New Money

Note: more writing on other subjects at tannerphilp.com

Something new is coming. Just as farming societies differed in kind from hunting and gathering bands, and industrial societies differed radically from feudal or yeoman agricultural systems, so the New World to come will mark a radical departure from anything seen before.

- The Sovereign Individual

Money is a means to an end, not the end itself. It may not feel that way given the obsession society has for accumulating money, but in the end it is just a tool. A tool that enables humans to engage in one of the most natural and primitive practices: the exchange of value. This practice is fundamental to the human experience. Our ability to effectively engage in value exchange is a direct corollary to the effectiveness of the tool.

Money has evolved over millennia to match the demands of the economy. The challenge is the rate of innovation. We have entered a new age of value creation, yet we are still relying on an outdated legacy system to facilitate the exchange of said value. Not only is this expanding the deadweight loss in production, it is fuelling systemic inequity through a system that benefits the incumbents and suppresses innovation.

Each evolution of money followed a phase shift in value creation. When economies were hyper-localized, money took the form of a tally system for IOUs. This worked for a time, but as economies expanded beyond a co-located collection of families there was a need for a better system. The emergence of agriculture unlocked intercommunal trade, so tally systems evolved to transferable items like collectibles to support the agrarian society. As infrastructure evolved and intercommunal trade continued to expand, the state emerged to govern the flow of value. To do so, the state took control of money, issuing state money. Over the last three millenia, state money has continued to evolve, from representative money, to commodity money, and now to predominantly fiat money.

In the agrarian society, those with access to water controlled the means of production and used that to monopolize economic output. This allowed those with the means to control those who did not. This gave rise to a system of slavery and later, serfdom. Without access to the means of production, everyone is an input. The owner captures increased marginal returns from those inputs and the wealth inequality gap only continues to grow.

For centuries this went on with help from the state — and in some places still does. When the state did finally step in to eradicate systems of slavery and serfdom, they were replaced with a system of wages. And this appeared to move these economies closer to a system of equal opportunity. There was now a promise of class mobility — capitalism, the great equalizer. However, the same systemic inequality continued in the industrial age with the monopoly of the means of production manifesting in physical infrastructure instead of water. Wage earners served as an input to the production lines while increasing marginal returns accruing to the owners of the equipment required for production (factories, trains, etc).

We are in the midst of another phase shift. A borderless digital economy where value is created outside the confines of physical production. Where no matter where you are in the world, or what your background is, everyone starts on equal footing. This is the promise of the Information Age — an economy of equal opportunity.

But even in its infancy, the same monopolistic phenomena found in previous eras is emerging. The internet was built to serve as an open infrastructure for the world, however, just as lords controlled the access to water in the Agrarian age, and corporations controlled the access to infrastructure in the Industrial age, a few large companies currently control the flow of information in the Information Age. It is unfair to ascribe these phenomena to malintent, it is a product of the system. One can only expect rational actors to optimize for maximizing their own economic potential.

The legacy financial system features a dynamic money supply controlled by the state, so a rational actor will always optimize for incremental accumulation, recognizing that the system is inherently zero-sum. The challenge is that the legacy financial system controlled by the state is in tension with the information economy that operates outside the context of the state. This is why we need a new system. A system built from first principles for the Information Age.

The Information Age: a new economy of equal opportunity

The Information Age has enabled a new way to organize. Humans are no longer beholden to proximity constraints in their value creation and capture. In the Agrarian and Industrial Ages, inputs and outputs were both physical, so to create value, one must have access to the physical means of production, and by extension, consumption was almost entirely physical. Today, much of the physical production that was traditionally completed by the workforce has been automated, and that is only increasing — it is estimated that in the next ten years, requisite human input in the manufacturing sector will decrease 34% [1]. And while automation increases, unemployment is decreasing [2]. Save Skynet, the robots are not to be feared. This is increasing human bandwidth to pursue new ways to create value.

With more than half the world now connected through the internet [3] and more than 40% with a powerful supercomputer in their pockets [4], the rails are there for an interconnected global economy. The challenge is that much of the world is not truly sovereign. Censorship resistant money will turn an information network into an information economy. And with the ability to create value in a network that transcends physical spaces, we need a currency that transcends physical monetarism. That is what cryptocurrencies offer. A money devoid of centralized control. A money that can be used by anyone, at any time. A money to support an economy abstracted from the state. A money that simply exists as a tool for the transfer of value. Money its purest form.

When the Bitcoin whitepaper was first released just ten years ago it ignited an entirely new design space. It started with a small group of people building the foundation and evolved to a small collection of teams exploring what could one day be possible with this new primitive of trust-minimized value transfer. Since then, more and more of the world’s most inventive people have been entering the space, pushing our understanding further and further of what is possible. At its core, however, the big opportunity in crypto has not changed: A Peer-to-Peer Electronic Cash System. Or said another way: New Money.

With some of the biggest institutions in the world now waking up to this opportunity, we are exiting the experimentation phase and entering the biggest global race in the history of technology, if not one of the biggest global races in history, period.

In technology there have historically been once a decade opportunities: (i) put a personal computer in every home (ii) organize the world’s information, (iii) put a personal computer in everyone’s pocket (iv) establish the world’s address book, etc. And in each of these there are usually 1–2 dominant players. Crypto is different. The opportunity to reinvent something as fundamental as the transfer of value is a multi-generational opportunity.

That opportunity could be worth tens to hundreds of trillions of dollars. The following essay walks through a three part framework for how to think about that:

1. What is money, how money has evolved, and what’s next

2. The different go-to-market strategies for crypto monies

3. How to value money

All three of these subjects are more complex than one might think. I have attempted to keep this essay as simple as succinct as possible but to truly understand the opportunity there is unavoidable nuance that must be teased out. So at the expense of brevity, please join me on this 15,000 word journey through the future of money.

What is money?

If you were to ask people to describe money the most common response would be something about cash, coins, or balances in a bank account. Try this. I did and almost all responses fell into one or a combination of those three buckets. What surprised me the most though was that when those same people asked me to describe money I didn’t immediately have a simple, one sentence response.

My answer mirrored something I would have written on an exam or heard on a recent podcast talking about crypto. “Oh easy, money is actually three things: (1) a unit of account (2) a medium of exchange, and (3) a store of value.” I then got one of two responses, either a dead-pan stare, masking an internal monologue that was probably something like: “Oh god, please get me out of this conversation.” or a more inquisitive, but equally uncomfortable verbal response of: “Okay, what does that mean?”

In the former case I’m confident that those people haven’t thought twice about our conversation. In the latter, I went on to explain each of those three examples, and although they may understand money a bit more, they probably also have not thought twice about that conversation.

This experience helped me internalize something I tacitly understood: money is abstract. If my economics professor had to take multiple lectures to explain what money was, and my ten minute explainer took people from confused to slightly less (or sometimes more!) confused, then an understanding of UOA, MOE, SOV doesn’t suffice. I don’t think my professor was inept, and I’d like to think I’m not either. So here it goes. Here is my simplest distillation of money.

Money is transferable credit.

What I mean is that money entitles the holder to redeem it for something else, and whoever accepts it can now also redeem it for something else.

All money is not created equal. What makes something good money and what makes something bad money? That is where it is helpful to unpack those three properties of money: Unit of Account (UOA), Medium of Exchange (MOE), Store of Value (SOV). We can use these as evaluation criteria for how effective a money is relative to others.

Unit of account

To have a system of transferable credit, there must first be an agreed upon unit of measure. Measurement is one of the most important advances in human history. This is what unlocked humans to engage in any form of trade. If Alice is going to trade X to Bob in exchange for Y of something else — both need to agree on how to measure each. In the earliest forms of barter this is easier because these trades are generally one-offs and that exchange can be negotiated on the spot. However, as soon as a market emerges, and the “X” that Alice is trading is money — transferable credit — then there needs to be an agreed upon unit of measure for in the broader market so that when Bob turns around and goes to exchange the money he got from Alice with Steve, Steve also understands what that represents.

