a16z Podcast - a16z Podcast: Beyond Bitcoin -- The Blockchain

Episode Date: October 24, 2014

It’s well understood that bitcoin can be used to buy and sell things/services, and the ecosystem of people accepting the cryptocurrency as payment is expanding. But what else can we use the underlying protocol for? How can we expand the same system that enables bitcoin-the-currency to flow and transactions to be recorded? This discussion (from the a16z Academic Roundtable 2014) examines that question, and answers why the currency is just the beginning of the story when it comes to this technology. You can watch video of the entire discussion here: http://a16z.com/2014/10/24/the-bitcoin-network-effect/ The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments and certain publicly traded cryptocurrencies/ digital assets for which the issuer has not provided permission for a16z to disclose publicly) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

The content here is for informational purposes only, should not be taken as legal business tax or investment advice or be used to evaluate any investment or security and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Welcome to the A16Z podcast. I'm Michael Copeland. You're about to hear a discussion that was part of our 2014 academic roundtable. This discussion focuses on Bitcoin and how it can be extended beyond its use as a digital currency. Participating in the conversation are Princeton's Ed Felton, John Hopkins, Matthew Green, and our own Chris Dixon.

The conversation picks up with a question from the audience, and Ed Felton responds. Question number one, I guess there are people who say Bitcoin is really blockchain 1.0. With blockchain 2.0, you could do what are referred to as distributed autonomous companies. I want to get your thoughts on Dax. All right. Let me talk about this. So distributed autonomous company, there's a lot of different jargon that people use to talk about these ideas of some kind of automated actor that is a first class actor within a system like this. They're sometimes called smart contracts or virtual corporations, etc. I really just, first, first, these things are fundamentally equivalent to each other. And second, I prefer just to use the term mechanism, right? As an engineer, I understand what a mechanism is.

And I think if we think of these things as companies or contracts, we can, I think that tends to make it a little bit more confusing. because at the end of the day they don't have exactly the attributes that companies or contracts or actors have their mechanisms. Their agents. Their agents in a sense.

Right. I mean a corporation is a legal structure that has limited liability and certain requirements for governance and reporting and all of that stuff. And that kind of doesn't apply to these mechanisms. So, I mean, I think it is really exciting. I think the idea that you could

extend the blockchain and have all these new features and have these autonomous, and I think software agents is much better. I think companies is a terrible way to explain this, but I think software agents that have these capabilities, including the ability to essentially transact funds, would make a huge difference. Now the question is, where are the limitation to those capabilities? I don't actually know where they are. They may be more limited than we realize. Second, a different question. Dan, you are probably alluding to this. Given you're looking at new capabilities of Bitcoin like technology using blockchains, to me the question really is the capitalistic question is, why would you do anything with Bitcoin? Why would he not

create your own coin? If it has more features, you would be a rich person, you know? Well, I don't know. I mean, I don't know if lightning strikes twice when you have these things, but I do think, I mean, that's what we're doing. So we actually, when we initially came out with zero coin, it was not very efficient, we approached Bitcoin and said, hey, this is great, you guys should adopt it. And they kind of looked at us funny. And they said, you know, this is not efficient. We would never do anything risky. And besides, We can't change Bitcoin ever again. And then they all got other jobs

because they realized they couldn't do anything interesting. But the alt chain, the ability to fire up these alt chains does let you do these kind of things. So I think that there's an important network effect that goes on here, right? Bitcoin has that network effect. They were there first. And so there are natural limits

on the ability to create new coins. Fundamentally, you have to bring some functionality to the table that people really value that that Bitcoin doesn't provide. And so maybe it's privacy, maybe it's an increased agent capability, maybe it's something else. But I think a Me Too coin won't get off the ground now. There was this kind of fad for novelty alt coins for a while,

but that died out pretty quickly. I guess given that we are in the land of unreasoned Horowitz here, Mosaic was the first browser, and an escape is the company which made money. So to me, I guess, maybe Bitcoin is maybe version 1.0. Maybe the next generation makes a lot more money, I'm not sure. I mean, I think there's certainly a lot of space for innovation here. Some of it on top of Bitcoin and some of it is something else. But I tend to agree that Bitcoin is not the end of the story in terms of the development of this technology.

