a16z Podcast - a16z Podcast: Trends in Cryptocurrencies

Episode Date: December 19, 2017

The internet, believe it or not, was just the beginning. Yes, it spawned an incredible number of uses (some unexpected), from marketplaces and commerce to publishing and social networks... but that’s all been built with old models of funding and coordination. Now, as we enter a new phase of blockchain-enabled innovation -- decentralized, distributed, crowdfunded -- we’re finally bringing capitalism to open source: Smart people can come together in new ways, to build new things. In this brief discussion from a16z Summit November 2017, founder and CEO at Protocol Labs Juan Benet and founder and CEO of Polychain Capital Olaf-Carlson Wee -- both of whom have appeared on the a16z Podcast for more in-depth conversations -- chat with general partner Chris Dixon to summarize the big picture on crypto, going beyond the buzz around ICOs to the golden age of protocols. ––– 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. Hi and welcome to the A16Z podcast. We've talked a lot about crypto on the podcast. You can check out the blockchain and Bitcoin tag on our website for more episodes. But this conversation, moderated by general partner Chris Dixon, summarizes the bigger picture and overall trends in cryptocurrencies, featuring past guests Juan Bennett, founder and CEO at Protocol Labs, and Olaf Carlson Wee, CEO of Polychain Capital. It was recorded at our most recent A16Z summit event in November, 2017. Can you tell us how you first got into all this stuff? So in June 2011, I found out about Bitcoin and just went down the veritable rabbit hole, which is something people say in this space, where once you start thinking about it, nothing else feels interesting anymore. So that happened to me pretty aggressively. I wrote my undergraduate thesis on Bitcoin. I joined Coinbase as a first employee and worked there for three and a half years. After that, I started Polychain. So Polychain is an investment fund that invests exclusively in cryptocurrency protocols. We do not invest in the equity

of private or public companies at all. It's this area of kind of new protocols and ICOs and all those kind of words you've been hearing. That's what we invest in. Well, I studied distributed systems at Stanford, and at the time there was this peer-to-peer winter in a sense. So later on, in around 2013, 12 and 13, I started working on a distributed file system called, IPFS, which is now a large open source project. And through that, ended up discovering a whole bunch of stuff around Bitcoin and the thawing of the peer-to-peer winter and like the coming of the period of year summer again. And that's when I got very heavily into all of this. Created the beginnings of Filecoin then, then started Protocol Labs in 2014. And so Protocol

Labs is a research development and deployment lab for networks like these. We make IPFS, Filecoin, and some other protocols. Filecoin is a decentralized storage network that uses a token to mediate the exchange between storage providers and clients. And the point there is to rewire the proof of work function of a system like Bitcoin to cause useful storage. So imagine all of the work that is being expended to maintain the Bitcoin ledger and have that same kind of exponential growth rate to this competition, but apply that to creating a useful cloud storage service that anybody can join. So a lot of people in Silicon Valley think, why do we need decentralized protocols like this? we have these amazing supercomputers in our pocket

that are interconnected and great search engines and they're free and then sometimes people say oh it's sort of for government to get around the government or something like this and this is the only purpose of these things what would you say to that? I'll say a couple things. One is these things in volume are not actually free so if you try to store hundreds of terabytes or

petabytes in Amazon S3 you're going to have a bad time just thinking about the bandwidth alone if you actually want to access all that data it's going to be very very expensive so that's where there's a margin that you can cut out so there is something to be said around these systems can create a better optimization if you allow everybody on the planet to participate as providers in this network. Falkoin's similar sort of analogous to Airbnb versus hotels or something, right?