Unlike the measure of immutable laws of natural science like volume, weight, time etc. There is nuance in the measure of money. Some monies are better at this than others — below I will unpack the strengths and weaknesses of the three broad buckets of money (1) commodity money, (2) representative money, and (3) fiat money.

Commodity money — a money whose value is in the materials it is made of i.e. a gold coin.

Establishing a unit of measure is relatively simple. Each gold coin is one ounce of gold, an ounce is a uniformly understood unit of measure (can’t cheat gravity), so the gold coin is uniformly understood as an ounce of gold. The attack vector here is debasement. The scale on which the gold coin is measured can not lie, but the coin itself could. Debasement of gold goes back as far as the Aegina sea turtle coin issuance [5]. In theory a commodity money should be the best unit of account because it is itself the measure, however, the risk of dilution can degrade its efficacy as a unit of account.

Representative money — a money that is not itself the commodity, but represents a commodity i.e. a certificate to redeem for an ounce of gold (carrying around a bunch of gold could be burdensome). This is where the term “face value” comes from — the “face” of the certificate represents its value.

This form of money is relatively simple in theory. If the money represents a commodity, the measurement process is also straight forward. Alice can take her gold certificate and swap that for an ounce of gold — a uniformly understood measure. In practice there is a challenge here. There is still the risk of debasement in the gold itself, since the representative money is a proxy for the gold, there is also the risk of counterfeit. Maybe Alice’s gold certificate is actually fake, and when she takes that to the mint she is redeeming that for an ounce of gold that actually would have belonged to Bob or Steve who have real certificates.

Sidebar: Counterfeiting is one of the most devious forms of warfare. In early Colonial America, pre-Revolution, Britain did not want the colonies trading with each other. There was incentive to funnel all trade through Britain so that each colony had to rely on Britain. To obfuscate this, the colonies started printing their own currencies for intercolonial trade, some of which were very creative — Maryland issued a bank note in 1775 that depicted George Washington setting fire to a city while stomping out the Magna Carta [6]. Britain did not like this (obviously) so they set out to eliminate this practice. However, rather than sail over and burn all the new money, they did they exact opposite. They shipped over a printing press and started printing more of the currency they wanted to destroy. Debasing the currency and making it so widespread that the purchasing power was null. Two centuries later the Nazis tried to do the same thing in WWII. They started printing British Pounds and injected them into the economy in an attempt to undermine the purchasing power of the Pound and send the British economy into purgatory.

Fiat money — a money with no intrinsic value (commodity money) and no proxy for intrinsic value (representative money). Fiat money’s value is derived from the issuer: the government. If the government says this money is worth X, it is worth X. During the American revolution, the Union launched their own currency called the Greenback, which got its name because it was “backed” by the green ink it was printed with.

Of the three broad buckets of currencies, fiat currencies have the most vectors of weakness in their ability to be a good unit of account. There is no specific commodity backing a fiat currency, and a fiat currency does not have a direct and static proxy value to a commodity that has a stable measurement. That does not mean that fiat currencies are uniformly worse at being a unit of account than others, there are just more attack vectors. For example, although the US government does engage in activities like quantitative easing, which is the practice of the central bank injecting money into circulating supply by purchasing government bonds, the measurement of USD is relatively ubiquitous in the context of the global economy. The money supply is increasing, and the purchasing power of the USD may be changing, but there is still a high degree of confidence in the accounting record of the USD.

It is important to note that being a good unit of account does not mean that 1 USD will always equal 1 loaf of bread. Purchasing power and unit accounting are two completely different things but are sometimes conflated. Just because a currency is dynamic in its value relative to other things does not mean it is a bad unit of account. A good unit of account is a broad understanding that something is money and a high confidence in the efficacy of the measurement of said money.

Coming back to our definition of transferable credit — if the unit of account property of money is the measure of the credit, the medium of exchange property is the transferability.

Medium of exchange

Money as a medium of exchange functions as a proxy for value contributed and consumed in the economy. It is what lubricates the marketplace by enabling the transfer of a value between market participants without each participant having to match supply and demand of physical goods and services one-for-one, at the same time.

Without a medium of exchange, trade would have to take the form of barter. The challenge with barter is the requisite double coincidence of wants. What this means is that two trade partners would have to want exactly what the other person was selling, at that same time, in divisible quantity, in order for there to be a successful trade.

An example: Let’s say Alice, who specializes in production of oil, wants to purchase livestock from Bob, the best farmer around. In a barter economy Bob would not only have to want oil in order to engage in a trade, he would have to accept a quantity of oil divisible by the livestock at the going rate. This is the double coincidence of wants — each person wants what the other person is selling, in a quantity that lends itself to a trade. But this is rare, so Bob has a few different options: he could (1) refuse to trade, (2) accept the trade and then try to find a trade partner for the oil later, or (3) coordinate a three way trade with a third party, Steve, a florist.

Enter money. In order to mitigate this problem, markets adopted their own monies to enable the transference of credit. Now Bob could sell livestock to Alice in exchange for a quantity of money that Alice got from selling 2 bottles of oil to Steve. This allowed markets to flourish because the participants were no longer constrained by the double coincidence of wants

Some of the earliest known examples of money are actually physical ledgers. There are records of a system of record historians have intuitively dubbed a tally sticks. The oldest recorded is the Ishango Bone, dating back to 18,000 BC whereby debits and credits were recorded on a baboon femur. Whatever the debits and credits added up to at any given time was the total value accrued to that artifact — this effectively functioned as a medium of exchange without the need to exchange large assets. The Uruk people of the fourth millennia in Mesopotamia used a similar system of accounting that was effectively IOUs recorded on stone tablets — the oldest such example shows what historians believe was a pay slip for a credit of beer [7]. This system is similar to bank ledgers. Or, let’s say the Uruk ledger was housed in a public space and any update to the ledger could only be recorded if the commune all came to consensus on a transaction — that is effectively a blockchain. Interesting that the most recent examples of money mimic the earliest forms of money.

Other examples through history include collectibles, like seashells in West Africa, or commodities like sugar in West India, Salt in Abyssinia, and Tobacco in Virginia. Each of these media of exchange reduced the friction of trade in the economy to varying degrees.

One factor that impacts the effectiveness of something as a medium of exchange is the acceptance, or redeemability of the money. If a money is only redeemable for a narrow set of goods and services, the medium itself is narrow and has low relative purchasing power. Think of gift cards or loyalty points. One could argue that a gift card functions like money. In the context of the gift card issuer, let’s say a restaurant, it has the same purchasing power as the USD. Fifty dollars from the gift card or fifty dollars cash will have the same purchasing power. But outside the context of the restaurant the gift card is relatively useless because it is only redeemable for a discrete set of things. If you wanted to use the gift card in a secondary transaction, let’s say, your teenage neighbour who cuts your grass — they would have to want to dine at the restaurant, and plan to spend an amount equal to the value of the gift card. The point here being, if a money is only accepted for a few things, it is not a good medium of exchange. The ubiquity in which something is redeemable is a key determining factor.

Another key factor in a money’s effectiveness as a medium of exchange is the portability of the money. This can be impacted by (1) physical limitations ie. physically transferring cash or coin (2) functional limitations ie. interbank settlement delays, or (3) political ie. North Korea constricting the exchange of Won with other sovereign currencies.

A good medium of exchange is accessible and broadly redeemable. A good money is also predictable, which leads us to the third prong in the properties of money: store of value.

Store of value

One thing we can thank economists for is their judicious use of intuitive nomenclature. A store of value is quite simply a money’s ability to store, or, retain, its value over time. Think of this like storing foodstuffs in a cellar for future consumption. You want to have confidence that when you go back to the cellar, the same quantity of foodstuffs will be there. This is like money and its future purchasing power. If you own some money and want to use it at a later date, you want to have confidence that it will have the same relative purchasing power. However, unlike the food in the cellar where your chief concern would be mice nibbling away at your supply of food, with money the primary concern is central authorities affecting the broader supply.

