Ten years after the mysterious figure or group of people known as Satoshi Nakamoto introduced the world to bitcoin, cryptocurrencies are still largely seen as an exotic invention that most regular folks view with skepticism. While the bitcoin’s underlying ledger technology, the blockchain, is enjoying greater experimentation and adoption by companies and countries, cryptos are still tough for most people to fathom. It doesn’t help that the biggest headlines tend to be about theft of these assets.
“Cryptocurrency — no one owns any and no one uses it. That’s kind of where we are today,” said Ari Paul, chief investment officer of BlockTower Capital, a crypto-asset investment firm, during a keynote speech at the second annual Penn Blockchain Conference held at Wharton. By no one, he meant relatively few people. He estimates that around 35 million people globally own cryptos — less than 1% of the world’s population. Among these crypto owners, Paul believes that fewer than 2 million actually are active users. Most hold it for speculation. “This is an incredibly tiny niche industry with very little usage and adoption.”
But developments are afoot. There are people who are working to solve the problems that have hindered wider acceptance of cryptos, especially by institutional investors. “They are quietly building infrastructure,” Paul said. They are also seeking solutions to problems ranging from the straightforward — such as lack of institutional-quality trading software — to much deeper concerns like security of assets. Issues of governance are being hammered out, as is dealing with differing regulations among nations.
Paul recalled that just six months ago, his firm had to build its own crypto trading software because there were no institutional-quality ones on the market. BlockTower Capital also had to “self-custody” or act as a disinterested protector of assets because there weren’t any viable options, he said. In such a setup, a firm could potentially steal the assets it is in charge of protecting. “That wasn’t by choice. We didn’t have trustworthy, third-party custodians.”
Crypto Asset Management
Now, a few firms are getting into the crypto custodian business. Investment behemoth Fidelity Investments has soft-launched a bitcoin custody solution and plans to roll it out in scale, Paul said. Other firms are also in beta tests. He added that Fidelity offers a key feature that could go a long way in assuaging the jitters of crypto owners: “Their security solutions are stronger than intelligence agency grade.” That’s needed because unlike shares of stock, cryptos are a “very easy thing to steal. It’s a very easy thing to launder, so security is really important,” Paul said.
“The exchanges are quite amateurish, even the big [ones].” –Ari Paul
Several “meaningful” crypto investment funds also have hit the market, Paul said. These are not the reported 100 or 200 funds managing about $5 million of assets and “run out of a 25-year-old’s apartment,” he said. (Their assets got to $5 million because of the stratospheric rise in crypto prices in 2017.) The new crop of crypto funds is heftier: There are about 30 of them in the U.S. with median assets under management of $25 million. Two venture capital funds focused on cryptos also have emerged — spinouts from tech VCs Andreessen Horowitz and Sequoia Capital.
Pensions, endowments and family offices of high-net worth clans are looking at investing in crypto assets as well, Paul said. With more trusted money managers handling crypto investments, institutional investors have been gingerly testing the waters. “They did it indirectly via very, very trusted brands. They’re not investing in cryptos, they’re investing [with] Andreesen Horowitz,” he said. “They’re trusting the brand reputation and the people at the fund whom they’ve had a relationship with.”
Other advances in cryptos are happening, too. Several folks are trying to build a “Bloomberg for cryptos” but they haven’t succeeded yet, Paul said. There’s innovation going on at the protocol layer of bitcoin and Ethereum, a blockchain platform. Others are looking into offering “innovation as a service,” he said. It could enable companies, for example, to create a separate internet for crypto miners to communicate block solutions to each other, which improves profitability at the margins, Paul added.
Among crypto exchanges, though, more expertise and maturity are needed. “The exchanges are quite amateurish, even the big [ones],” Paul said. For example, even though Coinbase is a market leader, it doesn’t provide after-tax reporting on transactions. The level of expertise in the industry, however, is about to change. The former chairman of the New York Stock Exchange and other Wall Street veterans are launching crypto exchanges and “bringing their technical expertise, operational efficiency and regulatory compliance” experience, he said.