Far from it. Yeah, thanks. So I have a question that really segues. from what the earlier discussion about regulation was about. You know, it seems to me that there's a couple of features of a Bitcoin-like system. And one is that it's gold-like in that there's a government independent or nation-state, let's say nation-state independent. quantified thing that's used as the basis for some of the transactions. So that's one issue.

Another issue is this issue of taxation. And, you know, both of these in some sense are threats to government, more in Matt's instantiation of the zero coin. But, Ed, to some degree, you know, if you think. think really hard about how taxation is done today. Most of us are taxed in a way by our corporations. So there's a trusted third party involved in the taxation process that the government has a lot of regulatory power over. So, you know, it's widely believed that, you know, a lot of small businessmen cheat on their taxes, right? You know, and so it's a very

interesting question how the nation state responds to its way of doing business, and I would appreciate it if both of you gentlemen could comment on that. Okay. All right, I guess I'll go first. Right, so you alluded to the underground economy and the way that people engage in all kinds of off-the-books transactions in order to avoid taxation, right? And so a key question here is, does the existence of something like Bitcoin make that easy? or more common. And you could argue that it does because it's a transaction

that doesn't involve the banking system. On the other hand, a lot of the unreported transactions today happen in cash. And cash is an ideal technology for doing it off the book's transaction. The only drawback being

you need an in-person transfer. My sense is that the barriers to... The thing that keeps all of the economy from going off the books. The factors that keep that from happening are not very different if you switch to a Bitcoin world, right? That the conspiracy to not report income has to be too large in a sizable company. And the consequences of getting caught to the leaders are too large. And I think it's factors like that, as well as a social norm that to just not pay taxes at all

on your income is kind of not okay, I think all those factors remain. That said, the fact that you may be replacing the traditional banking system for electronic transfer of money with something that is harder to regulate inherently is an important thing. And this is one of the things that makes people, the heads of people in government hurt. They're used to saying, well, if Citibank is doing something we don't like, we'll call Citibank and talk to them about it. So if Bitcoin is doing something we don't like, we'll just call Bitcoin and talk to them about it.

But Bitcoin is not the kind of thing you can call and talk to. They won't find themselves wanting to negotiate with the protocol, which is not a thing you can do. So I don't have an answer to the tax question, except that governments will always find a way to collect taxes. I'm not too worried about them. What is really interesting is the fact that

lately, I mean, and lately means the last few decades, finance has been used as a way of essentially enforcing the law, not tax law, but all kinds of other laws. And more recently, there are laws that actually try to regulate certain behaviors, maybe under the rubric of risky transactions, but certain people can't open bank accounts. If you have a business that's legal, but maybe not savory, you can't open a bank account. And so I think the fact that, you know, these kinds of systems exist helps to kind of restore a little bit of balance to that, and that may be a good thing or a bad thing. I'm not. saying people should violate regulations or the law, but historically these kind of systems,

cash has been important, and electronic cash will be important, too. I think it's important that it's already the case that if you are a reputable business that deals with large Bitcoin transactions, those have to be reported to the government, or you're going to end up behind bars pretty quickly. I'll ask a quick follow-up question, actually. So if Bitcoin continues to grow, do you think the Fed might actually try to disrupt it at some point? And if it did try to disrupt it, could you speculate on how it might go about doing that? New York.

Well, right, so you'd start, Matt said New York. The New York Department of Financial Services, which is the part of New York State that regulates the financial industry, is already looking at some significant regulation of Bitcoin. They have proposed a regulation, something called a Bit License. And you need to get one of these licenses and do all kinds of process and disclosure and so on in order to be allowed to be in business, in a wide range of businesses relating to virtual currencies, doing any business with anyone in New York State. And so we're seeing that for sure.