A money’s effectiveness as a store of value is rooted in its future predictability of purchasing power. One of the challenges with that definition is that future is entirely relative. Everyone has a different time horizon for value accrual so a “good” store of value is relatively subjective depending on when someone needs to redeem that currency. For someone living paycheck to paycheck, the future predictability of their wealth is quite simply confidence that their wages will be able to cover next month’s rent. Most people have a relatively short time horizon for wealth accrual. The median household savings account in the US has a balance of $4,830; the average is better at $16,420 [8], and the average monthly expenditure is roughly $5,000. What this data tells us is that the average family needs to maintain high liquidity in their store of value.

Today the majority of the world — both in breadth of people, and depth of reserves — hold their wealth in the base currency of the economy in which they participate. Some economies are wildly unpredictable in their money supply, and thus the purchasing power for individual market participants ie. Venezuela, Turkey, etc. As a reaction, many people have opted to hold other sovereign state currencies, like the US Dollar [9].

Money is a function of network effects. Every buyer is a seller: the wage earner is selling their time and attention to their employer to then buy goods and services; the people/businesses selling those goods and services want to accept the same currency they pay wages in.

The best store of value is whatever is most easily and predictably redeemable for the end purchase intent. Since much of the world is turning over their money supply relatively quickly, the money that has direct purchasing power for consumption is going to be the best store of value, for them. For any other form of money that is not directly accepted as a means of payment there are inherent inefficiencies to redeem for future purchases. Even the most liquid assets in an optimally efficient exchange markets are subject to unavoidable costs in both price discovery and execution time.

To some, a suggestion that the US Dollar is the best store of value is contrarian. And I don’t disagree that for some, the US Dollar is not the best store of value. With an inflation target of 2% and an average annual variance in purchasing power at -2–3%, exclusively holding dollars will result in some level of wealth degradation. Aggressive quantitative easing targets has resulted in a capital market where commercial banks are force-feeding the market with debt. This is pointing to a pull back in the US economy, which most macro investors can see [10], however, most people can not take the long view.

A brief history of money

To understand where money might be going we must first understand the evolution of money: where it started, what it has enabled, and what its limitations have been.

In the following section I will share some of the historical advances in monetarism as well as vulnerabilities that have emerged. This will provide some insight into money’s origins, how it has been used effectively, where the challenges have been, and where the opportunities are for iteration. This will give us a mental model to assess the opportunity for crypto to reinvent the global financial system.

What you will see in the ensuing section is that money, although static in its core function as a transferable credit system, is very dynamic. There have been good applications and bad applications.

Note: This is not an exhaustive historical record of money. I have selected segments of history that enumerate money’s progression. There are a lot of great comprehensive resources on the history of money; my recommendations can be found at tannerphilp.com

The earliest records of civilization show a species that sustained itself through foraging. From what we can see, humans generally organized in communes that ranged anywhere from 15–150 [11] — the earliest, most organic validation of Dunbar’s number [12]. Even in these insular communes we see early forms of monetarism intra- and inter-community. The trade of collectibles gives evidence of some inter-commune trade — some of which was the exchange of goods for an opportunity simply to forage in an area occupied by another community. [13]

The Neolithic era brought about a division of labour. 15–150 person communes evolved to communities of 1000+ with people now taking on a higher degree of specialization in production. This enabled people to start accruing wealth. Much of this was effectively accounted for in tacit IOUs that we see in different forms of Tally Sticks.

With the size of the community now well past the Dunbar number, and a quasi credit system in place, there was now a need for coordination and arbitration, so a loose political structure emerged. The catalyst for this was agriculturalism. Humans evolved beyond just-in-time production for sustenance; agriculture enabled the accrual of inventory. Population density grew and a political hierarchy was established to govern the allocation of resources. The genesis of the State is unknown, but the first record of a governmental system was found in Southern Mesopotamia circa 5,000 BC [14] — the same region that the oldest Tally Stick was found with our first records of wage earners.

The advent of the State established the requisite arbiter for transactions, so the State started to standardize money, unlocking a taxation and a credit system.

The Bronze Age brought centralized currencies. In 1100 BC, the Greeks implemented a currency called the Drachma, which translates to “a handful”. The Drachma has taken many forms through 11 centuries but the first example was quite literally, a handful. It was six bronze rods. Now obviously carrying around a bronze rod, let alone six that made up one drachma (why they couldn’t just denominate one rod = one drachma, I don’t know), so there was bound to be some

It is generally cited that the first coins were introduced by the Lydians somewhere around 700 BC [15]. We’ll call this the dawn of central banking. Although the Lydians were first, it was the Greek Aegeans that proliferated coinage in sixth century BC. In early sixth century BC a Greek Statesman Solon paid a prize of 500 drachmas to the winner of the Olympic Games [16].

With great power comes great responsibility

Money is a powerful tool that unlocked higher production and global trade. But as history has shown, any powerful tool will inevitably be weaponized. Money has been one of the most prolific oppressive tools by central authorities. It is human nature that corruption will manifest at any centralized control point. No matter how altruistic the central authority is, the law of self interest will always overpower.

Not more than 200 years later we have evidence of self interested manipulation. When the Han dynasty overtook the Qin dynasty in 206 BC, Emperor Gaozu started privately minting coins for self gain. This practice continued intermittently until 144 BC when Emperor Jing abolished private minting [17]. Two hundred years later, Roman Emperor Nero engaged in a similarly impactful practice, however, instead of privately minting new coins, Nero recalled silver coins in circulation, had them melted down and a reminted with additional non-precious metals. In 60 AD, coins were debased down to 90% silver. The Roman empire continued this practice over the next 200 years, with coins only containing 5% silver by the year 265 AD [18].

Inflation in the Roman empire took the form of physically debasing the coins (diluting the base metal). In the 13th century AD, France undertook a similar practice but without the hassle of actually changing the composition of the coins — they simply didn’t stamp them and would periodically declare that each coin was worth less. This practice happened 123 times between 1299 and 1500 AD [19].

During this time, Venetian bankers were engaging in lending practices that had a similar effect on the value of the Florin (the dominant currency at the time). Private bankers were overextending themselves in credit issuance which was artificially inflating the money supply in Italy. To combat this, the Venitian Great Council passed a law in 1321 that banks had to maintain reserve balances equal to outstanding deposits. If they didn’t they had to live on bread and water until the deposit was returned and if after three days the deposit still had not been returned, the banker was beheaded in the public square [20]. Banking was a dangerous job. If that law was decreed in the US there would be a lot of blood in the streets given this was, in effect, fractional reserve banking — the dominant form of banking we have today.

It is important to note that this all took place 347 years before the first central bank was enacted in Sweden in 1668, so there was no “lender of last resort” if a private bank defaulted. Hence the heavy penalties for a default in Venice at the time.

Fractional reserve banking is the practice of banks maintaining only a portion of deposits on hands. This allows the bank to issue credit to borrowers which drives a return for banks on lending rates. Fractional reserve banking has been a catalyst for economic boom cycles through a leveraged credit system, but has also been a root cause of bust cycles when that leverage gets overextended.

The reason that banks today can do this and are not subject to the same penalties as the Venetian bankers is because they are governed by the central bank who can lend to the commercial banks that extend credit, ensuring there is money to pay depositors in the event of a shortage. Central banks have the ability to print new money, which is why there is always the option for a bailout. One lever the central bank has on money supply is to set the reserve ratio that commercial banks must maintain — this in effect is a lever on money supply.