So you're taking advantage of excess capacity. Yeah, so I think that's the perfect analogy because there's a ton of spare storage on the planet that can't be added to our storage provider because it's extremely difficult to build a storage business. So if you have a petabyte of storage, great, but how are you going to sell it. How are you going to build a business? How are you going to attract customers? How are you going to compete with Amazon? The bar is way to be able to sell those bytes on the network. But if you had an algorithmic market that you could trade that storage in, then the thing gets very, very different. This is precisely the right way to look at it, an Airbnb for storage, where it's mediated by a token. The other thing I would say is, decentralization is an important security feature that right now we are taking, we're not really realizing how important this kind of thing is. So when you try, trust a huge third party and you trust them entirely with all of your data and so on, they control everything around those bits. And if they control those bits, they effectively control your digital life. And this may be fine to a lot of people who traded their digital

life for really nice things like maps and social and messaging and so on. It is less so fine for businesses, for governments, and so on. So there is a very strong interest in uprooting from these free but not quite free clouds and to creating something that is verifiable. So you shouldn't have to trust a third party to do the right thing. You should be able to verify that they're actually doing the right thing and be able to move to someone else when they're not. Well, we're seeing this with sort of the, you know, the regular hacks, Equifax, the DNC hack, right? Like more and more people are realizing the flaws in the centralized security architecture. One key feature of these protocols is the idea that the users, the token holders, control the

protocol. Are the owners. So the file coin protocol, right, actually isn't really owned by Juan, right? The file coin protocol is a pure, peer-to-peer system. So if you want to invest in the file coin protocol, the only way to invest in that is to buy file coins. There's no company you can really back, per se, to get exposure directly to that protocol. And broadly, I think part of what Juan's referring to is a larger trend, which is turning networks into peer-to-peer marketplaces. So when you think about bandwidth, CPU, GPU, cycles, and storage, these are the types of things that have historically been brokered by centralized entities, but now you could have equally like a file coin, you might someday see a Wi-Fi coin, or you might see a compute coin where people can actually

send out, you know, or share rather their CPU-GPU cycles and earn money in a native token. It's a fully peer-to-peer network, and it just removes any inefficiency of the middleman. Now, if you take that to its logical conclusion, this basically makes sense for any extractor from a network. Many of the major Web 2.0 companies that have seen a substantial growth in the last 15 years, this is Twitter, Tumblr, Etsy, eBay, Uber, every single one of these companies could someday see competition from a peer-to-peer protocol. So instead of using Twitter the company, you use Twitter the protocol. And so there's no more value extraction by that centralized entity. And instead, that whole peer-to-peer network, Twitter, the protocol, is actually owned by the users themselves.

Now, where do you think we are, if that will someday be the case, like where do you think we are in that kind of evolution? Because it seems like a lot of the things being built today are things like what you're building one, right, which are more kind of infrastructure layer, and sort of building kind of the equivalent of like the AWS for the Web 2.0 era and not necessarily the app layer. So a lot of the protocols that are going to be able to do that kind of, like the Twitter protocol type structure will require a different framing of infrastructure in order to operate in this nice peer-to-peer public and verifiable context. And to do that, you need a whole bunch of infrastructure to be built out first. So that's where we are today. Once those layers

are structured, then you can build a lot of the consumer apps. There will be a few consumer apps appearing in 2018 and so on. But I would expect to find actual competitors to the world of normal social, where people are choosing these applications for their own right, not because they're in this different world, later, like maybe late 2018 or 2019. So I think this period is entirely about, or mostly focused on building out the infrastructure to power those applications later on. Yeah, and one way I think about this is what I call the Web3 technology stack. So this is, instead of the web stack that you'd see a website on, and so this is built on all the technologies we referenced earlier, like AWS and things like that, this is the stack

of technologies that you need to run peer-to-peer applications. So going back again to the peer-to-peer Twitter, there's this really simple problem today, which is where do I store the tweets, right? It's a super baseline problem. But until you have IPFS and an incentive system using something like FileCoin, on top of that, you can't really have reliable peer-to-peer your file storage. So you can't really build Twitter the protocol until Filecoin is deployed and robust and easy to use. And we're definitely in the infrastructure building. We are in the phase where with the normal internet you had to kind of log your IP address and things like that. I don't think we really even have the browser maybe. So I think it's early, but the consumer apps will come