That is traditional financial regulation coming to the Bitcoin world, and there's a huge culture clash that happens when some garage entrepreneurs get a letter from a guy in a suit in New York telling them that they have to fill out this very long reporting requirement. So that's number one. Thus far, though, I think many other aspects of government have taken a wait-and-see approach. And I think at the federal level, they've done a pretty good job of getting what they need out of the system, like reporting of large transactions for money laundering purposes, without wanting to disrupt the whole thing.

I think a lot of people in the sort of old-school finance and financial regulation world just think this whole thing is a bubble and we'll go away if they ignore it. I don't think that's true, and I think that as they wake up, they may start looking at what they can do about it. but it's also the case that by the time that happens, it may seem larger and more established and more legit, and so they're more likely to keep their hands off. So the scarcity of the number of currencies today

comes from the number of countries to zero-th order, right? And then the scarcity of the number of precious metals comes from the periodic table, that there's only certain number of elements. What I think I heard you say was that you think the scarcity of cryptocurrencies, as in Bitcoin, maybe one, or two others in the steady state comes from the existence of a network effect that there can be

only one, Facebook and Google Plus can't ever happen in that world. Are you basically saying that there's going to reach a point where you can layer on top of Bitcoin or whatever comes after it enough features that will basically solve all the needs for privacy and speed and size and everything, that there won't need to be another one in the sense that if I want something that's more secure or can I add another 12 bits to the size of my security hash, why would it ever stop if we think about features only becoming more rich and more important? I don't know that it will stop at the sense that I think it's the case that if you can

convince the community that you're a new thing is enough better along some dimension they really care about, then there will be a space for your currency to get a foothold. Maybe something that existed before falls away, right? Someone else had the most secure, most private, or most efficient, or fastest transaction clearing currency before, but now they don't anymore, you do. And just like what it would, if you think about what it would take to displace Facebook as the Bigfoot social network, you have to be enough better that people are willing to switch. even despite the network effect.

Actually, I don't agree with that. I think that there's room for a large number of altcoins, and I think the reason that the existing altcoins are not as popular is just because of inefficiencies in the way that exchanges work. And I think that as exchanges become more efficient, that property, I don't think there's an analogy to Google and Facebook. I think that you could have Google and Facebook and transact both. Well, I think you can then get to the interesting point

where you talk about this exchangeability is a key issue. Exchangeability is essentially like compatibility between different platforms, right? And there's all these strategic games that get played around compatibility. I would expect them to get played here, too. Is there a basket currency in a steady state, which is just basically derived, its values derived, and not whether it can. I think it's partly a technical question, whether that is something that can arise and operate efficiently. And I know there are people, even in this room, who have opinions about that. I think, I think to your, that's a great question, and it's like one of the biggest questions, I think, in the, in the Bitcoin community. I think the network effect is underestimated. There are multiple layers of that. So, for example, the company I'm involved with Coinbase is going out and doing deals with merchants. So, you know, they've announced Dell and a whole bunch of other big merchants. And that's going to, I think, pick up steams. You have the merchants. You have the consumers. They have 1.8, I think, million consumer wallets at Coinbase now. There are other companies, too, that have them. That's a big deal.

