network: The Bitcoin network is a permissionless, public network. This means anyone can participate in the network - the only requirements are that you need to run a copy of the Bitcoin software (which is open sourced and publically available). A permissioned network, as the name implies, requires that the network administrator (often a company or foundation) allow you to participate.
Distributed Ledger: A distributed ledger is a ledger that is maintained, replicated, shared and synchronized across all parties (nodes) participating in the network (vs. being maintained by a single entity). While it is costly (redundant) to store data this way, the redundancy is a security feature of the network
Tokenization: This is a digital representation of an item, often times a security, on a blockchain. Other items such as digital goods (“skins” in a video game, in-game items, etc.) are prime examples of “assets” fit for tokenization. Tokenization generally comes in two forms: fungible and non-fungible tokens (NFTs). Security tokens can be thought of as a digital representation of a stock - scarcity is important but one share is interchangeable with another. Non-fungible tokens on the other hand could represent digital goods, in-game items, art, etc. - where each token is a representation of something that is truly unique.
Utility Token: This is a term that was coined by the industry to describe the native token (often used interchangeably with currency) that are required to access/use or otherwise participate in the network. As an aside, the industry has framed this as an alternative to a security. From the vantage point of the SEC, there are securities and non-securities and it’s becoming increasingly clear that most ICOs are or will be deemed to be securities.
Base Protocol vs. Application Layer/Application Tokens: Bitcoin is what is considered a base protocol. It is the most primitive layer of the network from which everything is built. Some protocols (Ethereum being the most prominent current example) enable computations and programs to be run on top of the protocol (often referred to as DApps ~ decentralized apps which refer to the underlying platform is itself a distributed system). If the base protocol is analogous to TCP/IP and HTTPS then an application layer token is similar to a FB.com. Unique to the digital asset ecosystem, many of these decentralized applications have a native token which enables access to use the application (this however is an area that is quickly evolving).
Next week’s post will focus on the potential use cases and adoption progression of the asset class. Please check back to this page frequently or follow us on twitter.