in, you know, call it three years or something like that. So to that point, what are some of the projects that you're tracking closely and excited? So a lot of these are mostly a developer facing. They're not really meant to be used by regular people. They're really not. So, for example, IPFS and Filecoin could be used extensively by regular people in the same way that when you tweet, that gets stored on Twitter servers, but you don't really think about mechanically how that happened. So there's a layers of abstractions that will be built on top of most of the things that we're investing in today. So most of what we're doing are like, you know, to use like a lot of lingo would be verifiable off-chain computations. So this allows smart contracts in smart

contract systems like Ethereum or Tezos or DFINITY to actually have more complicated logic that's computed off the blockchain and then a proof is sent back to the blockchain in order to show and prove to the rest of the network that that computation was valid. That's a system called TrueBit. But this is all, as you can probably tell, not true bit is absolutely not meant to be user-facing. It's a developer tool so that developers can build things that become user-facing over time. This is just to me if you give some context. So, you know, we think as we described, there's a lot of benefits of decentralized systems. One of the big disadvantages is, at least currently, is scaling.

So Ethereum can what handle, like, 10 transactions a second or something, which is just many orders of magnitude lower than a system like Facebook, right? And so there's a variety of efforts on many different fronts to make those systems scale better. And, like, Trubit is one way to do that. And so there's a lot of stuff going on now that we're all involved with, which is how do we get these systems to scale better, which I think is very similar to what happened in 95 to 2010, sort of on the infrastructure side of the kind of Web 2.0 world, right?

Yeah, I think that's exactly right. The cloud went through a whole bunch of phases of optimization, and that's where we're hitting. So Bitcoin introduced blockchains and this open-ended consensus system where you could add any transactions, but it was horrendously slow. And just like the throughput is abysmal for what you actually need in an application, right? And so it's partly for that reason, I think, that Silicon Valley effectively dismissed a lot of the potential of Bitcoin. It just looked like such the wrong thing. If you could beat the throughput of Bitcoin. Bitcoin with a SQLite database in your phone. Why is this thing useful? And so everybody kind of missed the point. The point was to establish this different kind of computing context where you have public verifiability and immutability. And once you show that that's possible, then you apply all the standard techniques for scaling, this kind of thing, parallelism, hierarchy, and so on, and you can build up something that's really high throughput by either moving the computation off chain, by having faster blockchains and all that kind of stuff. So expect that to happen over the next year or two. Already there's a bunch of academic results.

that show this is not only possible, but it's provably so. So now people are building those implementations, and we'll see them live in the next two years or so. So let's talk about ICOs. People have probably heard about ICOs. There's good and bad, obviously. Mostly bad. So this concept of an ICO, though, theoretically is very interesting. So this stands for initial coin offering. And this is the concept that when I want to launch a new cryptocurrency protocol or new token built on top of one of these smart contract systems like Ethereum, I actually raise capital from kind of the crowd on the internet, so anyone in the entire world in cryptocurrency. So like I literally raise Bitcoin and raise Ethereum in order to distribute my

new cryptocurrency token. So part of the reason this is so theoretically interesting for me is that for the first time we're seeing cryptocurrency technology being used to accelerate the development of cryptocurrency technology. So I think that despite ICOs right now being very noisy, sort of scammy and all these things. It has created an inflection point where when you have a brilliant idea, the capital is much more readily available from a large group of people that actually conceptually understand what you're working on. And so the kind of literally billions now that have been raised in ICOs just in the last year, it has created an inflection point for this entire space where the pace of development will never be, it's never been faster and I don't

think it will ever go the other way because the genie is sort of out of the bottle. it's crowdfunding done right in a sense in that you now have an infrastructure project that you can actually crowd fund from its users and developers and investors who understand the potential value of this thing and they're funding it and you're going broadcast straight to the whole world and making a case for it. There's so much capital right now in the world that that's why you're getting this massive level of noise. So a ton of people are flooding into the space that don't really have a good idea of how to tell the difference between a really solid project and one that's not. And that's what creates a whole bunch of noise. The moment

that a lot of projects were able to raise a ton of capital very easily, then that attracts a whole bunch of players that are not that good and can kind of pass off that they're good. And so that's what we're seeing right now. We're seeing probably like, hopefully this is the peak of the hype cycle. Hopefully this will not get worse next year. So hopefully we have now peaked this and it's going to go back down. And then suddenly we'll get a lot more rigor in investing. So I think things that would help the spaces to establish very credible groups that can analyze this stuff and provide independent reports that say this is why this thing, we think this thing works, or this is why we think this thing is broken, so that people can understand that.