Different institutions have different reserve requirements based on the number of assets under management, but they are typically between 3–10%. This means that if a bank has $100MM in total assets, and a 10% reserve requirement, the bank only needs to actually hold $10MM on hand at any given time. This is modern alchemy. If someone deposits $100 into a bank account, the bank can then turn around and issue $1,000 of credit — credit that is now out in the wild being spent. Without printing any new money, the bank just turned $100 into $1,100. If that bank has a reserve requirement of 3%, that $100 deposit could now be turned into $3,433.33.

Bankers may think they are turning water into wine, but they are far from miracle workers. This is another powerful tool in modern finance that has enabled a lot of good. It has enabled banks to extend credit to entrepreneurs and businesses building the future, but with anything misaligned incentives will almost certainly result in this can be weaponized for self interest. Everything comes down to incentives. If a banker is paid an annual salary based on performance for issuing credit with a multi-year maturity (i.e. a 5% down 25 year fixed-rate mortgage) they will implicitly act in self interest to overextend credit.

The fractional reserve system only works when there is high trust in the banks issuing credit. As long as people trust that the bank is good for their deposits, people will leave their money in the bank and just take out what they need when they need it. Because banks only have to maintain a fraction of the reserves on their balance sheet, not everyone can take their money out at the same time, the bank will not have that on hand. So everyone has to trust that the bank is managing the reserves effectively. If everyone tried to withdraw at the same time the bank could only give back $0.10 on the dollar (assuming equal distribution). So as soon as confidence is shaken, people start running for the exits to try and get their reserves out before a default scenario. This is what triggers a bank run. The classic 1946 movie: It’s a Wonderful Life depicts what a bank run looks like. That ended with an act of generosity from George Bailey and there was a nice moral to the story in the end. In 2008 we saw this in real-life with the collapse of the housing market which triggered creditors to start demanding repayment on loans — loans which banks didn’t have the reserves to pay back. This time there was no Mr. Bailey there to bail the bank out, so this time the government had to come in with a bailout. That took the form of Quantitative Easing which is the practice of the Central Bank purchasing securities in order to increase the money supply and lower borrowing rates to increase the rate of spending.

An America that looks away is ignoring not just the sins of the past but the sins of the present and the certain sins of the future.

— Ta-Nehisi Coates

The 2008 collapse was not the first example of a destabilized monetary base. The Great Depression saw a decade of economic decline that had a material impact on at least 25 countries. Various theories contend a different causation for the Depression — Keynesian theory suggests a contraction in demand; Monetarist theory suggests a contraction in the money supply; and other theories are various combinations of the two — the common thread is that there were triggers from a central authority. The US had dropped off the gold standard and 35% of commercial banks defaulted. The central bank did not step in to increase the money supply — unlike in 2008 — so people were left with fractions of their wealth and spending remained suppressed for a decade. This exposed how little control the populous actually has on their wealth.

History doesn’t repeat itself, but it does rhyme

— Unknown (possibly Mark Twain)

As history has shown us, centrally controlled monies are exposed to inherent vulnerabilities rooted in misaligned incentives. As Frederik Hayek said in a 1984 interview with the Cato Institute:

“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government — that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.”

This is what Satoshi Nakamoto understood. Bitcoin is a rebellion against the state — not in opposition, but in obfuscation. With more and more value creation moving to the open, borderless digital economy, it is antiquated to rely on a financial system controlled by central authorities. The advent of the internet gave everyone open access to the global information network; crypto is the missing piece to turn the information network into the information economy.

Crypto offers the opportunity for individuals to be self sovereign in their relationship to the economy. As noted above, the benefits of this are vast, and more important than ever as we step into a new paradigm of value creation, but there are also inherent costs in a self sovereign currency.

Go-to-Market for Crypto Monies

The big opportunity in crypto is new money. The opportunity to reinvent how human beings exchange value. That is a once a millenia opportunity. If a cryptocurrency becomes the dominant form of money it will be worth trillions of dollars, the only question is how many digits are going to be in front of the big “T”. Estimates range anywhere from high single digits to triple digits [21].

Given the open nature of cryptonetworks, the underlying technology stack is entirely dynamic. What really matters is the go-to-market strategy. Everything else is a feature that can be forked in or forked out.

Rearchitecting the financial infrastructure of the world is by definition disruptive. Innovator’s Dilemma would tell us that disruptive innovations start narrow and expand. Crypto will be no different. Like (include innovator’s dilemma example), crypto’s best shot to replace the dollar and be new money is to start narrow and expand. The question then is where to start:

The reason the USD is good money is because it has the widest breadth of use — said another way: it is redeemable for the most things. In order to disrupt an incumbent, like the USD, a disruptive technology needs to meet a fundamental need that is not being met. The most valuable currency will be the one that powers the biggest economy (GDP).

There are two variables that drive the total GDP of any economy.

1) The number of people in the economy

2) The average GDP per capita, or said another way: how much each person is earning/spending

I would argue that the most high leverage opportunity is to first grow (1) the breadth of people in the economy and then (2) grow the depth of what those people are spending on. Money has a network effect, the more redeemable it is, the more people will demand it. If all of the people I have an economic relationship with are transacting in currency A, and I hold currency B, I will probably convert into currency A.

It’s not enough to just have the biggest population. If that were true then China and India would have the first and second highest nominal GDPs respectively [22]. They do, however, have the second and sixth highest GDPs [23] but are 108 and 157 in GDP per capita [24]. The US, which has the third largest population, holds the top spot for GDP but is number 19 in GDP per capita.

The US has held the position as the largest GDP since 1871 which at the time was 3.15% [25] [26] of the global population, not far off of the 3.3% it stands at today [27]. The US’s ascension to this position is an interesting case study. First, as people came to the new world, population was growing rapidly while per unit economic output lagged behind. The population grew steadily with a 35% compounded growth rate every decade from 1790 to 1860, while GDP per capita was still low. Economic activity was still generally insular. Britain wanted to constrict not only trade with any other nations, they also wanted to limit intercolonial trade — to do this Britain put in controls eliminate intercolonial and international trade. However, as a critical mass of people started to develop within each of the colonies, there was enough human capital to start dividing labor and move to increased specialization. To enable intercolonial trade the colonies started developing key infrastructure to enable scaled up production and efficient trade.

This was in direct conflict with Britain’s intent to keep the colonies siloed and sequestered from the global trade circuit. In effect, they wanted the US to be their resource outpost with no independence. Enter the American Revolution — with Britain serving as the main supplier of gold and silver, the soon-to-be United States of America needed financial independence, so in 1782 Robert Morris, Superintendent of Finance of the United States, secured a loan from France to establish the private Bank of North America. This was used to finance the war, issuing new dollars on a fractional reserve — but ultimately without sufficient reserves, those dollars were redeemed for 1 cent on the dollar (a 99% haircut) in 1791. This was not the same impact as we would have today as most people in America at the time were still relatively self sustaining though farming and agriculture, but with independence, the US now needed its own self sustaining economy. So in 1792, the United States Mint was founded, and coins were issued using the same standards as the Spanish currency [28].

Now with critical mass, the US moved from generalized labour within colonies to a division of labour and specialization. Around the mid 19th century is when economic activity really hit its stride with the advent of railways and commodity exports [29]. This resulted in a steep increase in economic activity, raising global trade, and by extension GDP per capita. This was only possible because there was a critical mass of people. When the US did reach the top spot in 1871, the population was bigger than Britain, France and Austria, and was roughly the same size as Germany [30]. India and China were five and ten times larger [31] [32].

Crypto (whichever the winning one is) will follow a similar trajectory. Today the adoption is small and for the most part it is treated as a novelty or an investment, but that will change. With large companies like Facebook, and sovereign states like China now working on their own cryptocurrencies, we are entering what could be the biggest race in human history. What makes this race interesting is that although everyone will eventually converge on the same end-game — new money — there are very different strategies to get there. In the following section I will unpack these different strategies and through a simple taxonomy.

