As Crypto begins being increasingly identified with wild speculation, crashing prices and Ponzi schemes, it’s worth remembering the vast potential upside that the sector offers.
Many cryptocurrency enthusiasts envision Bitcoin (or Ether) replacing the dollar as Money. The jury is still out but both adoption and volatility trends make us dubious.
For the emerging crypto ecosystem to really change the world, it must evolve from speculative experimentation to sustained value creation through experimentation. Putting aside replacing the dollar, how could this happen?
Crypto proponents often focus on reducing transaction costs in the financial system, micropayments, and more user-controlled social media. Yet, transaction costs are already low (e.g., retail stock trading is free and credit card interchange fees might average 2% but the net after credit losses and customer rewards is much lower), micropayments are an area that could benefit from innovation and efficiencies but by definition micropayments are small potatoes, and while users say they want more privacy and better control over their data in social media, their behavior suggests otherwise. We would welcome being proven wrong, but these killer applications for crypto don’t seem that killer.
More interesting in our view is the potential for crypto to subsuming the current path for ambitious entrepreneurial efforts. Could a crypto ecosystem replace Silicon Valley?
Make no mistake, Silicon Valley start-ups are very good at connecting and organizing people. Start-ups create value by aggregating ideas, insights, and skills while simultaneously contracting – via equity ownership - how the value created by the (newly connected) group will be divided. Silicon Valley creates miracles, and the Silicon Valley start-up structure is standard precisely because it has evolved to effectively organize entrepreneurs and connect them to resources.
On the other hand, standards always look great until they are replaced by something better.
Could new ventures be financed in a crypto ecosystem rather than Silicon Valley? Venture capital firms (VCs) provide start-ups with the bulk of their financial resources. VCs themselves can be thought of as another layer of “start-up” – VC firms start as an idea (investment strategy), form a robust team, raise money from their own investors, and execute on the plan. This second layer of start-up is very costly. Limited partner (LP) investors in VC Funds require high returns to compensate for the risks associated with start-up investing. VCs are expensive, often absorbing over 30% of their Fund’s profits through management fees and carried interest.
Silicon Valley is high cost for very high value. A good deal – but high costs are always an opportunity for something better.
Alternatives to the Silicon Valley model for building nurturing start-ups have been tried, but nothing better has emerged (yet). LPs have tried to go it alone and invest directly into start-ups. Corporations have created internal VC funds. The 2012 JOBS Act made crowdfunding legal. But none of these alternative paths have made a serious dent in traditional Silicon Valley’s dominance. Silicon Valley VCs continue to represent the pinnacle of screening, funding, and nurturing ambitious start-ups, largely inside the traditional corporate structure.
And yet, this is odd if you think about it – the connection afforded by the internet has upended the business models for most centralized gatekeepers (music labels, film studios, publishers, etc.) – why not VC?
Crypto’s potential to upgrade the Silicon Valley model will be the topic of a handful of future essays. We don’t purport to have the answers, but any revolution begins by imagining what might be possible - in this case crypto as the fundamental tool for organizing new ventures and financing innovative projects.