Discourage people from investing in things that they don't fully deeply understand why it's going to work. I don't know how well we can do that, but that's one thing. And just setting standards as a whole community of saying projects should have actual degrees of implementation, really strong teams, certain levels of track record before going through this thing, right? So that'll take curation, right? So it'll take a set of investors and platforms and so on that can apply a certain level of curation to the entire system to distill the signal from the noise. People hear about the news like Bitcoin and, you know, the debates going on there.

I think it tends to be something that's focused on much more by the news and not by people that actually work in the space. Yeah, I think it brings up a larger point, which is governance of these protocols. So this is the idea of, you know, how do you do you do? decide what to do with Bitcoin the protocol. So once this thing is live and running, it's like a live software project, live financial system, and then somebody comes up with a way to improve it. That may have tradeoffs, may not have tradeoffs, just like how do you change the protocol? And right now, in pretty much every live system, there isn't a clear governance model.

There's no formalization around how decisions are made or executed. It's really all very vague. And I think one thing that's very interesting to me is on chain. So like on blockchain, governance systems where you actually use the protocol to create a voting mechanism to actually upgrade and change the protocol. There are a lot of projects working on this right now, but if you can do this effectively, it basically means that the protocol governs itself, right? And now there's no entity outside of that protocol that has undue influence on that protocol and also presents a weakness, both from a security and compliance perspective. So to me, for these protocols to become more robust and also iterate a lot faster on the technology, we're going to need

on blockchain governance systems where people can actually stake money in order to vote on protocol changes, which then everyone can kind of agree on to move the protocol forward. Completely agree that where governance is right now kind of sucks. Bitcoin, I think, is the best example of this. The debates that have been raging for the last two years are about relatively minor things. So increasing the block size became this huge holy war. And when you step back and look at what they're talking about, it's just increasing one factor either by 2x or something like that, which academically people proved will have close to

zero impact on the actual network. So this is a huge holy war around people not agreeing on some very basic facts. And so absolutely we need really strong governance structures. I think Ethereum has done a lot better in that regard, but it's still very unclear. I also think systems like either on blockchain governance or some kind of guidance mechanism will work. Then again, we should also look back at the most successful open source projects and how they do it. Linux is run by Linus Dorvalds. So it's like one person that ends up delegating to a whole bunch of other people to prove why it's successful. Not arguing that that's necessarily the best thing, but as we go into building the future and building new things, we should also figure out what has worked in the

past and what hasn't. People did try to come up with voting systems for a lot of open source, and it ended up going worse. So there's some open source projects that were running to the ground effectively by just communities of people effectively using democracy to kind of drive the project into building way too much, trying to be way too much for a lot of people. So there's an element of curation there that is important to not lose. There's another factor that is going to become relevant with proof of state protocols. And if we end up building this on-chain governance thing, which is you don't necessarily want majority of money to decide the outcome of the protocol and every decision, because that could lead to really bad incentives. So if you just allow

pure majority of money vote in, say, the U.S. governance, which is not, I guess, not that different from what's happening, but there's a very strong difference there where at the very least you have a whole bunch of rights and laws in place to prevent just arbitrary decision-making. The majority of ether, for example, can't vote to say suddenly destroy all the other groups, right, or something like that. So I think this is very green field stuff, but it's going to impact the scalability and utility of these protocols down the road. And so it's a big problem to solve. So if people have good ideas around this, you should build something. Just to explain how much electricity Bitcoin mining uses, this is exactly like what Juan is trying to do here, is take that and make it into something that's actually useful, like storing files instead of just wasting electricity.