There's sort of regulatory stuff, you know, like people have done a lot of work now on Bitcoin's legality. There's developers building on top of it. There's the mining community, which effectively provides a security layer. And then there's sort of this intangible thing of just people having faith in there's some value in Bitcoin, right? Sort of, like, as time goes on, presumably people will get more faith. And then to your question of extensibility, I think there could be fatal flaws. I think a lot of the objections I've seen so far, like, for example, fees being too high. to prevent, that would prevent

micro transactions. What you're seeing is off blockchain transactions. So Coinbase is big enough now that a lot of the transactions flow internally and they can make those, they basically waive those fees as an example. And I think you could imagine, I think it might maybe like email, like you'll have a Gmail, you'll have a Yahoo, and like internally

they'll probably have deals and cross trades. But it's very important I think then psychologically to know that it's an open you have SFTP underneath it and I can always opt out, right? So I might depend on, I think that you'll end up a situation like, probably like email, where you sort of depend on a corporation, but also are reassured that you can always opt out. I also think another good analogy would be TCP, and like you think

about things like DHCP is a good example, where you think you're going to run out of IP addresses, but then you come up with a scheme like that, which again, like, I think Coinbase would be an analogy there where, you know, but it's very, very, I believe it's very, very important to have an open protocol at the basis of it that has strong network effects. But what if you can't opt out? I mean, what if it becomes the case that regulation says Coinbase is trusted because they know their customer. And that's sort of effectively happening. Like, for example, with the IRS ruling,

first that sounds terrible. You have to compute all of your changes. It turns out, well, Coinbase will do that for you. Now, as a Coinbase shareholder, that's good for us, right? Because we can provide a service. To your point, it's bad for the community, I think, because you're suddenly dependent on places like Coinbase for that. Raises the cost of venture.

That's right. That's right. But the open source community is very, you know, advanced as well. And I bet you there's going to be interesting open alternatives as well. but it's a great question I just think it's to me it's sort of like the other way I think about it is there's sort of 10,000 of the best software developers in the world are building stuff on Bitcoin and whenever

somebody says Bitcoin can't do this it's to me in some ways they're betting against those 10,000 developers you know and it's very hard to predict how that will play out over time but so yeah the question everything that you showed you didn't really touch on time

at all and that's the big thing about Bitcoin and cryptocurrencies that bothers me, just the resolution time to guarantee that this transaction did, that I have two confirmations. I mean, that's 20 minutes right now that has to happen. And if I can actually do a transaction bigger than a certain block, like, I'm almost enticed to try to double spend because someone might want to try to do something faster. Like, do you have thought about that? I think that's another case where a service like Coinbase can, you know, if it ends up being there's five large services, then internally they can, internally, Coinbase can, internally Coinbase can

settle instantly. And if they have a deal with bit pay, for example, they can settle instantly. I don't know. Not really, right? Sure. You can find outside of your network? No, an internal. I'm an internal. So if you're a consumer who pays for Dell and they're managing both sides of it and then I imagine there'll be sort of interoperate.

I mean, look, it could also be there's a new thing, a new cryptocurrency required. I'm saying to me there's two paths to play out. One is you sort of build layers of extensions on top. The other is you finally say, you know what, we can't do this anymore. We fork it or quit. Or you just have an institution emerge, which acts as the trusted party for that function.

That's right. That's right. I guess to me it just seems like a big, big hole in cryptocurrencies, just in general, just the resolution time to ensure that this transaction happened. And you didn't really touch on that portion of it during your presentation. I think it gets lost on a lot of people. They don't realize that, you know, to feel actually comfortable, like if I'm doing a cash transaction in San Francisco, I'm going to go hand a guy $100,000 and I'm going to wait for those coins to come in.

I'm going to sit there for 20 minutes with him until I have those confirmations, because I actually gave him cash, and I want to make sure it happened. And are there any efforts to accelerate that time? So some of the alt coins, actually anonymous altcoins, have middle semi-decentralized layers where there are the users, and then there's kind of a small number of supernodes. And an experiment that some of these alt-coins are doing is trying to use those for fast confirmations. I don't know if it's a good idea that they're doing. For interesting remarks, I had two related questions.

The first is I wonder if you could comment upon the volatility of the value of Bitcoin. and whether or not criminal or legal or regulatory challenges are really going to influence it a lot. And secondarily, since a currency often is really used by people and is valued for its stability, what would happen if some sovereign state that was progressive decided to issue a cryptocurrency and peg it to their own currency and try and wipe out Bitcoin by actually introducing the idea of something actually would have a stable value? Let's see. So, I mean, when it comes to volatility, it's the short-term volatility that scares people.

