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Why Our Investment Thesis Hasn't Changed | Avichal Garg, Haseeb Qureshi

Tue Jun 13 2023

Podcast Summary

Hosts and Sponsorship

  • The podcast is hosted by Santini, Hasib, and Avitro.
  • The podcast is sponsored by Fails Markets and Carbon.

SEC Actions Against Coinbase and Binance

  • The hosts discuss the recent SEC actions against Coinbase and Binance.
  • The market rebounded after the news, possibly due to relief that the Coinbase case was relatively clean.
  • There is a clear legal theory that all exchanges are operating without proper licenses.
  • Some believe that everything in crypto besides Bitcoin is a security.
  • SEC Chairman has named almost everything in CoinMarketCap's top 10 as security, except for Bitcoin, Ether, stablecoins USDC and Tether.
  • Naming individual coins as securities erodes credibility and forces the industry into a corner of noncompliance.
  • The industry is fatigued and not complying anymore, waiting to see how it plays out in court.
  • There's a philosophical issue around credibility when everything is labeled as a security without going in front of Congress to explain why.

Trust in Institutions and the Role of SEC

  • Trust in institutions has been eroding since the 1970s.
  • Many organizations and institutions that were once trusted have become irrelevant due to outdated structures and frameworks.
  • Rules need to be updated for digital assets, a global market, AI control of billions of dollars, and other modern developments.
  • Failure to acknowledge this problem leads to a lack of collaboration and running trust.
  • Organizations like the SEC play an important role in protecting consumers from fraud and loss of money.
  • Crypto succeeding indicates that old systems are atrophying (banks, press/journalism, police legitimacy).
  • Concrete plans are needed to fix these.

Global Market Opportunities

  • Well-intentioned technology solving real problems will ultimately succeed in the market.
  • Teams are hiring engineers overseas or shutting off US access to their products due to regulatory risks.
  • The global market is large enough to sustain really large businesses even if the US steps away for five years.
  • The US capital markets are still overwhelmingly the biggest, but DeFi protocols in the States don't take many risks due to regulatory concerns.
  • Before 2020, it was considered suicidal to start a crypto project in the US, and people went overseas instead. It's likely that this trend will return.
  • Crypto is not affected by the trend of moving away from globalization, as it remains global in nature.
  • The mobility of intellectual capital and companies in the crypto community allows them to adapt and move easily.
  • Investors who invest at the earliest stages are not greatly affected by short-term fluctuations, as they look towards long-term scalability.
  • The US markets may eventually open up for crypto, but there are enough opportunities in other regions to bootstrap off of.
  • Timing and market sizing are important mental models for investors to consider.

Mental Models for Timing and Sizing Markets

  • Humans have cognitive biases that make it difficult to understand large numbers, macro biological entities, and low probability events.
  • Startups involve low probability events with large numbers and exponential growth, which is difficult for our intuitions to grasp.
  • To account for this bias, we need to massively overcorrect and build conservative models that still project out exponential growth.
  • Even with conservative models, some ventures may still be worth investing in due to their potential for huge growth.
  • The intersection of biases can lead to huge growth in technology.
  • The number of people with phones has grown exponentially in the past 15 years.
  • Large companies today did not exist 15 years ago.
  • Disruption and scale do not necessarily translate to revenue for investors.
  • The equation for success in technology is size of market, take rate, and costs.
  • Lowering friction of participation leads to explosive market growth.
  • Technology businesses require fewer employees than traditional industries, resulting in higher net profit.
  • There are questions about how profits are distributed among users, shareholders, and governments.
  • For investors, scale is a key factor for success.

TAM Calculations and Planning

  • TAM calculations are overrated in the crypto industry.
  • Bitcoin is the only cryptocurrency for which a TAM calculation may be useful.
  • Ethereum's TAM has changed significantly over time and is difficult to calculate accurately.
  • Relative analysis of cryptocurrencies is more useful than attempting to calculate their TAMs.
  • The value and problem-solving capabilities of a cryptocurrency should be the focus of analysis, rather than its TAM.
  • The process of planning is more valuable than the plan itself.
  • It's important to think through market structure and customer needs when creating a business plan.
  • TAM (total addressable market) numbers are useless, but the thought process behind understanding the market is important.
  • Bitcoin and Ethereum are currently the most valuable assets in crypto, with a large margin over other assets.
  • There are three critical pieces of infrastructure being developed in crypto: computational infrastructure, decentralized finance (including stablecoins), and a third space that is not US or Chinese.

