10 Thoughts on Blockchain for the New Year - Revisited

Prior to New Year's Eve 2019, I published the article "10 Thoughts on Blockchain for the New Year". It was the most popular piece I've written on the subject. A number of people indicated they were inspired that someone with my traditional Wall Street background was highly supportive at a time when Bitcoin was trading under $4,000, well off it's all time high of nearly $20,000 a year earlier. To be honest, it was easy to be supportive, given the resilient, hard working efforts put in by members of the community during good times and bad. Also for someone like myself who's used some of the mainnets directly, I know the technology is terrific! And oh how times have changed, with Bitcoin smashing thru to new all time highs above $30,000 as I write this article on the exact day of its 12-year anniversary.

A phrase I used in the original article to frame that period was "a kind of mating dance taking place between the centralized and decentralized worlds," projecting that it would "take about two years to complete before it's settled." Given that we're 2 years on, it's time to revisit where we are now in my 10 thoughts for 2021 outlined below. As you'll see, I think we're at an even more critical juncture.

1) Last year Bitcoin caught the wave of institutional investors seeking safe haven from the risk of inflation posed by central banks' massive money printing in response to Covid-related economic slowdowns. The key aspect of Bitcoin capturing their interest is the 21 million coin limit and hence potential as a store of value. Paul Tudor Jones, for example, in a piece I posted in May noted that Bitcoin "scores 66% of gold as a store of value, but has a market cap that is 1/60th of gold’s outstanding value." As compelling as the Bitcoin return potential relative to gold may seem, the actual potential is far greater.

To understand why let's consider this quote from Satoshi in February 2009, shortly after Bitcoin's initial implementation:

The root problem with conventional currency is all the trust that's required to make it work. 1) The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. 2) Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. 3) We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. 4) Their massive overhead costs make micropayments impossible.

I inserted the numbers 1 thru 4 to emphasize there are 4 "pain points" which Satoshi set out to address. (This is how I introduce Bitcoin to my class at Columbia, reformatting Satoshi's commentary and whitepaper into the familiar "problem/solution" logic flow of an early stage pitch deck.) Pain point #1, currency debasement, is what draws the comparison to gold's market cap, which today is around $10 trillion versus Bitcoin's $600 billion. The remaining 3 pain points relate to banking activities. To the extent they can be managed more efficiently onchain, the banking industry's market cap of several trillion dollars can also be added to the potential upside for Bitcoin. (To be fair, banks also have large lending operations which cannot be replicated onchain at this time, however it's also fair to point out bank lending activities are driven in large part from their custody and payments operations that can be performed onchain. More on this later.)

2) Just as the previous retail driven run-up in Bitcoin was accompanied with value also flowing into competing protocols and expanded use cases, I believe institutions will look to diversify within crypto as well. (The institutional-oriented CME's planned launch of Ether futures next month is one indication of this.) With retail leading institutions down a similar path, the major difference I see is that institutions have much deeper pockets. Deeper pockets produce higher valuations, which brings in further investment looking for returns, supporting many projects to stages beyond "crowd funding", and extending this cycle longer and deeper.

3) Arguably the news of PayPal accepting Bitcoin and some other cryptos onto its platform is equally important, perhaps even more so, than the institutional investors coming in. With crypto now in reach of PayPal's 300 million global accounts, it provides the critical mass of mainstream utility that Bitcoin previously lacked. Without that offset traders can more easily push the price around, unlike the US Dollar, for example, which is in decline versus other major currencies, however a relatively orderly decline inline with its growing deficit in trade.

4) The mass entrance of institutional investors and large payments networks will, I think, lead to some tension with the Bitcoin core developers. The new entrants are driven entirely by commercial reasons, and at some point they will become more interested in Bitcoin for more than its store of value component, leading them to question why its not further optimized for the cost and scaling pain point parameters Satoshi sought to address as well. I also do not think the commercial players will place the same emphasis on prioritizing privacy as core developers, which further puts scaling solutions more front and center. As one institutional investor put it to me "why copy all of gold's characteristics including its shortcomings like difficult to physically transfer when software can make transfers high frequency and seamless?"

5) Lending and liquidity will continue to be hot areas as these are key components of a fully functioning financial system. No point in debating "DeFi" versus "CeFi" at this time, given the large magnitude by which credit notional exceeds a base currency, I continue to recommend getting exposure to both formats. I made this same point in the book on blockchain investing I co-authored which was published in March 2020.

6) Bigger picture, what's taking place is that the architecture for a new financial system is being built, before the global economy at large has onboarded. This differs from the legacy system which is a collection of non-interoperable networks and patches which evolved more or less as extensions of old relics like paper and precious metals. This time the platform will lead and be complete for the economy at large to onboard.

7) An example of the above is stablecoins, a way for fiat users to realize the 24/7 seamless, relatively low-cost, cross border transfer benefits of blockchain architecture. Regulators and central bankers like the EU's Christine Lagarde are correct in pointing out they can become so large as to pose a threat to the overall financial system, especially if holders view them with the same confidence as insured deposits which they are not. If the largest stablecoin Tether (USDT) with its $21.4 billion market cap of $1 tokens was an insured bank it would be ranked #76 by deposits, just ahead of Commerce Bank. A year ago at $4.5 billion it wouldn't have even cracked the top 200. With this rate of growth it's clear why regulators are looking closely at this product.

8) Why aren't large banks being more aggressive in this space than myself and some others thought they would be by now? There are plenty of things they could do like custody and lending. Well all I can do is recall the response from PayPal co-founder Peter Thiel when asked the same question about large banks and their late entrance to the digital payments space, wherein he cited political dysfunction of large corporations and how the "smarter" people are reluctant to participate in projects that are less likely to work (starts at 9:30 mark of this video if anyone wants to watch his entire response.)

9) I concluded my article of 2 years ago by stating that "Proof of work works, it’s time to coalesce around a standard, move to wide scale adoption, and get more mainstream." I still believe the largest Proof of Work chains are the safest and most immutable. However there could be a gradation where Proof of Stake chains offer adequate security to meet end user needs, while also more readily providing other important features like scalability. It's one reason why I am closely watching Ethereum's transition to its "2.0" Proof of Stake protocol.

10) Two years ago the dominant theme was the centralized versus decentralized "mating dance" as I called it, today there is something arguably much greater at stake. While it's been a long-standing dream of the Bitcoin Maximalist that some day Bitcoin would become the world's reserve currency, today due to the consequences of Covid that accelerated longer term trends in digitalization and upset the economic order between the US and other parts of the world (most notably China), the global reserve battle is now on. It's one reason I chose to spend the holiday season in Bretton Woods, New Hampshire, site of the famous trade and currency conference in 1944, so I could announce a new investment research project I am part of to examine this competition and the major implications for its winners and losers.

In 1944 it was between the US dollar and a supranational currency called "bancor" championed by British economist John Maynard Keynes. The dollar won and remained dominant even though much of the Bretton Woods framework has been dismantled. Today we see the competition as being between the US Dollar, Yuan, Euro and Bitcoin. Although it's much too early to declare a winner, that Bitcoin even has a proverbial "seat" at the global reserve table is quite stunning for a 12 year old technology with no sovereign backing. How soon will we know if there's a clear winner? Let's touch base again 2 years from now to find out! In the meantime, follow me for future updates on this project and others.

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