The different go-to-market strategies

At the most meta level there are two broad potential GTM strategies: (1) the physical world, and (2) the digital world. Within those, there are different strategies. Physical: (i) floating exchange (ii) fixed exchange; digital: (i) platform (ii) app. Everything else is a feature set within these buckets. Below is a diagram with examples. I will unpack each of these in the following section.

Physical World

The opportunity in the physical world is to disrupt existing sovereign currencies, or said another way, capture part of the existing GDP that is currently measured in fiat currencies. The opportunity here is big. One hundred trillion-plus big [33]. Size of opportunity and size of barrier to entry are typically directly correlated. When the opportunity is to replace sovereign currencies, the barrier to entry follows a non-linear positive correlation.

One factor is the explicit resistance from those that stand to be disrupted from their incumbency: governments, central banks, financial institutions, etc. The other is the implicit resistance from consumers who are unlikely to augment their existing behaviour. X% of adults never replace their banking relationships; replacing a currency is going to be an even bigger lift when there is already another currency accepted. That applies to both consumers and producers, and the resistance from one reinforces the other.

Within the physical world GTM opportunity there are two broad strategies: (1) floating exchange and (2) fixed exchange.

Floating exchange

These are assets whose value is not pegged to that of another. Examples include: Bitcoin, ZCash, Litecoin. These currencies fulfill an unmet need by those who adopt it.

Bitcoin, for example, initially gained traction because it served a unique need for a group of individuals who want money that is: (i) decentralized — no one can unilaterally affect the supply/distribution, (ii) censorship resistant — no one can unilaterally block a transaction, (iii) permissionless — anyone can participate. These features come at a cost of increased friction (i.e. nascent custody solutions, shallow redeemability, etc). For many, that is a trade off they are willing to make, and we are seeing that it is working.

The first adopters of Bitcoin — before parabolic price swings made BTC attractive to speculators — largely came from the cypherpunk community who were willing to make tradeoffs on other properties of money. Many others will have a different desired configuration of trade-offs. Where Bitcoin sacrifices throughput efficiency for decentralization, other currencies make a different set of trade-offs, centralizing consensus in favor of increased throughput efficiency. This is just one of a number of vectors where tradeoffs are made. The optimal configuration of these tradeoffs will be determined by the market. For example, those who value privacy may opt for Z-Cash or Monero.

Each of these are effectively product features that serve the needs of different customer segments.

A note on volatility

For some, volatility is a feature, not a bug. The potential for massive value increase is what incentivizes people to contribute to the network. One of the most fundamental breakthroughs from the Bitcoin protocol is not technological, it’s social. Never before have we seen 10,000+ disparate actors, unknown to each other, come together to contribute to a common output. That is what the Bitcoin has done with its network of miners through the aligned incentive of capturing a piece of the Block Reward. The volatility of Bitcoin and the potential for big movements in price is what incentivizes more people to contribute and for each of them to contribute more hash power. In the early days of the network, when Bitcoin was valued in the single digits, people did this not for the relative value at that time, but what it could be worth. They’re thinking in terms of percentages, not dollars.

Where volatility is a bug, however, is for those who want to use it as a replacement for fiat currencies. Consumers are less likely to spend a currency that could be worth twice as much tomorrow; and producers are less likely to accept a currency that could be worth half as much tomorrow. As soon as a buyer or seller has to think about the efficacy of the future purchasing power of the medium of exchange there is a non-zero cognitive cost. People already have a set of decisions they work through on whether or not to actually engage in a transaction — the decision then of which asset to use in that transaction is another friction point. In a world of competing currencies for the same potential end, the one with lower friction will win out.

Fixed exchange

Given the challenges in volatility of a floating exchange currency, a new asset class has emerged that adds a new dimension: predictability.

These are assets whose value is pegged to another reference asset, mostly commonly the USD. These are commonly referred to as stablecoins. The stability is generally achieved in one of four ways:

1. Fiat Collateralized: a cryptographic representation of a fiat currency held in reserves eg. USDC, Gemini Dollar
2. Commodity Collateralized: a cryptographic representation of a commodity held in reserves eg. DigixGold
3. Crypto Collateralized: a stablecoin is issued and pegged to the value of an asset (commonly the USD). The value of that is maintained by locking up another crypto asset at an over collateralized position relative to the value of the stablecoin issued i.e. lock up $150 of ETH for $100 worth of a stablecoin. If the price drops below the minimum collateral balance, the ETH is liquidated to cover the position. eg. MakerDAO.
4. Algorithmic (Non-Collateralized): maintains stability by minting and burning tokens to maintain a stable currency. If the price rises above $1, the smart contract will mint tokens and sell them, bringing the price back to $1. If the price drops below $1, the smart contact will open up buy orders to bring the price back up to $1. eg. Basis (now defunct)

A natural question that often emerges about Stablecoins is: if you want a cryptocurrency to track the dollar, why wouldn’t you just stick with dollars?

Fiat Collateralized: there is important nuance within this bucket worth unpacking.

The easiest to understand is a straight 1:1 collateralization that is effectively just a digital representation of my dollar i.e. I deposit a dollar into an account, that dollar is held in reserves, and one stablecoin is issued to me. If I want to convert back into dollars, that stablecoin is burned and my dollar is released to me. This is how a fully audited system like Gemini works where they operate at 100% reserves of outstanding Gemini Dollars. The pro of this is that issuers can have full confidence that their stablecoin will remain stable to the dollar, because everything outstanding is backed 1:1 by the same reference asset it is tracking. The tradeoff to a system where each outstanding token is backed by reserves is that everyone in the system is now reliant on a third party to manage the reserves, creating a centralized failure or choke point. One risk is the third part goes evil and misappropriates the reserves, or the other is that they remain good actors, but are shut down by another third (fourth?) party i.e. the government (the man!).

Another version of a fiat collateralized system is one where the reserve ratio is less than 1.0. Like the above example, funds are deposited into reserves and a stablecoin is released. The difference is that instead of each outstanding stablecoin having a dollar earmarked in reserves, there are more outstanding stablecoins than what’s in reserves. This is a system that lends itself to issuing credit, no different than the fractional reserve banking system. This is effectively how Tether operates — they have now openly admitted to only holding (X%) of reserves. This is still higher than the 3–10% reserve ratio currently imposed on large (charter?), however, those financial institutions are highly regulated, and, as we saw in (years XYZ), even that can lead to ruin. So a (loosely?) regulated entity like Tether does pose significant counterparty risk, and has the same challenges of being a centralized choke point for other actors.

An iteration of the straight 1:1 collateralization is a mixed basket reserve i.e. Libra. It’s more of a stable(ish) coin since it won’t necessarily track direct 1:1 parity to any specific reference asset. The mixed basket model has a number of different fiat currencies represented as reference assets that are held as collateral for the issued stablecoin. The value could be pegged to direct parity with any reference asset i.e. the USD. This would result in a dynamic state of under or over collateralization depending on the strength of the USD relative to the other currencies held in reserves. Libra, however, is not going to peg directly to any one existing reference asset, it will have its own value derived from the value of the reserves. Given the reserves are diverse, the value of Libra will be dynamic relative to each individual existing reference asset i.e. if someone exchanges $1USD for Libra and the USD strengthens relative to the rest of the reserve, the Libra would be worth less than $1USD if they exchange back. Libra functions more like a global currency index. Libra will thus emerge with its own purchasing power index, which is a departure from other stablecoins we explored above that are direct 1:1 pegs to the USD. While the others are digitizing existing currencies, Libra is an entirely new currency. To call Libra a stablecoin is a bit of a misnomer — it is more a new reserve currency masking as a stablecoin in the interim. With the ability to change the mix of assets in the reserve, the Association could in theory influence CPI in the same way central banks do, but instead of printing and burning supply, they could just change the mix.