Creating a Third Space and Infrastructure

  • The creation of a third space, which is neither US nor Chinese, is happening in the world.
  • The market wants a US dollar denominated system that the US government cannot unilaterally shut out.
  • NFTs are being used as infrastructure for digital property rights to own assets and not get cheated by platforms.
  • Three categories of infrastructure are being created: digital store value, digital dollars, and NFTs as infrastructure.
  • Valuing derivatives protocols should not be based solely on the size of all derivatives traded but on what kinds of derivatives would naturally suit themselves to being traded on a public blockchain.
  • Crypto investors need to understand microstructure and differences in preferences and users.
  • Crypto has access to the same rails as traditional markets, but with a different set of strengths and skills.
  • Improving offerings and changing economic models can exponentially expand the market.
  • The McKinsey AT&T study predicted less than 1% of cell phone users in the US by 2000, but the actual figure was 109 million.
  • Crypto is here to stay and incumbents may pick up on broken aspects of crypto to build around it.
  • Centralized players like Binance are highly profitable, while Coinbase has not been profitable for a long time.
  • It's currently not a great time to be a centralized player in the US, but outside the US is a different story.
  • Most countries outside the US are trying to give more clarity and attract the crypto industry by setting sensible guardrails.
  • It is in the interest of the industry to make crypto more trustworthy and move away from any shenanigans that exchanges might be up to.
  • FTX collapsed because people were withdrawing en masse due to some issue.
  • Decentralized products have a clear advantage over centralized ones, but there is still room for one or two centralized services like Coinbase or Binance.
  • There are many unsolved problems in the crypto space related to security, UX, and scalability that need to be addressed for it to reach its full potential.

Investing and Capital Markets

  • The success of a business depends on the problem it is trying to solve.
  • Centralized legacy organizations are less likely to succeed compared to decentralized and startup organizations.
  • New technologies require changes in the human organization as well, which can be difficult for legacy businesses.
  • Amazon's success in e-commerce is due to their focus on software and putting engineers in charge, while Walmart struggled due to their focus on traditional retail practices and IT personnel.
  • Legacy financial organizations will need substantial internal changes that may only be possible through starting anew or having founders who prioritize the survival of the organization above all else.
  • Decentralized and startup organizations are more likely to succeed than incumbents.
  • The podcast discusses areas and sectors with the most opportunities in the current market.
  • Specifics are helpful, such as talking about price points and entry points.
  • The macro conversation is dominated by inflation and interest rates, but there is a third eye that dominates both of those two: innovation.
  • Startups need to innovate to succeed long-term, regardless of macro headwinds.
  • Availability of capital changes how you fundraise; next year may be a rough time to fundraise for most people.
  • Layer ones and the design space are underexplored areas with potential for power law winners.
  • Winner take all is not ideal for creating resilient systems.
  • Relying solely on EVM systems creates choke points and surface areas for attack, inhibiting innovation.
  • Layer ones and early L2s require a lot of infrastructure to be usable at scale.
  • Decentralized computation pieces will converge with AI and crypto, creating interesting opportunities for buying resources using decentralized currencies.
  • DeFi creates a third space for transactions that cannot be shut off by a singular government, allowing the recreation of financial instruments within the ecosystem.
  • Interest rate swap protocols and Hourglass protocol are fascinating experiments in DeFi governance power and preferential economic terms.
  • NFTs have potential to go mainstream from a consumer perspective.

Mainstream Adoption and Challenges

  • Hal Finney in the early 90s on cypherpunk forums talked about digital casting and e-cash.
  • Most people don't understand money as a technology, but they do understand baseball cards and collectibles.
  • Games, collectibles, and luxury goods are things that everybody understands and will help crypto go mainstream.
  • Infrastructure, DeFi, and NFTs are the three categories to think about for a digital economy worth as much as the United States.
  • There is still a lot of capital locked up for crypto, but people are not deploying at the same pace due to risk aversion.
  • Risk aversion is prevalent among investors currently.
  • Despite a lot of capital being earmarked for the space, it may be dribbled out more slowly than in previous years.
  • The growth rate and supply/demand of capital are the two factors that determine return on investment.
  • High growth rate and low capital is the best situation for investing, followed by high growth rate and a lot of capital.
  • Low growth rate makes it difficult to make money regardless of how much or little capital there is.
  • Crypto is a high-growth area with less pursuing capital, making it an opportune time to invest aggressively.
  • Big institutions and funds are slowing down their investments in crypto after a frenzy of investing in the past few years.
  • Some cryptocurrencies have solved real problems and built important technology, justifying their high valuations.
  • However, most cryptocurrencies that are down 90% from their highs will not recover and will either die or become a small fraction of their previous valuation.
  • The fundamental utility of cryptocurrencies is significant, but many did not have enough to justify their crazy valuations.
  • Money can flow easily in the crypto market due to the laid-down rails for wallets, NPC solutions, and institutional knowledge about crypto.
  • If the market comes back too quickly, it might poison the well. It's better if things come back more slowly so builders can put their heads down and build.
  • A lot of startups may run out of runway like what happened.