Right? There are longer-term trends, changes in the underlying demand for Bitcoin, but it's a short-term volatility that scares people, no doubt. And I think this comes into play in two ways. One is it makes it a relatively risky investment. But risky investments exist. If investors know that they're risky, then so be it. And I think financial regulators are trying to make sure that people who are touting Bitcoin as an investment are clear that the price goes up and down a lot, and so on. So I think that will shake out. The other issue is for that transfer of money from Alice to Bob, right? Alice wants to buy a widget from Bob. Alice has some dollars. Bob wants to end up with some other currency, let's say, and it's convenient for Alice to buy Bitcoins for dollars, ship them to Bob, and then Bob sells them for his currency. So then the issue is a fluctuation, investment. value that might happen during that period, and that's like the 20 minutes to an hour period that it takes the transaction to really fully clear.

And for that, there are companies that will mediate the transaction and just eat that risk. It's one of the things that Coinbase, for example, does. If you're a merchant, you want to get paid, you want X number of dollars because you gave somebody a pizza, and somebody in exchange for a small fee will guarantee that you'll get X number of dollars even though the customer is paying in Bitcoin. And so there are businesses that will absorb that risk. And so I also don't think that's a big long-term problem. I think the exchange rate of Bitcoin will settle down if it grows. You get more liquidity in the market and you get more sophisticated economic modeling of what the fair price is.

And then I think the volatility goes down somewhat. So Bitcoin has been around for a while, and it seems as the number of transactions, the daily transactions, hasn't moved that much. It hasn't really had the uptake over the time that it's been out. And it being out for a while, I'm wondering what you guys think might be the forcing function that might cause it to grow, especially with things like Apple Pay coming down the line, and Visa still working on their kind of solutions to make things easy and convenient. What's going to make Bitcoin successful for the market? Silk Road 3? I don't know.

But, I mean, the international payments have always been the big thing. As a research matter, I have a colleague in Brazil and I needed to get $10,000 from a grant to a sub-grant to him in Brazil. It took three months for him to get that money. You had to set up an account.

So we all know that there are huge problems with international payments. I think that's one of the places where you're going to see the big adoption, but people have been saying that for a year or two now, and I'm waiting to see it happen. I mean, I don't know, if you take like a science fiction view of like, you know, this will be around for thousands. If you were into year six, so I would say first of all, the second of your point in transactions, there's data, there's the best data I've seen is the transaction volume has gone up, the non-speculative, like the payment transaction volume. It's not exponential, though, it's linear. We'd like to see exponential, so I agree.

I still think it needs a long way to go, but I think there need to be more what we could call kind of native Bitcoin applications built, things like international remittances that you couldn't do with traditional payments. we're just starting to see, at least from our perspective, entrepreneurs come and sort of pitch that to us. So the same thing with the Internet. Like they built the browser, they built the web server, where's the Yahoo, where's the Amazon, where's the Google, you know.

It takes a while, I don't know, I think it's still a while. Yeah, and there's a whole bunch of sort of practical usability and practical security issues that regular users don't want to deal with and shouldn't have to deal with. And it's taking some time for the tools and technologies and products to arise that actually smooth that over.

