Opinions and analyses

14 January 2018

A Framework for Blockchain Investing

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There are several primers out there on blockchain and cryptocurrencies — often used interchangeably, incorrectly — so I will not try to put forth another one here. Further, this post is not intended to be a guide to investing in cryptocurrencies (like Bitcoin), or the mechanics of investing in tokens/ICO, or a framework for professional investors to map tokens against existing equity investing paradigms.

My roots in the crypto community go way back to a significant stint at RSA Security where I had the privilege of working with leading researchers like Ari Juels and Markus Jakobsson who contributed significantly to the development of hashing based “proof of work” long before blockchain and cryptocurrencies took off. And yet, I missed the early rise of blockchain technology in the form of cryptocurrencies and fat protocols — primarily because I was focused on investing in emerging markets post 2008, but equally because I did not fully realize the impact trustless decentralized computing could have. But now I am a believer in blockchain technology (not the same as cryptocurrencies) and as we approach the end of 2017 — was this the real year of the blockchain?- I wanted to share my thoughts on how any tech investor could be thinking about this paradigm shift in technology.

An emerging technology stack

We often look for a framework for thematic investing when we have a complex set of rapidly evolving technologies that could collectively redefine almost every industry. I assume some familiarity with the technology as I put forth one here, but there are other good ones which may serve you well.

At its core, I see three layers of opportunity for value creation and capture and, for some amusement, I will try to shoehorn clichéd analogs from the original California Gold Rush relevant to this new gold rush into each one of them.

  • Infrastructure : hardware, software, and services to enable the operationof protocols and applications being built (picks-and-shovels)
  • Protocols: the software that allows distributed nodes in a blockchain to talk to each other and exchange information/data about each application, securely (mine-operations)
  • Applications: utility software that allows the exchange of value/services/information between real world actors (people and institutions) leveraging trustless, fat protocols underlying it (gold

There is a fourth layer

Investing in blockchain related companies on a portfolio basis via Application Tokens or in Protocol Tokens is best handled by sophisticated investors (high net worth individuals, VC funds, family offices, hedge-funds, etc.) delving into this emerging and highly risky asset class. My friends at Pillar VC have put out some good analysis of why token investing can make sense to such investors and how. This fourth layer does not directly relate to the tech stack and is out of the scope of this write up.

A framework is not a formula

Each of us will have to figure out what part of the stack we are most comfortable investing in, and when. And we all have to do the work we usually do (find the opportunities, apply the usual rigor), but then we also have to map them against a fast evolving frame-of-reference.

  • Infrastructure plays of the legacy kind (Google, Microsoft, etc) are not pure-plays and are pretty rich in valuations already. And Infrastructure Startups need teams that excel at both IT infrastructure and Blockchain infrastructure and those are hard to find. But if you do, there are some real gems there.
  • Applications (dapps) are of low quality as a cursory scan of Token Report will indicate; this is a low signal-to-noise-ratio sector and it requires both rigor and reach to find quality. And even when you do find them, the good dapps are sitting on the shifting sands of evolving protocols and infrastructure below them. To complicate matters, regulators for each domain (e.g. FINRA and the SEC for financial services) are projecting uncertain regulatory regimesoverhead.
  • Protocols are where most of the evolutionary action is and personally I would be looking for the best teams that can solve the hardest problems in blockchain: making scalable, secure, easy to use, protocols that can deliver on the promise of decentralized trustless computing.

However, like everything else in the blockchain sector, things are not always clear cut. Many dapps are rolling out their own protocols (or “forks” of more established protocols) and protocols have developed coupled dapps. One exciting protocol example is IPFS and the associated storage application FileCoin.

I hope we all march forth and prosper, but please do share your thoughts and comments with me — whatever I know, I learned from you!

(Caveat: this is supposed to be informational and not investment advice.)

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