Financial Difficulties and Funding Challenges

  • In the next six months, there will likely be layoffs and companies trying to sell due to financial difficulties.
  • Many startups will hit the last six to twelve months of their runway and realize they can no longer support a ten-person team.
  • LPs in the capital markets may pull back due to FOMO, which could affect funding for startups.
  • The top five to eight firms in crypto are unlikely to have issues as their capital bases are strong, but it could take out the next 50 firms.
  • Norms in crypto make it difficult for Down Rounds as it is challenging to make the math work for many protocols.
  • Some real constraints will need revisiting because earlier markets did not work this way.
  • The speaker discusses the opportunity for well-capitalized liquid protocols to build ecosystems on top of multi-sig platforms.
  • Non-custodial startups could acquire teams from more well-capitalized companies with liquid currencies.
  • The speaker suggests that buying Bitcoin and ETH may be a better investment than putting money towards an early-stage startup.
  • It is difficult to predict when a great founder will show up as an early-stage investor, so it's important to pay attention to those who are coming in now.
  • Token side investments are currently interesting because there are many decentralized options available, such as Solana and Cosmos.
  • The speaker does not provide advice on buying cosmos or hold any atom.
  • There are serious issues with the ecosystem and token.
  • Despite this, there are pockets of real technical development with real use cases.
  • ETH is currently at 2017 prices despite everything that was theoretical in 2017 being real now.
  • Humans tend to overestimate what's possible in two years and underestimate what's possible in ten years due to exponential growth.
  • The crypto market has gotten things wrong, such as Plato Earn being a big narrative mistake.

Crypto Gaming and Lessons Learned

  • Most crypto games are not entertaining and are essentially financial engineering.
  • Crypto gaming is an interesting area, but it suits certain types of games better than others.
  • Play-Darn was the wrong path to go down and made the industry look foolish.
  • The Dow craze was off and made the industry look foolish for endorsing it.
  • Crypto got some things right, such as tokenizing value and bringing it on-chain in a decentralized network.
  • Blockchain technology has been more efficient than traditional financial systems, leading to central banks and financial services companies incorporating it into their services.
  • The 2017 ICO craze taught the industry a lesson about why laws around disclosures and investing are important.

Governance and Regulation

  • Vesting is important in capital markets to maintain trust and legitimacy.
  • Strong commitment mechanisms are necessary for strong capital markets.
  • The crypto industry is iterating towards best practices, similar to the early days of the internet.
  • Regulations are currently hampering the ability of protocols like Uniswap to capture value through fee switches.
  • People are scared that turning on fee switches could lead to SEC deeming it a security, harming adoption and token holders.
  • Uniswap's governance and operation as a decentralized exchange are affected by real-world factors.
  • The value of something is measured by the difference between the value it creates and the cost it incurs.
  • SushiSwap and Curve have shown that taking fees on the underlying market is an effective way to capture value.
  • Uniswap believes that it's still early in DeFi, and they should focus on growing the pie rather than extracting profit now.
  • Uniswap has made acquisitions, but it's unclear who will make decisions on capital allocation - Uniswap Labs or Uniswap holders.
  • The speaker questions whether VCs can be good stewards of capital and suggests giving it back to token holders.
  • Creating structures that allow for well-informed people to make decisions is important, rather than a decision by committee situation.
  • The speaker supports vesting structures for teams and founders as a necessary thing in reinventing the capital markets.
  • Direct democracy is not tenable, and a well-informed group of people elected by that group of people is needed to get things done.
  • The value of tokens may ultimately come from the cash flow they produce, rather than controlling large amounts of capital.
  • Tokens' value capture is a US-centric question, and the rest of the world may figure it out before the US due.

Global Opportunities and Legacy Financial System

  • The Telco Act of '96 was a crucial event that laid the rules for the internet and unlocked its potential.
  • The rest of the world understands this lesson and sees an opportunity to not be dominated by American companies again.
  • Tokens as cash flows are a new financial instrument that needs regulation and disclosures, but it presents an opportunity for economic empowerment for historically left-out people.
  • Regulatory actions need clarity to reopen the design space in a more open way, which will create more value in global markets.
  • The legacy financial system is broken, exploitative, and has been fined hundreds of billions of dollars over the last 15 years.
  • Big banks have been fined hundreds of billions of dollars over the last 15 years.
  • The focus should be on solving the problem of poor people getting screwed by fees instead of arguing over technicalities.
  • Money can be moved around faster and cheaper on phones, solving problems like not having a bank in your local area or taking payday loans.
  • The rest of the world may figure out solutions to these problems before the US due to legacy institutions standing in the way.
  • The American government will eventually do the right thing, but it may take longer than other countries.
  • The guests are welcome back for future conversations about catalysts and monolithic versus modular approaches.