Commodity Collateralized: all of the same principles apply to the above example except the reserve is a commodity instead of a fiat currency. I wasn’t going to include this but then I figured there would be at least one know-it-all who would say “you know, there are examples of stablecoins backed by commodities”. So here you go, faceless internet know-it-all, they exist.

Ok, now on to the interesting implementations of stablecoins.

Crypto Collateralized: this is an implementation that obviates the counterparty risk of the fiat/commodity backed collateralization. There are tradeoffs, however. Let’s dive in.

The primary value proposition of crypto is decentralization. Stablecoins backed by physical assets will never be able to escape a degree of centralization given some third party needs to both custody and govern those assets. Crypto-collateralization eliminates this attack vector by decentralizing the whole stack. If someone wants to obtain a token that holds a stable value relative to a reference asset they can collateralize that with another asset as long as it has a liquidity path to the reference asset. For example, if I want a stablecoin worth $1USD but don’t want to deposit dollars, I could back that up with some other asset that has a relative value to the USD. The one challenge here is that given these two assets could diverge in value — and likely will given the volatility of crypto — I could be in a position of artificially inflating the money supply of USD in the case of my collateral dropping below parity value. The solution to this is to over collateralize. This is what MakerDAO has done. Maker allows someone to take out a loan in the form of a Stablecoin (DAI) by locking up ETH. The current minimum reserve ratio for Maker is 1.5, meaning if I wanted to take out $100USD of DAI I would have to lock up at least $150USD worth of ETH. This mitigates against a scenario of DAI becoming overextended. In order for DAI to be issued and not artificially inflate the money supply of USD, at least the same value of outstanding DAI needs to be locked up.

There is a lot of nuance to the Maker system that is very interesting and worth diving into but I am already long winded enough in this essay so I will leave it to the reader to dive in at their own leisure. I would recommend Placeholder’s overview as a good starting point [34]. In sum: (1) You lock up ETH >1.5x the DAI you want to take out in a smart contract which eliminates the counterparty risk of centralized reserves. (2) If the value of your reserves drops <1.5x the outstanding DAI you hold, the smart contract liquidates your reserve to buy back the equivalent DAI from the open market you hold. You get the remainder less the stability fee, which covers the cost to execute + a penalty. (3) Governance is handled by holders of the MKR token (not a stablecoin). They set reserve ratios and stability fees. (4) If things go crazy and the total reserve ratio of the economy is <1.5x, more MKR tokens are minted and sold to recapitalize the reserves. This is a penalty through inflation for MKR token holders, so this incentivizes good governance. (5) If there is a massive drop in the value of collateral (i.e. everyone is undercollateralized) a global settlement is triggered and all loans are paid out. MKR minting could make up the delta if it doesn’t bring it back to parity.

The benefit to a crypto-collateralized stablecoin is decentralization. There is minimal counterparty risk given the absence of requisite third party custody of the reserves. The trade-off is the need for over collateralization. This does have a second order benefit to other holders of the reserve asset, given the constrained supply locked up in a collateral contract. This reduces the velocity of that monetary base (more on that later) which increases the value of the currency in circulation.

The question arises, why would someone want to lock up one asset in order to take out another with less relative value. One answer is that some people may want a crypto asset that obfuscates the fiat financial system with the purchasing power parity of the dollar. But in reality most are using this as an opportunity to do leveraged buying of more crypto assets i.e. lock up $150 of ETH for $100USD of DAI -> buy $100 of ETH -> lock up that $100 of ETH for $66.67 of DAI -> buy $66.67 of ETH -> and so on. With $150 of ETH you could theoretically have a fully leveraged position that approaches $300.

Algorithmic: with all the complexity and attack vectors of collateralization methods, what if we just said “F it!” and did a stablecoin sans collateral. It’s possible, let’s unpack it.

The algorithmic model effectively says: “ok we want to have a crypto asset equal to the purchasing power of the dollar, but we’re not going to backstop it with anything”. You may be thinking: “wait, can you do that? Can you just say something is worth something else and call it a day?” Well, yes and no. You can’t just deem something to be worth something and away you go, but you can program a dynamic supply to match demand and pull things back to neutral. This is what was proposed in 2014 by Rober Sams with the Seignorage shares model. Like above, I will give the Coles Notes version of explaining but would encourage you to read A Note on Cryptocurrency Stabilisation: Seigniorage Shares for a deeper look.

Basically (1) The currency is created and sold for $1USD. (2) Shares of a DAO are also sold to create a pool of capital available to stabilize the price. (3) If the value of the stablecoin exceeds $1USD, a smart contract mints and sells more of the stablecoin, increasing supply, and bringing the value back down to $1USD. If the value drops below $1USD, the smart contract uses its pool of capital to buy back stablecoins on the open market, reducing supply and bringing the value back to $1USD. (4) Excess proceeds that accrue to the DAO (i.e. more stablecoins are sold than bought) are dividended out to those who funded the DAO.

All this talk of stablecoins may be leaving you asking: why all the hassle just to get back to something that has the same value as a dollar — why not just use dollars and avoid the headache? Good question! Especially since we’re talking about the go-to-market for crypto. There are a number of motivations people may have (i.e. margin trading with DAI) but for the purpose of this I will highlight the two most general applications I see.

The first is the biggest opportunity for stablecoins I see which is the ability to obfuscate the existing financial infrastructure. In North America, things operate *generally* efficiently, so this isn’t a massive pain point, but in much of the world, the modern financial system is not very accessible. Payment rails are inefficient, FX trading is inaccessible for many, and the banking system is often inept, if not downright corrupt. We see examples of people depositing money into a financial institution never to see it again (find example of seizure of funds). So the ability to have a currency with the purchasing power of the dollar that is in-part, or fully decentralized/self-sovereign fulfills a fundamental need.

The above example is not an immediate pain point I have felt being a Canadian citizen, but one that I have found is that it can be very difficult to get in and out of crypto. The on and off ramps from fiat to crypto is very inefficient, even more so in Canada where many banks have outright blocked any transactions associated with crypto. The process to actually convert dollars into crypto can take days or weeks at times. Sometimes I want to get in and out of crypto at a higher frequency, however, so what I have now done is buy a block of stablecoins that I can stay in crypto and move in and out of more volatile assets with little friction. I am effectively pressing “pause” on volatility at times, without moving out of crypto entirely. This problem may be solved in the long run when on/off ramps become more efficient but for now, stablecoins allow you to enter the arena and decide when you want to be in the game vs. on the sidelines.

Stablecoins are in effect augmenting existing behaviour in the physical world. The digital world is an emerging economy

Digital World

The opportunity in the digital world is to create an economy around emerging behaviours, or said another way, net-new GDP manifesting in the digital world. The opportunity in the digital world is smaller in relative dollar figures today (it’s not one hundred trillion to start). Given that, the barrier to entry is predictably lower.

Explicit resistance will come from those that stand to be most disrupted. In the battle of physical world currencies that’s the State and the banks; in the digital world that’s the large tech incumbents — namely, the big four (Google, Amazon, Facebook, Apple) — that stand the most to lose in an economy of peer-to-peer value transfer

These incumbents thrive on amassing and audience and controlling the flow of information. This runs the gamut of: personal information, the social graph, purchase data, search history, etc. And when these are pieced together, these platforms can make inferences that even in the deepest periods of introspection we may not even find in ourselves. Armed with this trove of information, these networks use this control to extract value by aggregating user attention and selling that to advertisers.

The big four [35] stand to lose the most in a digital economy where end consumers have the tools and incentives to create value for each other.