Paul cited the case of Mt. Gox, a bitcoin exchange that folded in 2013 after a massive heist, as a failure exacerbated by a lack of business expertise. “It was run by a guy in his mid-20s back then, a team that was totally out of their element,” he said. It “didn’t have anyone who knew how to run a business.” That skills gap became a big problem after “massive consumer interest” quickly ballooned Mt. Gox into a billion-dollar bitcoin exchange that needed high security. But the team was not equipped to handle such a fast-growing business, he said.
Cryptos Gaining Legitimacy?
When bitcoin first emerged, people would say, “I can’t believe we’re involved in bitcoin. I thought that crap is illegal,” said Ron Quaranta, founder of Wall Street Blockchain Alliance, on the panel on investing in cryptocurrencies. People also dismissed bitcoin after lumping it together with other financial bubbles, added Bart Smith, head of Susquehanna’s digital asset group. Bitcoin’s 2017 trajectory did seem loopy: It jumped 2,400% from its intraday low to a peak of nearly $20,000 in 12 months. However, Smith said, “if you think bitcoin had a 1 in 20 chance of replacing gold globally, then buying $20,000 in bitcoin didn’t seem so stupid.”
Besides, Smith pointed out, central banks today continue to make the same mistakes that led to the 2008 financial crisis. While people refer to cryptos as anonymous digital currencies used by outlaws or terrorists, they forget that established financial institutions have caused much economic harm, added Jonathan Boos, institutional sales and distribution director at SharesPost, a marketplace for tokens and shares of private companies. “You look at the amount of fines banks have paid, it’s staggering.”
“I don’t know of major banks that are not looking at crypto assets in some shape or form. The worst thing … is to be left behind.” –Ron Quaranta
Today, crypto assets are gaining legitimacy. “The exciting thing is that the tourists have left,” noted Albert Wenger, managing partner at VC firm Union Square Ventures. “The people who are in for the long haul are the ones sticking around.” As the get-rich-quick crowd has dwindled, the true believers in decentralization are busy building long-lasting infrastructure and applications for cryptos and the blockchain.
Wenger said what’s particularly exciting about the blockchain is that for the first time, parties can reach consensus on transactions without a central authority — for example, everyone can see and agree that Jane transferred $100 from her account to Joe’s, instead of a bank validating the activity. “That’s sort of a fundamentally new capability,” he said.
Meanwhile, financial institutions seem to have reached an inflection point in the wider adoption of crypto assets, said Quaranta, whose organization works with financial institutions. Most big banks have innovation teams looking at the blockchain, he said, adding that “I don’t know of major banks that are not looking at crypto assets in some shape or form.” They’re not blind to the existential threat posed by the blockchain and AI. “The worst thing [for incumbents] … is to be left behind,” he added.
One area of interest is the “tokenization” of assets. “We’re doing a deal now where we’re selling real estate as a token,” said Adam Cole Jacobs, co-founder of Bitsdaq, a crypto exchange, in a panel on China, cryptocurrencies and the blockchain. For example, one property can have anywhere from 100 to 1,000 owners, each of whom buys a fragment of the real estate. “So if the property values go up, you can sell your token” and make a profit, he said.
But Smith said some investors have pointed out that tokenization of assets don’t necessarily have to be on the blockchain, which has no central authority or regulator. “In the U.S., there are IP (intellectual property) laws that exceed [those] around the world. The protection the SEC provides is invaluable to investors,” he said. Moreover, the asset has a “liquidity stream that’s monthly. It’s not daily and you don’t need to put it on the blockchain.”
Despite its issues, the blockchain is seeing greater adoption. “We’ve seen a lot more projects go into production,” said Karen Ottoni, director of ecosystem at Hyperledger, a group working to advance open-source blockchain technologies across industries. She said early doubts about whether blockchain can handle live transactions are being disproven. “We’re seeing live health care transactions taking place, [as well as in] trade finance, supply chain,” she said on a panel, talking about the network and ecosystem. “We’ll see more of that this year.”