And it's also what a lot of people are working on, like, Ethereum is switching over to something called proof of stake, which is going to hopefully solve that electricity wasting problem. So when you read the news articles that say that all the cryptocurrencies waste money, like this is actually one of the main efforts in the community is to make more efficient use of resources. Yeah, it's kind of insane how much power Bitcoin consumes. It's about... It worked too well as an incentive system. I mean, it overshot in a lot of ways. Yeah, last we calculated it was more power expenditure than all of Slovenia. And so I think it's much more now because of the recent spike.

A lot of miners came in in the last couple of months. So it's a lot of power. And so if you turn that into useful work, then you get all of this additional side-effect benefit. The good news is, or the good or bad news, is it shows you the power of the incentives of these systems. Satoshi's white paper, which basically is a set of incentives, and they work so well, arguably too well in the case of mining. that it literally created this much electricity waste. But it shows you the power of these systems, and what if you could harness those kinds of incentive systems for something better?

Yeah, I would say that that's one of the most important things of the entire space. So the proper application of game theory into these systems. So I think computing has had game theory in it for a very long time, but never quite like this, never to the point where you can just describe a few incentives, encode them into a protocol, and then release it to the world, and just watch the effects happen. watch massive mines appear out of nowhere and start mining Bitcoin.

So that is extremely exciting because there's a lot you can do with incentive structures to turn normally centralized systems into decentralized ones and build a whole bunch of applications that would be very difficult for one small party or one single party to achieve on its own. Yeah, and one thing about these systems broadly is that ultimately a blockchain protocol is just a way to organize humans very, very precisely, without a central hierarchy telling people what to do. So you could think about like if Bitcoin was a corporation trying to organize the mining, it would never be as efficient as it is with just this decentralized protocol that incentivizes all these various actors around the world to do this very precise behavior.

And you see also very, very efficient capital coordination in a lot of these systems. So like with ICOs, I think that it's probably the fastest and most efficient capital coordination we've ever seen in capitalism, like since money was invented. people literally put a cryptocurrency address on a web page and within 30 seconds raise $100 million. So what are some of the things you guys are excited about the next couple of years? I'm really excited about the application of smart contracts. So these are more advanced logic that can be built into a blockchain like Ethereum. I think that lots of exciting things will be built with smart contracts over the next couple years that are sort of hard to imagine, more like sort of sci-fi, just because it's such a new tool

that I don't think the world has ever really seen. I would say in the short term, things like formal verification coming to smart contracts, so we don't have single-line bugs that lock up hundreds of millions of dollars. Whoops. In the kind of medium term, once the infrastructure layer is structured, then what are those applications that are going to come? What are the consumer apps that are going to be so good on this medium that have nothing necessarily to do with decentralization or crypto assets, but are inherently a really good

consumer application, because that's what's going to make all of this go mainstream. And I think in the long term is just rewiring power structures on the internet. I think there's the possibility here of enabling, keeping a very open internet in the long term, which is not necessarily going to happen. So the freedoms of the internet have been eroded for a while, and they're going to continue being eroded, especially if there's any kind of bigger geopolitical problems than potentially the internet might charge. Like, who knows, right? There's a whole bunch of censorship and restriction already, and it could be that we don't have end-to-end encryption from one country to another in the future. Like, there could be a sequence of events that happens that prevents

that. And so I think that these systems can enable, can build the foundations at an incentives layer to make sure that we preserve those kinds of freedoms. And so I think that's a very important thing. Which one of your protocols is already used for anti-censorship, right? Yeah, so Catalonia tried to declare independence and try to vote for it. The Spanish government censored the website. And so then the Catalan government put their website on IPFS and distributed it that way. So it was pretty cool to see the Catalan president tweeting out the link to IPFS. So that was exciting. So we're seeing the first volleys of this kind of thing. That's going to increase over time. But it'll come to

head at some point when government sort of, government is in a big way catching up to the freedoms of the internet and figuring out how to restrict them and how to deal with them in some places enable it, in some other places restrict them. So I think there's going to be a ton of questions that are going to hit, hopefully not in the next year, probably later. But hopefully by that point, we have really strong infrastructure to remain free. All right. Great. Thanks. Thanks, Chris.