The implicit resistance from consumers is lower for two reasons: (1) consumers do not need to augment their current relationship with the money they hold today. Digital world currencies do no immediately cannibalize the existing banking infrastructure, so this is net new money, from a different source, for a different purpose. (2) there is not a strongly correlated proxy value for things in the digital world economy, so the measurement of digital world currencies is relatively ambiguous. This mitigates changes in consumer behaviour as a result of short-term volatility of the currency. Unlike physical world currencies where people are thinking about relative purchasing power in the physical world, where there is an opportunity cost to holding fiat currencies,

is the cold-start problem of new behaviour. So while the digital world GTM strategies do not face the challenge of requiring an augmentation of behaviour in an existing paradigm, they do require someone to adopt new behaviours in a new paradigm. This presents a new category of challenges. Challenges that are familiar to those who have built consumer product and coalesce around one theme: adoption.

The highest leverage opportunity for adoption is the platform. Platforms are the invisible engines that take linear create n-squared growth opportunities. Even Apple, which is default closed, opened up the app store to external developers. This is credited as the killer move that turned the iPhone into a twelve digit opportunity.

Every platform needs its killer app. The Apple II had Visicalc, the Nintendo had SuperMario, the Blackberry (yes the Blackberry) had mobile email, the iPhone had iTunes, etc.. In each of these, the killer app catalyzed initial adoption, but the platform is what enabled these to evolve to thriving ecosystems.

The killer app brings an initial audience, showing the opportunity for developers. Developers build more apps to tap into that audience, increasing the richness of the experience. That richer experience increases adoption, creating a bigger opportunity for developers. And the virtuous cycle continues

The key question is where that first killer app will come from, which brings us to the two strategies to capture the opportunity in the digital world: (1) build a killer app and generalize to a platform, or (2) build a platform and incentivize someone to build the killer app. Both strategies have pros and cons, let’s unpack those below.

Killer app => Platform

These are currencies used by end consumers at the application layer. Examples here include: Basic Attention Token, Livepeer, Steem, Kin.

Historically, the most successful platforms were built first to support a specific application, then generalized to support others. The best products are generally built by people who build for themselves; the corollary is a faster rate of iteration because the developer is the customer. This also means that the platform serves a very specific purpose. So while the initial addressable market may be constrained, the tools are specific enough to support this fast iteration to go from zero to one. A specific use-case that solves a fundamental need for a small audience has a higher probability of catching fire than a general use-case built for a large audience.

When it comes to money, however, there is an inherent challenge in specificity: the velocity problem. The velocity problem has been written about ad-nauseum [36] [37] [38] [39]. Each of these analyses raise sound arguments. In sum, the theory goes as: if a money has a narrow use case, and is easily redeemable then no one will hold the token. People interacting with the network will obtain the token right when they need it and then move on. Kyle Samani gives a good example of a ticket to a show — no one is going to go buy a bunch of movie tickets and hold them for future viewing opportunities, they will just buy them as needed, therefore movie tickets would not make good money. Why would I hold movie tickets in inventory if all they could get me is a movie, and I can buy them on demand if I do want to see a movie. It would make no sense for me to lock up some of my wealth in movie tickets with such narrow redeemability.

Unpopular opinion: the best way to overcome the velocity problem is to first subject a currency to the velocity problem. Let me explain:

What the velocity problem theory fails to consider is the dynamic nature of networks — and I would call any economy a network. The velocity problem is driven by two variables: (1) a narrow use-case and (2) is easily fungible i.e. as long as it is easy to buy a movie ticket I am not going to worry about buying and holding them for the future.

Therefore, there are two options to crack the velocity problem (1) increase the breadth of the use-case for the money or (2) make it less fungible i.e. if the only way to get movie tickets was to order them ahead of time and they take months to arrive, you may order a bunch and hold them in inventory. I’ll tackle those in reverse order because the first one is easy to knock off as a bad idea.

How not to solve the velocity problem
One could manufacture friction points to mitigate transient quick in and outs, however, a consumer will just want to hold a base currency that is easily redeemable. Emerging cryptonetworks have launched their own tokens with the stated objective to have people purchase that token for a specific use-case. This creates friction for the user, and in the near-term it may show some modicum of success, but this should be attributed to first-mover advantage where users use the token because it is the only way to interact with the network. This is not a sustainable model because the first opportunity a user has to opt into a network with less friction they will abandon the highly specialized money. The efficient markets hypothesis would suggest that a competitor will offer the same service and reduce the friction by offering it in the dominant base currency.

Platform => Killer app

These are currencies used primarily by developers building on top of open infrastructure. Examples include: Ethereum, EOS, Tron, Loom.

This is the Field of Dreams strategy. Build it and they will come. This is challenging because without a specific use-case, the platform developer has to build general enough to attract a breadth of potential apps. By building for everyone you end up building for no one. App developers have to make trade-offs and pick this closest option as opposed to something that is specific to them.

The benefit to this strategy is that it allows a platform to have many shots on net all at once. If the app=>platform strategy is a sniper, the platform=>app strategy is the shotgun approach. The benefit to app developers is the ability to leverage existing infrastructure instead of building for themselves to start — and that is something we see often. Ethereum is a great example of this in crypto. The Ethereum virtual machine allowed anyone to launch their own token and get to market quickly. That is what we saw in 2017 with thousands of ERC-20 tokens all coming to market at once. Every single one of those token issuers made tradeoffs to get to market quickly, accepting the shortcomings of Ethereum for their specific use-case.

With centralized platforms like Windows, MacOS, Facebook, etc, the platform would then absorb the apps that take off either through a copy and crush strategy, or through acquisition. They are able to do this because they own the customer relationship. In crypto, however, the reverse is true. Given the open nature of blockchain protocols, the app always has the option to fork and abstract away the underlying platform.

We are seeing this with tokens launched on Ethereum en masse. Open protocols allow developers to fork a base protocol, strip out what they don’t need and add what they do need — all custom to their specific use-case. Given this is the base level infrastructure, the consumer is unaffected and the developer is able to take destiny in their own hands. Even if the base level protocol is the exact right configuration for a use-case, why would the app developer still not fork for the sole purpose of capturing more value. There is an argument that the decentralization of the Ethereum network is enough of a reason to stay, but I would argue most consumers do not care about the decentralization of a permissionless chain, and actually, if given the choice between a product that runs on Ethereum vs. one that runs on a more performant, but more centralized chain, they would choose the latter.

One strategy we are starting to see emerge in the platform wars is buying the killer app (ie. Tron’s purchase of Bittorrent) or fund the development of the killer app (ie. EOS’s investment in the Voice, or Ripple’s investment in Coil). These platforms are able to do this because they either (1) have a lot of liquid capital from sales of the currency or (2) have a lot of liquid protocol tokens sitting in treasury.

It is too early to tell if these will play out. The challenge I see is that history has shown us that most often the killer app comes first. The most successful products are built to solve a problem, and then a business model emerges around it. The platform to app strategy feels like a solution in search of a problem.

What will the winner be worth?

The future value of the winning crypto(s) has been written about ad nauseam — and for good reason — this could be a multi-trillion dollar opportunity. Earlier this year some friends at one of the leading venture capital funds in the world let us know that they set up a pool across all of the partners for what the most valuable cryptocurrency will be worth in ten years. The high end: $100trillion; the low-end: $10trillion.

While both of these numbers are big, a $90trillion spread is a big spread. This venture fund’s pool is a microcosm of the broader crypto ecosystem in how people think about valuing crypto. The valuation theses for crypto roughly roll up into one question: can a new cryptoasset replace the dollar?

Depending on your answer to this questions, the implied valuation will be very different based on a number of factors: valuation model, addressable market, expected utility, etc. The valuation framework of the USD is different than the framework applied to an asset like gold in almost every way. So the expected future value of the winning cryptoasset will be very different when viewed through the lens of money 2.0 vs gold 2.0. Let’s unpack each of these lenses.

The new money lens (money 2.0)

When thinking about what the value of a new money could be there are two key variables to consider: (1) breadth of the economy — how many people are using the currency, and (2) depth of the economy — the aggregate value of transactions within the economy.