Autonocrats vs. Anthropocrats
While companies and investors are figuring out how to profit from cryptos and blockchain, there is a more fundamental battle taking place within the community. It is a philosophical fight between the “autonocrats” and “anthropocrats,” said Lane Rettig, a core developer at the Ethereum Foundation, the nonprofit behind the Ethereum blockchain platform and the ether crypto. “Autonocrats are people who put maximal trust in autonomous systems,” he said during a keynote speech. “Anthropocrats … are people who don’t really trust autonomous systems. They want humans to be in charge and humans to have a layer of judgement.”
At its most fundamental, the decentralized nature of cryptos and blockchain could ostensibly create a new kind of society because it has the potential to throw off the yoke of any central authority, whether it is a government, central bank, company or another entity. Indeed, Rettig sees Ethereum, as well as other blockchain platforms, as “an operating system for building better human institutions.” The engineers who are developing this technology can set the rules for this digital society. Hence the debate: Should they develop a decentralized, purely tech-run system, or should they make room for social, legal and ethical aspects as well?
Autonocrats have this “platonic dream of the blockchain to be this neutral thing that has no social layer on top of it. It’s just code,” Rettig said. So, the only reason to make changes to the blockchain protocol is if they’re technically required for the network to function. Autonocrats don’t want to add a “social” layer such as a court system because once it’s added to the blockchain, “you begin reducing the benefits,” he said. That means a transaction can be voided if it violates some “social norm or law,” Rettig added. “At that point, what’s the difference if you use the bank or use PayPal where you already have those issues?”
But anthropocrats argue that “without recognizing that blockchains are inherently social and … political things, and without engaging with real social systems in the real world, their appeal is going to be very limited,” Rettig said. They want blockchain to not only make sense for businesses and people to use, but also to dovetail “into existing legal and social systems.” The view is that if blockchain is “not able to engage with society, with the world, with existing legal systems, then they will just be ruled illegal in many jurisdictions,” he said.
“If we don’t figure out governance of blockchain, then our hands are tied and we can’t build things on it because … those institutions of the future really require a very stable base offline.”— Lane Rettig
Rettig is leaning toward the anthropocrat camp. “The problem is, increasingly, the questions that we face in Ethereum are less technical and more and more social,” he said. To build better human institutions, he said the new system must have good governance to root out such evils as corruption and collusion, which would be tough to accomplish merely using technology. “If we don’t figure out governance of blockchain, then our hands are tied and we can’t build things on it because … those institutions of the future really require a very stable base offline,” Rettig said.
In a way, Rettig and his peers are facing the same dilemma as the Founding Fathers when they labored over the wording of the U.S. Constitution to serve as a framework for a young America. Rettig admits that he didn’t think about these fundamental beliefs until he was “trying to design better systems and got to this stage of ‘first principles.’” At Ethereum, the folks debating these principles are the core developers, or “coredevs.” They are the ones making decisions for the protocol, according to Rettig.
These folks are “very technically brilliant” but “are not prepared to answer these social questions today” about philosophy, ethics and the social contract, Rettig said. “We don’t necessarily have training in this field. We don’t have confidence that we can make the right decisions, and core developers are very afraid of legal liability as well if they step in and start making these decisions.” Without the social layer, he said, “we can’t have nice, important things like sustainable funding for the public good.”
So, Rettig is developing a solution that combines both views: “We have to find a happy medium here.” He is taking a “marbled approach” — adopting “strong, centralized leadership” in some areas that protect core beliefs and applying decentralization when it comes to allocating resources fairly. “We need to be very clear with ourselves and each other about things like our goals and our values and our vision for what blockchain can be,” Rettig explained. “A goal is to build these fairer, more open, transparent and just systems that work for humans everywhere.”