So, you know, it's not like a random member of the public who just wants to buy a pizza with Bitcoins can easily do that right now. But there's no fundamental barrier to that existing. It's just that it's not there yet. I mean, one of the things I'd say is with all of the press hype around Bitcoin, there's four venture-back startups or something. It's not that many. You know, like, it's sort of been a little bit disproportionate amount of press to the actual entrepreneurial activity. It takes a while for, like, you hear a lot of entrepreneurs who are, like, doing other stuff. I'll say to them like what do you really want to do

like Bitcoin but like it takes like it's actually the two big Bitcoin and virtual reality the ones I was here but it takes years for that to really happen they're at another job they have to go so I think it's happening it's just it takes time

so what do you think of a company like PayPal incorporating this kind of technology when they basically have the consumer space already in that area It's, well, in the case of Bitcoin, it's very, well, first of all, they did a partnership with our company, Coinbase, so that was good. But, um, selfishly. No, I mean, I mean, it's, because the regulatory issues loom so large here, it's always, from my perspective, good to see, even the IRS ruling on Bitcoin. Like, it's good to see just people acknowledge that this is a, this is a real thing and that it can be used legitimately. So I think from that perspective, it's a very positive thing. Applications other than Silk Road.

Yes, anything that's not associated with, you know, because so much of the early press was around these illicit activities and things, and so just good to just see it sort of being used in more mainstream context, I think. Legal practice. Yes. So this is kind of a random curveball question. I'm not an economist, but apparently you need some kind of. of healthy inflation rate for the economy to grow. And, you know, that's not really built

into Bitcoin. I mean, it's, if you want to be Keynesian, you need like a, what, 3% inflation rate for people not to sit on their money in a way. And Bitcoin doesn't have that, obviously, like, instruction, but how do you see that playing out? And is it really going to, if it grows enough, could it have an impact on how economies work? Yeah, I mean, this kind of goes to the question of what is Bitcoin's monetary policy? and contrary to popular belief Bitcoin does have a monetary policy right now the monetary policy

is grow asymptotically to 21 million Bitcoins but that could change by consensus of the community that 21 million limit is not inherent mathematically it's just a number that is hardwired

into the currently used software that number could change the policy could change if there is a consensus in the community that it needs to And so I think there is flexibility. If the community decides with a strong consensus that that is what needs to happen, it'll happen. So what scares me about Bitcoin today is not that economic issue, not just that economic issue. It's the way that Bitcoin is insured that there will only be 21 million coins.

It's the fact that there are these halvings of the mining reward, and that right now mining reward is what drives the network. And there are some papers out there that have done some. or trying to look forward into what that means for the hash power of the network. And it's scary. I mean, there comes a point where the network may just destabilize and fall apart. And that's much scarier to me than the fact that some people are doing this radical experiment in nine kinds of economics. I mean, that may just not work.

But the protocol blowing apart really will scare people. And I think that is what will get people to get their hair on fire to actually change the policy. I think for me, I would love it if some good economists took Bitcoin seriously enough to, there's very few, in my opinion, very few academics who are taking it seriously enough to even study these questions. And I think it would be great if they did. I have yet to see, like you read like Paul Krugman or something, and he makes very basic mistakes about Bitcoin and clearly has not read the paper. And so it's hard to take those seriously.

And so, for example, if you go into macroeconomics, one of the assumptions people make about currencies is that currency is tied to a country. And that's tied to a country and that you have inflation and things like this, when the amount of the volume of money outpaces the value of goods in that country. As an example, no one has ever studied, to my knowledge, a currency that isn't tied to a country. There's no country of Bitcoin or something. And it very well could be that Bitcoin evolves in a way that I think it will. It'll be sort of a transmission protocol layer.

And what does it mean to have to need inflation? I'm not saying I have the answer to it, but I just don't, I feel like a lot of the analysis so far has just been very superficial. and that it needs to be studied. We would love for people to study, both on the computer science side, one reason we're talking about today, but also on the economic side. I just feel like it's almost been lampoon

so much that it hasn't been taken seriously. Also, if you think of Bitcoin more like gold than dollars, you don't think about the gold voluntary policy. It's just something else. It's funny. People say, because there's only so many of them, the price will always go up, but we have so many counter, like gold, for example.

I don't think anyone thinks gold will always go up. There's plenty of examples of things with fixed quantities where the price doesn't always go up. Again, I find the analyses to be kind of superficial.