On (1), breadth of the economy — one way to do this would be to assign a probability to the penetration of the money market i.e. how much of the global monetary base will be replaced by crypto. There is a taxonomy to how money is measured, denoted by M(x).

M0 = Notes and Coins in Circulation

M1 = M0 + Liquid Commercial Bank Deposits + Federal Reserve Bank Credit

M2 = M1 + Time Deposits <$100k + Consumer Money Market Accounts

M3 = M2 + Large Time Deposits + Institutional Money Market Accounts + Illiquid Assets

MZM = M3 + All Money Market Funds

Some of the assets included in M3 and MZM are not as likely to be disrupted by crypto, so there is not a discrete number that we can say is the total addressable market (TAM) for crypto as a money alternative. If we were to use M2 as our target, that would be ~$75trillion [41]; if we were to then add the components of M3 and MZM that function as monies then that figure would be ~$90trillion [42].

Like many startup pitches, one could look at the TAM and ascribe an expected market share capture. An iteration on this would be to go money by money and ascribe an expected market share capture to each money supply ie. Cyprus Venezuela would have a higher likelihood of being disrupted than the US. Summing these would help build up to a reasonable expectation of what the total penetration could be over what time scale. Like most (all?) startup pitches, this will likely be wrong, but it is a starting place.

There are two steps to this analysis: first, how much of the existing monetary base will be replaced by crypto; second, of that crypto monetary base, how much of that will be cryptocurrency (X). As you can see there starts to be a lot of assumptions baked in, and when you’re talking about trillions of dollars, a few basis points of variation changes expected value in the order of billions.

On (2), depth of the economy — this is the effective GDP of the economy in which the currency is being used. How much are people transacting in the currency and what is the unit economics of those transactions. For this, one could look at existing GDP and make an inference for market share capture i.e. what are people spending on today, and what % of those spends would we expect to be replaced by a cryptocurrency.

But when thinking about a currency becoming new money, that kind of exercise becomes far too narrow and misses the important edges of the economy. If you believe that a cryptocurrency will be new money, then you must value it the same that a money’s value is derived. There is no one de facto valuation model, but the most common would be the Equation of Exchange, which is a derivation of the Fisher Equation. The equation of exchange is made up of four variables:

M: Money supply

V: Velocity of the money

P: Price of transactions

Q: Quantity of transactions

The equation is one of equilibrium. If you know three of the four variables, you should be able to derive the value of the unknown.

MV = PQ

If you know P (average price of things being bought), Q (quantity of things being bought), and V (the speed at which tokens are changing hands), then you could derive the value of M (monetary base). M would be the total value of the currency, so if you wanted to find the value of an individual token, you would divide M by the token supply.

As you can see from the above, PQ is the GDP of the economy. When we talk about money, it is hard to get an exact value for P and an exact value for Q, but these can be looked at in aggregate — the mix between P & Q left relatively ambiguous.

Velocity (V) is the rate at which the currency moves in a given time period. The higher the velocity, in theory, the lower the value of the currency. A high velocity would infer that the currency doesn’t “hold” value, because it is so easily accessible and fungible. That doesn’t mean that a low velocity is better — that would mean that no one is using it, and people still need to transact, so that would mean they are using something else, and the total potential value of the unused currency is much lower.

One way to determine velocity is to look at the average account balance and extrapolate that for the period of time you want to determine the velocity of currency. That is effectively the user’s “reserves” to support spending behaviour. As a simple example, If you wanted to do this for one individual person in USD, you would look at their average bank account balance over a period of time, let’s say a year, and then look at how much they spent over that year.

Let’s assume an average balance of $5,000 and an average annual spend of $30,000, the annual velocity would be: $30,000/$5,000 = 6.

This is for one individual person, but you could also do this for an entire currency base. Take the average total spend in USD over a period of time and divide that by the average amount held in reserves over that same period of time i.e. total bank deposits (+money stuffed in a mattress).

There has been a lot of great writing on the equation of exchange model that I will not aim to replicate here — I would need to do an entirely new essay — but if you want to dive in more I would recommend these three: (i) Cryptoasset Valuations; (ii) On Value, Velocity and Monetary Theory; (iii) On Medium of Exchange Token Valuations.

The important thing to note about the equation of exchange is that it is a present value equation. To determine the future value using the equation of exchange you would need to assign either a growth rate, or make assumptions on the future input values. Some have tried to use discounted cash flow (DCF) analysis, however, in the lens of new money we are talking about economies, not companies. There is no “cash flow” analysis to draw on — we are trying to value the cash itself.

My view is that the future value should be derived in the same way that a country’s projected GDP is derived: expected output of the economy. How many people will be participating (population), what is the production function of those participants — which can be broadly measured by (i) public good production within the economy, (ii) existing market share of global industry, (iii) innovation ie. net new production.

The gold replacement lens (gold 2.0)

A common narrative in crypto has been that Bitcoin is digital gold. An asset that has similar properties to gold — discrete total supply, predictable inflation of circulating supply — but is more secure and easier to move around. The argument is that Bitcoin is a better store of value than gold.

That analogy has then carried through to asset pricing models. A quick back of napkin math would say that if Gold is worth X, and Bitcoin is better than Gold at being gold, then Bitcoin should be worth at least X. In theory that is not a terrible valuation starting point; however, it is important to get the basic assumptions right.

An easy (but incorrect) assumption would be to take the total value of gold at present — roughly $8 trillion USD — and say that Bitcoin should be worth in the order of $8 trillion USD assuming it replaces gold. I have seen/heard this argument many times. The challenge with this is that roughly half of the supply of gold is used in jewelry and artifacts [source]. Yes, this jewelry can store value for people; but no, not many of these people are going to trade in their rings, necklaces, and antiques for a Ledger Nano hardware wallet.

So on an aggressive asset allocation schedule we could assume that Bitcoin could be worth $4 trillion USD as a gold store-of-value replacement. This would assume 100% adoption. When considering that more than half of the SOV allocation of gold (>25% of total supply) is private sector investment, it seems much less plausible that >50% of people will convert.

There is also the incentives of incumbents to consider. If a cohort opts out of the gold market, the price elasticity is unlikely to be linear, there is a compound impact in attrition of demand. It is impractical to assume that the vacated demand for gold would be absorbed by the current market, the loss in value would undermine the narrative of a store of value, so there could be a run on the bank, so to say. But the reality is, the incentive of holders is for this not to happen, so there will be resistance and likely ignorance to the possibility of a run on the value of gold. It’s a game of prisoner’s dilemma and no one wants to be the one hold the empty bag. Which means everyone’s going to resist giving up their bag.

Concluding thoughts

My view is that crypto — not just Bitcoin — will fundamentally change how we exchange value. Period. Full Stop.

To say that crypto is just a store of value is a cop out. It’s taking the less offensive position because it threatens less of the existing financial infrastructure. That to me is near-sighted and naive.

It is my view that crypto will replace the money we know today entirely. That’s a $100 trillion+ opportunity. The question I’m asking myself is if that will come from existing incumbents (countries) disrupting themselves, or if it will come from a new entrant (Libra, Bitcoin, etc.) and disrupt the incumbents. There is a good argument to be made for either, and there is an argument that they may coexist. If they do coexist, will new global currencies follow the geopolitical trends of today, with multiple economies existing on the same order of magnitude, or will it follow a power-law distribution with 1 winner?

Without getting too esoteric, I think we will evolve to two worlds: (1) A digital replica of the existing financial taxonomy — nation states controlling currency, only with heightened level of surveillance and censorship. The antithesis of the vision of crypto. (2) An alternate world for those that choose to opt-out of the state. I don’t think we will enter the meta-verse, but for a portion of the world, I do believe that there will be a blue pill for the exchange of value. The way in which these manifest is still TBD. It looks like China will be the first to roll out (1), the race for (2) is already underway and will likely end before many people have a chance to react.

“The future is already here — it’s just not very evenly distributed.”

- William Gibson

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