Emergence of The Crypto Economy

  • The Crypto Economy is native to the internet. Like the internet, it is global, accessible to all, decentralised and unstoppable. Bitcoin, not the US Dollar, is the reserve currency of The Crypto Economy
  • Crypto itself can be thought of as programmable money. It allows for the rapid iteration of incentive structures and therefore new forms of organisation, like DAOs (decentralised autonomous organisations) as well as entirely new business models
  • Having gone unnoticed by the mainstream, a parallel financial system has been built by the crypto community over the last 10 years. It works, is in many ways superior to the traditional financial rails and is seeing increasing adoption
  • Use cases are no longer limited to speculation and trading. Crypto can be earnt, spent with merchants, used for cross border payments, prediction markets and as a store of value amongst many others
  • DeFi or Open Finance, if allowed to reach it’s full potential by regulators, promises compounding financial innovation, akin to what we’ve seen in the open software space over the last 20 years
  • These financial models and products may end up augmenting traditional business models and businesses
  • Technological risks remain widespread, but soluble
  • We were right, just a little early. Timing is everything in venture!
There are few suprises for top and bottom placed countries when it comes to their Economic Freedom Score
  • For a business model innovation, think of a social network that awarded tokens to the early adopters. These tokens would hopefully appreciate in value over time as the network became more popular, allowing value to accrue to the community instead of just the founders or investors. Further, the social network could allow users to create their own tokens and monetise their following through a similar mechanism.
  • Centralised fiat collateralised Stablecoins
  • Decentralised crypto collateralised Stablecoins
  • They issue 2 tokens, DAI; the Stablecoin and MKR; the Governance Token
  • DAI looks to maintain a soft peg to the USD and is created when users deposit Ethereum, which is the collateral in this case.
  • As the price of Etherum varies and varies significantly due to volatility, the borrower must over collateralise. The user is permitted to withdraw up to 2/3 of the value of Ethereum that was locked up. DAI charge a stability fee of 0.5% (which is clearly much better than a bank lending fee), but this fee can vary. If the fee increases it encourages people to pay down their debt, which they pay in DAI, which then gets destroyed or ‘burned’ by Maker Dao. So restoring balance to the ecosystem.
  • What happens if there is an oversupply? That is if there is more DAI in the world than demanded? The price of DAI traded on exchanges drops causing the stability fee or interest rate to increase. This encourages users to pay down debt with their DAI, DAI is ‘burned’ in order to contract supply and force the price back up to parity with the dollar. The principal of any loan is repaid in DAI, but the interest accrued is paid in MKR, the governance token. MKR is destroyed as well as an incentive to the MKR community.
  • DAO stands for decentralised autonomous organisation. It takes advantage of the wisdom of the crowd to make the optimal choice for the governance of the token as decided by those with the MKR token. They decide on the interest rate, loan terms and other issues. The number of MKR tokens only decrease and hence in theory increase in value as they get burned when loan interest is repaid, thus incentivising holders to take decisions in the best interest of the Maker Dao community.
A simplied flowchart for a decentralised crypto collateralised Stablecoin
  • Yield Farming as the name implies simply means to generate returns on your crypto. For example; Put 100k Dai or USDT into Compound, to receive interest and a token in return called cUSDT. That cUSDT can itself be put into another service called Balancer, a self-balancing index crypto fund that earns through transaction fees. In this case, the user is getting interest on the money they have borrowed from Compound, but also from Balancer.
  • Liquidity mining is the act of getting a new token as well as the usual interest bearing return in exchange for the farmers liquidity. Crypto protocols as in the example of Maker Dao are now offering governance tokens to users who provide liquidity on the platform. A governance token allows owners to vote on protocol governance, just like shareholders in publicly traded companies. But they are also tradeable and so can be bought or sold.
  • B2B Cross Border Payments
Financial flows within the global marketplace are surprisingly disconnected
  • Decentralised lending
  • Decentralised exchanges
  • Central Bank Digital Currencies (CBDCs)
  • Volatility: Order books are still thin, even in the most widely traded assets like Bitcoin and so volatility is high. This volatility is a significant barrier to widespread DeFi adoption, as a price crash can cause the collateral staked in a borrowing protocol to be irreversibly seized and liquidated.
  • Scalability: Whilst most blockchains allow for enough transactions per second for applications like lending, where high transaction throughput is not required, for other use cases like gaming or micropayments throughput is not sufficient. The next generation of blockchains seek to solve the throughput problem, without compromising on decentralisation.
  • Decentralisation: Many crypto projects purport to be valuable because of the decentralised nature of their protocol. But why should we care ? Decentralisation is a means to an end, not an end in itself. The purpose in the case of Bitcoin was to make it immune to censorship, corruption or cyber attack but beyond the point at which this is achieved, yields diminishing returns. However, at the outset, if a protocol has not achieved enough decentralisation to not be censored, the efforts amount to little. The returns to decentralisation in other words, follow an S-Curve.
  • UX: Usability of the ecosystem is also still quite poor. Many applications are not user friendly, they appear to be have been built for machines rather than humans. Transferring Crypto from one address to another requires entering a random string of digits for example.
  • Bugs: Smart contracts undergird the DeFi system but like all technical products are vulnerable to cyber-attack and plain old code bugs. The system is interconnected in increasingly complex and intricate ways and so vulnerabilities in one protocol can quickly bleed over into others.
  • Governance: Regulation poses another threat, with national governments yo-yoing between acceptance and crackdown as they seek to understand how private currencies may threaten their own interests.
  • Part 2 of this series will focus on the specific investment themes we find compelling here at Concentric

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